Retirees can determine how much money they can withdraw from their accounts each year without depleting their nest egg prematurely by using the safe withdrawal rate (SWR) method. This approach attempts to balance your expected income needs to live comfortably without the risk of running out of money by withdrawing too much too soon. While it is based broadly on your portfolio’s value at the start of retirement, you must also consider the total amount of your savings and other intended retirement income, including the progressing growth of your investment accounts, as well as your expected expenses each year.
How to Calculate a Safe Withdrawal Rate
The safe withdrawal rate helps retirees figure out a minimum amount to withdraw in retirement to cover basic needs, including housing, electricity, food, and transportation. In 1994 financial planner Bill Bengen came up with the 4% annual withdrawal rate, and this has been used ever since as the rule of thumb when determining the safe withdrawal rate. (In 2018 Bengen amended this amount to 4.5% to account for inflation.) According to the 4% rule, retirees withdraw no more than 4% of their starting balance each year. While this approach isn’t foolproof against depletion, it protects portfolios against market downturns by limiting withdrawal amounts. These limitations give retirees a much better chance of their portfolio enduring the length of their retirement.
To get started you would withdraw 4% in the first year of retirement, then increase that amount by the amount of inflation in following years.
If your nest egg is $200,000:
- Year 1: 4% of $200,000 = $8,000
- Year 2: providing for a 3% inflation rate, you would withdraw $8,240
- Year 3: providing for a 2% inflation rate, you would withdraw $8,404
Of course, you can always make adjustments to these numbers based on stock market performance and the value of your portfolio year to year — increasing the withdrawal rate if your nest egg is growing and decreasing the withdrawal rate if your portfolio value is dropping.
A Shortcoming of the SWR Method
A weak point of the SWR method is that it doesn’t account for economic volatility, asset allocation, and investment returns. Essentially, it’s a blanket method that doesn’t always apply to individual circumstances. A trusted investment advisor can help retirees determine the appropriate safe withdrawal rate based on their unique portfolio.
In Favor of the SWR Method
On the flip side, the safe withdrawal rate method is easy to understand, provides a predictable and steady income, and offers a clear path for retirees to better control their expenses.
While the 4% rule has traditionally protected retirees from running out of money, there are alternative methods that might be a better fit for you. A financial advisor can help determine how much you need to save and how much you can comfortably spend each year to avoid depleting your nest egg too soon.
