Those who are retiring in the next year are likely painfully aware that our current environment has prolonged low-interest rates, high unemployment, and a possibility of higher taxes. All of these elements could affect stock market earnings and economic growth. Knowing that, how do you determine a safe withdrawal rate for retirement assets that won’t result in you outliving your money?
In financial research, you’ll often see a recommended withdrawal rate of 4.5% of your portfolio annually. What you need to understand is that 4.5% is a historic average—much like we say the long-term growth for the stock market is 10.5%—it may not be the same percentage every year. When it comes to how much you can withdraw each year, you have many ways to calculate this number, such as online calculators that use variables you input for life expectancy and inflation. You can also calculate a rate using the historic cyclically adjusted price-to-earnings ratio for the S&P 500 index. Regardless of the method, there are still unknown variables, including how long your retirement will last and what your needs may be. You just have to answer the best you can and then review and adjust year-to-year like you did when creating a household budget.
At Henssler Financial, we calculate withdrawals based on your liquidity needs, not your age or some other market factor. We first create a customized financial plan accounting for your sources of income like Social Security, pensions, inheritances, rents, royalties, etc. Then we compare the income to your annual spending to determine if your current habits are sustainable over your life expectancy, using a 4.6% inflation rate. If you are still working, we may recommend you save more for retirement. Once you are retired, any shortfall is the money you need from your investment accounts to pay for living expenses.
Because we adhere to the Henssler Ten Year Rule, we plan for 10 years into the future, so in 2020, we are focusing on your spending needs through 2030. That money is then invested in fixed-income securities that mature the year you need the money. This largely protects the money you plan to withdraw from the fluctuations of the market. If the market is down, we can wait until your assets recover before having to sell to fill up your fixed-income portfolio. Furthermore, with a 10-year lead time, you have the time to adjust your spending.
Everyone’s situation is different. Some years you’ll see higher inflation or increased medical costs that could increase your withdrawals, while other years, you may see stellar growth and be able to withdraw less principal. Perhaps you’ve caught on already, but your overall financial plan—including how much you’re withdrawing—needs to be revisited at minimum every two years. Whenever there are life changes, including birth, death, divorce, marriage, or a change in employment or long-term health, your plan should be revisited and adjusted if needed.
Dr. Gene has often joked, “The last check you write before you die should bounce!” However, most investors and advisers generally prefer to err on the side of withdrawing too little money, having some left to your heirs.
If you have questions regarding planning for your retirement withdrawals, the experts at Henssler Financial will be glad to help: