Finding a safe withdrawal rate is an important step in retiring, but it is also an incredibly complex task. If you were to take money out of a retirement account at any rate, it would likely be too high or too low, depending on the asset class and the time frame selected. There are a number of factors that go into calculating a withdrawal rate: the target rate of return, the withdrawal time frame, as well as the risk tolerance and other personal factors. With all of these variables, it’s easy to see that it is impossible to determine an exact withdrawal rate, even if you could choose a rate that would be safe in the long run.
Withdrawal rates are a hot button topic among financial experts, and the topic is incredibly complicated. In this blog post, we are going to try to explain what a safe withdrawal rate is and how to determine one. Safe withdrawal rates are a great starting point for a safe withdrawal rate calculator.
It’s a common mistake for investors to take withdrawals from their retirement accounts at the wrong rate. For example, if you withdraw 1% from your $100,000 retirement account per month for 25 years, you will have to invest $252,000 to replace the $100,000 that you will lose. This is called the safe withdrawal rate and is simply a guideline for your retirement account.
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The Safe Withdrawal Rate (SWR) is an important part of retirement planning when you plan your retirement based on your investment portfolio. We’ve already talked at length about this type of retirement, which is the essence of the FIRE (Financial Independence and Early Retirement) movement.
But we haven’t gone into detail about how to choose a safe withdrawal rate for your situation. No TRS is suitable for all situations. And while there are some rules, you have to decide for yourself.
So by the end of this step-by-step guide, you should know how to choose a safe withdrawal rate.
A safe withdrawal rate is a withdrawal rate that is safe enough for a successful retirement. And a successful retirement means you won’t run out of money before the end of the retirement period you’ve chosen.
The withdrawal rate determines how much you spend each year as a percentage of your portfolio. So if you retire with 1,000,000 Swiss francs and the withdrawal rate is 4%, you can spend 40,000 Swiss francs a year. And every year you adjust this figure for inflation. It is important to note that the withdrawal rate is correlated to your original portfolio, not your current portfolio.
So with a higher withdrawal rate, you can spend more money each year with the same starting portfolio. But spending more increases the risk of running out of money. Therefore, a high absorption rate is more risky than a low absorption rate.
If you need more information and examples, I have done many simulations of withdrawal bets.
In this article, I explain my six-step method for choosing a safe withdrawal rate, but it’s not the only one. But I think this will work for most people.
I think the first step in determining a safe withdrawal rate is to decide when you want to retire. Of course, this does not mean that you will retire at that point. You may retire earlier or later than you had planned. But if you have a goal, you can plan from now until you reach your goal.
For example, I want to be financially independent at 50. So I have to chart my path from now until I’m 50. For the most part, I’m currently on track to achieve this goal. But that may change in the future.
Now that you have a starting point, you need an ending point. You should have a higher estimate of how long your retirement will last. There are several ways to solve this problem.
A simple way is to assume that you will live to be 120 years old. I use 120 because the oldest person checked was 122 when she died. If you plan to retire at 40, you should hold your portfolio for 80 years. These 80 years are your financing period.
The problem with this technique, however, is that you probably won’t live to be that old. For example, if you plan to enjoy 80 years of retirement and you only live half that time, you have worked too many years to fund your retirement plan. If you are too conservative, it will be harder to reach your goal.
Therefore, it is best to rely on statistics. Every developed country publishes statistics on life expectancy. For example, in 2019, the life expectancy at birth for a male child is 81.9 years. So I should expect to turn 82? Not really. There are three important aspects.
First, life expectancy at birth is not the most important statistic. What is relevant is the life expectancy at your age. For example, life expectancy at age 30 in Switzerland is 52.6 years, for a total of 82.6 years. And at age 50, 33.3, for a total of 83.3 years. Therefore, it is very important to do an age-appropriate assessment.
The second, if you plan your life expectancy accurately, what happens if you live longer? Your plan might fail. So while you shouldn’t plan to live less than your life expectancy, you should build in a margin of safety to live longer than that.
Third: Lifetime depends on your current state of health. Someone who drinks or smokes a lot, for example, has a much shorter life expectancy. On the other hand, a non-smoker who engages in frequent physical activity has a significantly longer life expectancy. So that’s something else to consider.
