“Safe” Withdrawal Rules

One of the great challenges facing those moving headlong toward their Golden Years is determining just how much they should withdraw from their retirement plan(s). From the vantage point of financial advisors, one of the difficulties in all of this is reconciling clients’ expectations with the realities of their portfolio sizes, as well as with ever-changing economic conditions. Many investors simply have too large a sum in mind when determining how much to withdraw on an annual basis. For example, let’s say one has accumulated $500,000 in his retirement plan. $500,000 sounds like a lot of money, and it is, in a singular respect – if someone handed you a check for $500,000 today, you’d surely say, “Wow, that’s a lot of money.” However, if you’re someone who decides to permanently stash his work shoes at age 65, is it still a lot of money…particularly if you’re in relatively good health and may have at least another two decades of living in front of you?

It’s not uncommon for clients in that position to think that taking out $50,000 per year from an account valued at $500,000 seems perfectly reasonable, but a closer look at the reality of that idea suggests otherwise. $50,000 is 10 percent of the account’s value, which means the markets (stocks, real estate, etc.) in which the money is invested would have to, at a minimum, continue moving upward at an average rate of 10 percent per year over the remaining years in the investor’s life in order for the $50,000-a-year withdrawals to remain unreflective of principal.

So what’s a good number? Ideally, somewhere in the range of 3 to 4 percent per year. This means that the guy with $500,000 set aside will take between $15,000 and $20,000 a year out of his account. For someone hoping for an amount more like $50,000, it can be a disappointment, but the lower figure is realistic, and one that will go a long way toward ensuring that the money never runs out during his lifetime. Even smarter than relying on a static percentage figure that does not change, is to adjust that figure no less than annually, based on the overall performance of the portfolio, as well as the level of inflation. While 3 to 4 percent may seem low to many, it is a figure that currently represents the best combination of a withdrawal rate that is as high as it can realistically be…while (likely) leaving behind at least another one to three percent each year for further compounding.

Some wonder why it is so important that withdrawn amounts remain free of principal. It’s a fair question – after all, if I’m age 80, is it really the case that I have so many years left that I need to limit my withdrawals to nothing more than interest? Here’s the problem that plagues investors and advisors alike: Even at that age, you simply do not know what lies around the corner. Maybe in between that point, and your ultimate demise, you need to pay for substantial care-related expenses; perhaps you will have to move into an expensive assisted-living facility. While it’s reasonable to assume that you will not eventually become the oldest living person on the planet, the heightened, age-related expenses you may well incur as you continue to advance in years could, at some point, become significant.

In the end, none of this is an exact science, but that does not mean it has to be entirely a guessing game, either, or that you should dangerously allow your expectations to be rooted in what you want, as opposed to what is sound. It’s never a bad idea to consult a financial advisor on this topic, and if you want to bend the ear of a fee-only planner in your area, look one up at http://www.napfa.org, which is the official website of the National Association of Personal Financial Advisors. It may cost you a few hundred bucks to enjoy some objective, professional advice on your personal situation, but that’s a small price to pay when you consider the potential cost of making a mistake in what is such an important area of financial planning.

The information contained here is for general information purposes only. The Financial Writer blog and Bob Yetman disclaim responsibility for any liability or loss incurred as a consequence of the use or application, either directly or indirectly, of any information presented herein. Nothing contained in this article, or any other article featured at this blog, should be construed as a solicitation or recommendation to engage in any financial transaction. You should seek the advice of a qualified professional before making any changes to your personal financial profile.

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