If you’re looking for some flexibility in your retirement finances, there’s often room to withdraw more than the classic 4% rule. That’s a primary takeaway from our latest survey on safe withdrawal rates. Together with my colleagues, we examined various methods retirees might adopt for managing their withdrawals from their portfolios, testing a total of nine different strategies. All of these allowed for higher withdrawal rates than the traditional 4% rule, initially proposed by Bill Bengen. I’ve also written before about ways to optimize funds for both spending and inheritance.
The best strategy to increase your starting withdrawal rate
For many retirees, boosting retirement spending becomes essential. After years of hard work, this phase is a chance to truly enjoy the rewards of those efforts. Starting off with more generous withdrawal rates can really enhance your early retirement experience. It’s likely retirees will feel healthier and more active, ready to embrace opportunities like travel, dining, concerts, and other adventures.
To determine safe withdrawal initiation rates, we analyzed 1,000 hypothetical return scenarios over a 30-year span, considering forecasts for returns and volatility. From this, we pinpointed the best starting withdrawal rate that maintained a positive balance in at least 90% of our trials. We specifically looked at a portfolio composition of 40% stocks and 60% bonds to ensure fair comparisons among the different methods we evaluated.
As illustrated in our findings, five strategies stood out brilliantly due to their robust starting safe withdrawal rates.
Fixed percentage: Starting safe withdrawal rate is 5.7%
This straightforward approach applies a static withdrawal percentage to the portfolio each year. While the percentage remains constant, the actual withdrawal amount fluctuates based on your annual portfolio balance. To keep substantial cuts from happening, there’s a floor in place so that annual withdrawals can’t dip below 90% of the original amount.
Retirees using this method won’t run the risk of exhausting their portfolio since the withdrawal is always a set percentage of the current balance. It adjusts naturally; if the portfolio’s value drops, the dollar amount withdrawn decreases, and vice versa. However, it doesn’t account for inflation adjustments. So, if living costs rise, increases in withdrawals rely solely on the portfolio’s performance.
For instance, in her first retirement year, Alice might withdraw 5.7% from her $1 million portfolio, totaling $57,000. After factoring in market changes, her portfolio drops to $980,720. In the second year, her withdrawal based on this amount would be $55,901.
Donations: Safe withdrawal initiation rate 5.7%
This method draws inspiration from how universities manage their endowments, smoothing out spending fluctuations by focusing on long-term portfolio averages.
In our tests, we calculated withdrawals based on a 10-year average portfolio value, as suggested by investment expert Charlie Ellis. Initially, we would use the previous year’s ending balance. Every subsequent year, we incorporate an additional year of portfolio data to find the average over the past decade, which then guides withdrawal decisions. Proper safeguards were also in place to maintain a minimum withdrawal of 90% of the original amount.
For example, Bob follows the same withdrawal starting as Alice and ends the first retirement year with a portfolio value of $980,720. His second-year amount calculates similarly to Alice’s at $55,901, but by the end of the next year, after a further slight drop, his new average portfolio value leads to a slightly reduced third-year withdrawal of $55,626.
Guardrail: Starting safe withdrawal rate is 5.2%
Developed by financial planner Jonathan Guyton and tech expert William Klinger, this method kicks off with an initial withdrawal rate while adjusting future withdrawals based on how the portfolio performs. If the market is thriving and the new rate remains below 20% of the initial withdrawal, it can increase to accommodate inflation.
Just like the previous methods, the guardrail strategy allows for a higher starting withdrawal because it systematically modifies amounts to avoid overshooting when the market dips, while permitting more spending during good times.
Consider Claire, who withdraws 5.2% initially. After her portfolio grows, the adjusted amount reflects this success and inflation, leading to a slight increase for the next year that remains proportionate to the portfolio’s value.
Probability-based guardrails: Starting safe withdrawal rate is 5.1%
This strategy includes ongoing assessments and adjustments, allowing for higher safe withdrawal rates. By regularly analyzing success probabilities, retirees can afford to spend more than they typically would with a static plan.
In our testing, we recalculated this probability annually. If success rates dipped below certain thresholds, proposed spending would decrease, and conversely, if conditions improved, spending could rise. To prevent excessive withdrawals during favorable markets, we capped annual spending at 120% of initial amounts adjusted for inflation.
For Diego’s first year, he withdraws 5.1%, and as the market performs well, he can increase his annual withdrawal slightly in response to a favorable probability shift.
Vanguard Floors and Ceilings: Starting safe withdrawal rate is 5.1%
Similar to the guardrail method, this technique sets an initial withdrawal rate but remains vigilant about inflation-adjusted spending to prevent overextending during downturns or under-spending in strong markets.
This method enables adjustments to find the right balance without being overly aggressive or especially conservative, which in turn permits higher starting rates.
Let’s say Elaine starts with a 5.1% withdrawal and faces a specific inflation rate; her following year’s total undergoes careful adjustments based on preset limits either way, ensuring she maintains a sustainable withdrawal strategy.
Other benefits of these five methods
The flexibility inherent in all five methods also translates to larger lifetime withdrawals, meaning retirees can access more funds across three decades, assuming a starting balance of $1 million. This benefit is particularly pronounced in the guardrail and probability-based guardrail methods, yielding total lifetime withdrawals of $1.36 million and $1.55 million, respectively.
Disadvantages of spending methods that maximize safe withdrawal initiation rates
Of course, there are trade-offs. Maximizing safe withdrawal rates often means extracting funds more rapidly, which could leave a diminished balance at the end of 30 years. For example, the probability-based guardrail method ended with a median portfolio balance of just $230,000, whereas the guardrail approach yielded around $700,000. This might not resonate well with retirees intending to leave substantial legacies.
Moreover, fluctuations in these strategies can be challenging for those who prefer stable cash flow to meet their needs. Particularly, the endowment and percentage methods could produce noticeable volatility in annual spending, which might not be ideal for everyone.
