When you’re young, you don’t really think much about withdrawal strategy. At 41 and semi-retired, I’m still focusing on accumulating. That’s why I haven’t written much about withdrawal strategies on Retire by 40. Last week, we posted an article about investing a lump sum in midlife. That got me thinking about withdrawals. It will be helpful to Julie and to us as well. Let’s go over a few standard withdrawal strategies first and then see if we can find something that will work for us.
The 4% Safe Withdrawal Rate
You probably have heard of the 4% Safe Withdrawal Rate. Basically, it’s been shown that your portfolio has an excellent chance of outliving you with this method. At the beginning of your retirement, withdraw 4% from your portfolio. Then increase the withdrawal amount to account for inflation rate annually. You should have 50-75% of your nest egg in equities to increase the chance of success.
The nice thing about this method is that the amount of money you can withdraw each year is predictable. It’s also simple so you don’t have to think too much about it. The risk is that you might retire right before a prolonged downturn in the stock market. In that case, this method will deplete your nest egg too quickly. Also, the stock market might not perform as well in the future as the past. If the stock market doesn’t grow like it has in the past 60 years, then 4% withdrawal rate might be too high.
The Constant Percentage Withdrawal
A more conservative withdrawal method is to withdraw from your portfolio at a constant percentage. I guess 4% to 5% would be pretty good here. The difference from the previous method is that your withdrawal amount will fluctuate from year to year. You’ll have less money to spend during the down years and more when the economy is good.
The big advantage here is that your portfolio should get through the bear markets without being depleted too much. The risk is the amount of withdrawal is dependent on portfolio growth. If your portfolio grows, then you’ll be able to deal with inflation. On the other hand, if your portfolio stagnates, then life will be more difficult due to inflation.
The Variable Percentage Withdrawal
Here is an interesting one from bogelheads.org – the Variable Percentage Withdrawal method. This spreadsheet figures out what percentage you can withdraw depending on your age, the projected time in retirement, and how the market performs. First you figure out your life expectancy. You can probably use your parents’ ages at death + 10% or something like that. So if you plan to retire at 65 and project 20 years in retirement, then you can start off withdrawing 7% and gradually increase the withdrawal rate as you get close to 85.
The nice thing about this method is that you won’t run out of money as long as you don’t outlive your projection. If you live longer than expected, then it’s going to be a tough few years at the end.
Here is a method for the few people who can reach financial independence before retirement age. If your cost of living is lower than your dividend and other passive income, then you’re golden. Your nest egg will stay intact and you’re guaranteed to never outlive your money. Of course, this is a difficult achievement and only a small minority of the working population will ever get there.
Early Retirement Withdrawal
Figuring out the right withdrawal rate is a big challenge for early retirees. This is because we’ll have many more years to spend in retirement. It’s also more difficult to project how long you’ll live when you’re 41. I think if you retire before 55, then you will have to be more flexible about withdrawal. You don’t want to rigidly follow one of these withdrawal strategies. You need to reevaluate your finances every year and see how much you should withdraw.
The good thing about early retirement is that you’re still young. You can work part time, become a landlord, consult, or find other ways to make extra income. You don’t have to quit working after taking an early retirement. Here is my withdrawal plan for example.
Age 40 to 55: We’re not planning to withdraw much at all. I will work part time. Mrs. RB40 will continue to work full time for a while and might cut down her hours in a few years. During this period, we don’t need to withdraw from our nest egg and we will continue to add more to it every year.
Age 55 to 65: This will be a crucial period for us. Mrs. RB40 will probably retire full time here. We’ll have to purchase our own health insurance and we’ll probably travel more. These things will increase our annual expense. Hopefully, our home will be paid for by this time and that should offset the increased cost a little bit. It’s still a long way off so it’s tough to compute right now. I’m guessing we can withdraw 5% from our portfolio every year during this period. It’s dependent on how much we have in our portfolio by then, of course.
Age 65 to 75: I think this period should be fine financially. We’ll qualify for Social Security benefits and Medicare at this point. That should help us with our expense and we should be able to decrease our withdrawal rate a little. We’ll probably cut down on traveling because it’s just not as much fun as you get older. I’m guessing 3-4% withdrawal rate during this period.
Age 75 to 85: I’m not sure here. We probably need to withdraw more of the portfolio due to the inevitable health issues that will crop up.
It’s tough to think about withdrawal rate when you’re young, but it’s still good to touch on it once in a while. It’s nice to know that the 4% withdrawal rate still holds up even with the recent financial crisis. (Updated Trinity study.) The variable withdrawal rate is pretty interesting too. Anyway, the key to early retirement withdrawal is to be flexible. If the stock market enters a prolonged downturn, then you might need to cut back a bit so you don’t have to withdraw as much during those years. Working part time is also a great option for retirees who needs a little extra income.
I’m interested to hear from full retirees to see what method you use. Please share your experience with the younger folks here.
Image credit: flickr by tpholland
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.