What Is A Good Withdrawal Rate For Retirement Savings?

I've come across several articles recently, and web site calculators (ugh, more calculators that mislead you, and don't work!), that offer guidance on an appropriate withdrawal rate for retirement savings. To keep this simple, let's only consider savings currently in a 401K plan, or traditional IRA. The basic question is, "How much should you withdraw from these savings, annually, during retirement so that you won't run out of money?".

Let's consider two main scenarios:

1) If you know that you have more than enough money to sustain you (lucky you, but you better be sure!), then the real question is, how much money would you like to leave to your heirs? Always consider taxes on withdrawals, and required minimum distributions starting at age 70, but after that, you have a choice. Either withdraw only what you need, or withdraw an amount that will be likely to leave you with a predefined amount (or as much as possible) at age 90 (a conservative life expectancy). The commonly referred to "4% rule", suggests withdrawing no more than 4% annually (adjusted annually for inflation), in order to make your money last for a minimum of 30 years. If that pays your bills and gives you some spending money, great.

2) More common, is the scenario where you need to be more careful about not overspending, because you will need all the money you have to pay your expenses through age 90 (same life expectancy as above). In this case, you will be withdrawing exactly what you really need, and no more. The discussion about what % to withdraw is moot. You are withdrawing because you have to, not because it's a choice.

One web site calculator designed to help you figure out a responsible withdrawal %, asked, "What withdrawal rate would you be most comfortable with?".  Aaaagh! What difference does that make if it won't pay your bills?  Whatever rate you entered, it then did some calculations and told you if it thought your money would last long enough. To get it to say, "Yes", you had to use trial and error until it worked. So then why did it bother asking you what you wanted? Helpful, isn't it? By the way, this calculator also used an inflation rate of 4% (historical average for the past 21 years is 2.17%), and assumed that Social Security payments would increase at the same rate as inflation. Social Security increasing at 4% annually? Really? I'd like to live in that world! Yet another example of why free calculators don't work.

The real point is that a specific withdrawal rate doesn't matter, and shouldn't be a goal. The real goal is, can you pay your expenses, including some "fun" money, and have your savings last the rest of your life? Here's an example of why a specific, and even large, withdrawal rate doesn't necessarily matter:

A couple retires at age 62 (they are both the same age), with $1M in savings, but has no income (they will wait to receive Social Security until they are 67). Assume they will earn 5% on their money until age 70, and then 3% thereafter (a reasonable approach). Inflation is assumed to be 2.25%. Their total Social Security income will be $25,000/year. For the first 5 years they will rely entirely on retirement savings to pay expenses ($50,000/year). Their withdrawal rate will be ~ 6% - 7% for each of those 5 years (enough to account for taxes on the withdrawals). At 67, the withdrawal rate will fall to ~ 4.0%, since Social Security income will begin. From then on, the withdrawal rate will increase slowly, year by year, because their expenses will increase with inflation, but their savings will decrease (Social Security isn't enough to pay their expenses, and they're withdrawing more than the 3% they're making) requiring them to withdraw a larger percentage of the total each year. At age 80, they will withdraw ~8.7% of their savings, and at age 85, they will need to withdraw ~15.0% of savings. Will their money last until they reach age 90 (a reasonable life expectancy). Yes! Barely, but yes.

The moral: your exact withdrawal rate doesn't matter, as long as you can afford to live your life. Use a reputable financial planning tool to figure that out, and don't worry about all the "rule of thumb" advice from articles and free calculators. You're smarter than that.

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