After years of building financial assets, the time will come when
you begin drawing on them to pay expenses during retirement. Before
that major turning point arrives, be sure to give careful thought
to how much money you will take out of your personal savings and
investment portfolio each year. The rate at which you withdraw
money from your assets is one of the most important factors
affecting how long they will last. In other words, it's not only
the amount of money you have saved, but how quickly you spend it
that will help determine whether you can still live comfortably in
your later years.
What to Consider
A number of factors will influence your choice of an appropriate
withdrawal rate. These include your age and health, the potential
impact of inflation on your assets and cost of living, and the
variability of investment returns you earn on your savings. If you
plan to leave a legacy to your heirs, you should allow for this in
determining how much to withdraw from your portfolio as well.
As you think about what your withdrawal rate should be, begin by
considering your age and health. Although you can't predict for
certain how long you will live, you can make an estimate. However,
it may not be wise to base your estimate on average life expectancy
for your age and sex. Particularly if you are healthy, you should
take into account your risk of living longer than a life expectancy
table would indicate. While average life expectancy has risen
steadily in the United States, reaching 78.2 years for a child born
in 2007, there's a 50% probability now that a healthy 65-year-old
man could live to age 85 and a 65-year-old woman in good health
could live to age 88. Moreover, there's a 25% probability of the
man living to age 92 and the woman to age 94. If they retired at
age 65, they could be withdrawing from their assets for 30 or more
Dealing With Economic Realities
Once you've estimated your likely longevity, think next about
inflation, which is the tendency for prices to increase over time.
Keep in mind that inflation not only raises the future cost of
goods and services, but also affects the value of assets set aside
to meet those costs. The real return on assets is their value after
subtracting for inflation. To account for the impact of inflation,
include an annual percentage increase for inflation in your
retirement income plan.
How much inflation should you plan for? Although the rate varies
from year to year, U.S. consumer price inflation has averaged about
4% over the past 50 years.2 Therefore, for long-term
planning purposes, you might choose to assume that inflation would
average 4% a year. However, if inflation flares up above the level
you assume after you have retired, you may need to adjust your
withdrawal rate to reflect the impact of higher inflation on both
your expenses and investment returns. Keep in mind as well that you
should periodically assess the potential of your investment
portfolio to generate income that will at least keep pace with
When considering how much your investments may return over the
course of your retirement, you might think you could base them on
historical averages, as you may have done when projecting how many
years you needed to reach your retirement savings goal. But once
you start taking income from your portfolio, you no longer have the
luxury of time to recover from possible market losses.
Just imagine how long it would take to restore the value of a
portfolio if it suffered a large loss due to a market downturn. For
example, if a portfolio worth $250,000 incurred successive annual
declines of 12% and 7%, its value would be reduced to $204,600, and
it would require a gain of nearly 23% the next year to restore its
value to $250,000.3 When a retiree's need for annual
withdrawals is added to poor performance, the result can be a much
earlier depletion of assets than would have occurred if portfolio
returns had increased steadily.
Coming to a Decision
Although past performance cannot predict future results, the ups
and downs registered by the financial markets and inflation can be
instructive when choosing an annual withdrawal rate. To provide an
idea of how much might be withdrawn annually from a balanced
portfolio so that it would be likely to last 30 years or more,
Standard & Poor's looked back at the actual record for stocks,
bonds, and inflation and analyzed all possible 30-calendar-year
holding periods since 1926. It determined that the average
sustainable withdrawal rate for a portfolio composed of 60% U.S.
stocks and 40% investment-grade bonds was about 6.0% per year when
adjusted for inflation (see chart).4
|How Long Will
the Money Last?
|The ups and downs of the financial markets and inflation
largely determine the income-producing potential of an investment
portfolio. This chart depicts the average rate of annual
withdrawals that a hypothetical portfolio of U.S. stocks and
Treasury bonds was able to sustain during a series of 30-year
holding periods since 1926. The average sustainable rate for all
30-year rolling periods from 1926 to 2012 was 6.0% when adjusted
for actual consumer price inflation.
|Source: Standard & Poor's. This example assumes a portfolio
composed of 60% stocks, represented by the S&P 500 index, and
40% bonds, represented by a composite of returns on long-term
government bonds, derived from yields published by the Federal
Reserve, and the Barclays Long-Term U.S. Government Bond index.
Annual withdrawals are adjusted for inflation based on actual
historical changes to the Consumer Price Index. Investors cannot
invest directly in any index. This illustration does not take into
account any transaction costs or taxes and is not representative of
any particular investment or security. Past performance is not a
guarantee future results.(CS000225)
In view of the variability of inflation and investment returns, as
well as the risk of living beyond your average life expectancy, you
may want to err on the side of caution and choose an annual
withdrawal rate somewhat below 5.9%. The goal, after all, is to
crack your nest egg in such a way that it will provide a reliable
stream of income for as long as you live. That may mean taking out
less in the early years of retirement with the hope of having
sufficient income for your later years.
This example is not intended as investment advice. Be sure to
consult a financial advisor about choosing a withdrawal rate and
how these issues and examples relate to your own financial
Points to Remember
- The rate of annual withdrawals from personal savings and
investments helps determine how long those assets will last and
thus whether you will have sufficient income for your later
- To determine a sustainable annual withdrawal rate, consider
your age and health and how future variations in the rate of
inflation and investment returns may affect your retirement assets.
A desire to leave a portion of your assets to heirs may also factor
into the withdrawal rate decision.
- Assuming average life expectancy may not be prudent in view of
the probabilities for living longer than an average life span.
Similarly, it may be misleading to assume that investment returns
and rates of inflation will closely mirror their historical
- A jump in inflation or investment losses due to market
downturns can have a significant impact on the income generated by
retirement assets. As a result, it may be wise to choose a
conservative withdrawal rate especially in the early years of
1Source: Centers for Disease Control, National Center for Health Statistics, 2011 (based on preliminary 2009 data, latest available).
2Source: Bureau of Labor Statistics, December 31, 2012.
3Example is hypothetical and for illustrative purposes only.
4The example was derived from the 57 30-calendar-year holding periods from 1926 to 2012. It assumes a portfolio composed of 60% stocks, represented by the S&P 500, and 40% bonds, represented by a composite of the total returns of long-term U.S. government bonds, calculated from yields published by the Federal Reserve, the Barclays Long-Term Government Bond index, rebalanced annually. The initial withdrawal is set as a percentage of the first-year value and adjusted thereafter for inflation based on actual historical changes in the Consumer Price Index. Investors cannot invest directly in any index. This illustration does not take into account any transaction costs or taxes and is not representative of any particular investment or security. Past performance does not guarantee future results.