For example, my life expectancy at my current age is about 83 years. So I’m going to plan my funding period until I’m 90 years old. For me, seven years is a sufficient safety margin. So I need to plan for at least 40 years of funding.
If your plan involves more than one person (for example, you and your partner), you obviously need to take this into account. For example, my wife is younger than me and women live longer than men, so I have to add 5 years to my estimate.
In order to estimate the success rate of the safe withdrawal rate, we need to know the asset allocation of the portfolio. In fact, a safe withdrawal rate will produce different results if you have a portfolio of 100% stocks or 40% bonds and 60% stocks.
Now comes the hard part. Assetallocation plays a role in the safety of your retirement savings. So it affects the success and duration of your retirement scenario in the worst case scenario. Indeed, there is a strong correlation between asset allocation and safe withdrawal rates.
If you have already made a decision about your asset allocation, proceed to the next step. If not, read on.
We’re talking about asset allocation in retirement, not asset allocation in your current savings portfolio. For example, I plan to stay 100% invested in stocks until retirement, and then I can shift 20% to bonds during retirement. So to choose a safe withdrawal rate, I need to consider an asset allocation of 20% bonds.
Bonds reduce your risk of early failure. In other words. You increase the worst duration of your portfolio. The worst duration is the earliest point at which the portfolio can fail at retirement. So you want it to be as high as possible.
On the other hand, if you have a large number of bonds in your portfolio, you are less likely to retire successfully. In fact, bond yields have historically been too low to support retirement. You can see it in action in this chart of the updated results of my Trinity survey.
Pension outcomes with different portfolios and withdrawal rates
Here are some examples with different safe withdrawal rates and different asset allocations (using my FIRE calculator):
- 4% 40-year withdrawal
- 100% equity: 93.67% success rate, can fail in 174 months
- 80% equity: 90.20% success rate, can fail in 270 months
- 60% equity: 86.03% success rate, can fail in 302 months.
- 3.5% Take-up rate from age 60 onwards
- 100% equity: 98.58% success rate, can fail after 222 months
- 80% equity: 98.58% success rate, can fail in 402 months
- 60% share : 95.17% success rate, possible failure in 437 months
If you want to be aggressive, 100% equity is the distribution most likely to succeed. However, it may fail first. Adding a 20% bond is usually a good bet, as it doesn’t hurt the probability of success too much and significantly improves worst case duration.
If you need more information, I have a guide on wealth distribution.
You now have all the information you need to choose a safe withdrawal rate:
- Your financing period
- Your asset allocation
With this information, you can use my FIRE calculator to get information on success rates and worst case scenarios for different withdrawal rates. For example, I entered my own situation (40 years old and 80% equity) to get the following information:
|Withdrawal percentage||Success rate||Worst duration|
Based on this information, I would use a 3.75% withdrawal rate. Some people prefer 3.5% if they are more conservative. And some people will even settle for 4% if they are aggressive enough. For me, one chance in ten of running out of money is one too many, but that doesn’t apply to everyone.
Since I’m still hesitant about asset allocation, I also got the job done with 100% stocks and 40 years :
|Withdrawal percentage||Success rate||Worst duration|
If I had to pick 100% of the stock, I would also pick 3.75%. But I would be wary of picking the worst term for retirement. So I would retain some flexibility to lower it to 3.5% if needed.
This step is optional, but for some people it can be helpful to have some certainty in their choice. There are several reasons for introducing additional security.
First, you may live much longer than expected. That’s certainly not a bad thing. But if you have planned for 40 and turn 60, your plan may fail.
Second, we must remember that all these data are based on historical results. These simulations have been going on for 150 years. And I’m sure they will continue to work in the future. But maybe they will do a little less well?
Third, your rates may change. If you haven’t factored in your expenses and they increase after you retire, your effective withdrawal rate may be higher than you thought.
So it’s not necessarily a bad decision to build a small safety margin into your retirement savings. There are several ways to add a safety margin:
- Reduce the withdrawal rate at the end
- Plan for more retirement years
- Increased likelihood of success in achieving goals and lower life expectancy.
Of course, the safety margin must not be abused. In the end, most early retirees will have much more money left over than they had at the beginning of their careers. So if you reduce your withdrawal rate from 3.5% to 2.5%, you’ll have a lot more money to save and will likely have a lot of money left over at the end of retirement.
If you’re retiring soon, you can hit the road with peace of mind. But if you are retiring in a few years or decades, you will need to adjust your retirement plan and safe withdrawal rate every year or so.
I recommend briefly reviewing the first five steps every year to make sure your plan is still appropriate for your current situation. It’s also a good time to see how you’re doing in retirement.
If you follow these six steps, you should have an idea of how to choose a safe withdrawal rate for your situation. This is a very important decision because it will determine your path to financial independence.
You may not be retired yet, but you still have plenty of time to think about it. However, once you retire, you cannot change your withdrawal rate without changing your expenses, which is not always possible. So it’s worth taking the time to think about your withdrawal rate.
I have changed my own safe withdrawal rate several times. By writing this guide and following the six steps myself, I increased my withdrawal rate from 3.6% to 3.75%. I think I’m pretty safe at 3.75%. But I probably won’t retire for another 15 years. So I expect my safe withdrawal rate to change again in the future.
The best way to play with these numbers is to use my safe withdrawal percentage calculator.
What about you? What is your own safe withdrawal rate?
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Sir, I want to thank you for your support. Poor Swiss is the author of thepoorswiss.com. In 2017, he realized he was caught up in lifestyle inflation. He decided to reduce his expenses and increase his income. This blog tells his story and his conclusions. In 2019, he set aside more than 50% of his income. His goal is to become financially independent. Here you can send a message to Mr. Send Bad Swiss.A Safe Withdrawal Rate (SWR) is the amount of money one should withdraw from a portfolio during a certain year without experiencing significant losses. The SWR is an important factor for a risk averse investor like you. We all want to keep our money safe and avoid losing it unnecessarily, but the problem is that it requires a lot of research and practice to understand the most appropriate strategy.. Read more about safe withdrawal rate chart and let us know what you think.
Frequently Asked Questions
Is 3% a safe withdrawal rate?
If you’re new to investing or simply don’t know much about it, it’s probably a good idea to start off with a low withdrawal rate. The low end of the spectrum for this category is typically around 3%, and the argument is that low withdrawal limits keep you from cashing out your investments too frequently, without having to worry too much about running out of money. If you’re just getting started with auto-cashing, you may be overwhelmed by how to pick a safe withdrawal rate. Some suggest picking the same percentage as your debt (3%), some suggest an amount greater than that, and others a small amount less. While a safe withdrawal rate may be the most common approach, it’s important to make sure you don’t get distracted by the math and forget to look at the bigger picture.
Is 2.5 a safe withdrawal rate?
During the recent financial crisis, many super-safe investment vehicles and CD’s went belly up, while many high-yield investment vehicles and high-yield CD’s have have yielded very poor returns, beaten down by the rotten economy. The question is this: what’s the best withdrawal rate one can withdraw a dollar at? How much money should you withdraw from your retirement plan? Do you need to take a “safe” withdrawal rate, or can you just withdraw at a rate that seems comfortable to you? The answer is, it depends. If you are planning to withdraw a fixed amount of money at regular intervals over an indefinite time period, like you might for a retirement plan, then the answer is “yes”, you need to take a “safe” withdrawal rate. This is because withdrawing too much money could cause you to deplete your account. A “safe” withdrawal rate is the rate at which your account would no longer have enough money to pay all of your retirement expenses.
What is the recommended withdrawal rate?
When it comes to withdrawing money from a savings account, the withdrawal rate is arguably one of the most important factors. It can be difficult to choose a suitable rate, especially if you’re not sure on what to look for. In this blog post, we’ll explore the terminology behind the withdrawal rate, and show you how to figure out the right one for you. In the current era of ultra low interest rates, the idea of withdrawing money from a savings account at a fixed rate is still very common. There’s nothing wrong with that, since in many cases it’s the most convenient way to take your money out of the bank. (As an aside, the concept of a fixed withdrawal rate is also a little outdated, if only for the fact that fixed withdrawal rates only existed while banks were still paying interest on deposits. With interest rates at near zero, it’s now basically impossible to get a decent return from a bank account, and the concept of a fixed withdrawal rate is a thing of the past.)
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