Understanding the Safe Withdrawal Rate

A few years ago, I was talking about the Safe Withdrawal Rate with another advisor. What he asserted was that you could still grow your portfolio while only taking out 4% a year. (This was before the studies lowered the safe withdrawal rate to about 2.8%.)

Then he sent me a mutual fund illustration and it was NOT the 'safe withdrawal rate' that we were talking about.

The safe withdrawal rate studies are about the various permutations of being able to not run out of money in retirement assumed a set amount of income per year and varying portfolio returns.

The studies show that if you take out 2.8%, you have about an 85% chance of NOT running out of money by the time you're 90 years old.

Here's where the rubber meets the road:

What he showed was taking out 4% of the annual portfolio value.

This is not the same thing as the safe withdrawal rate.

What he was asserting was if you had a portfolio of $100,000...

you could take out 4% for that year ($4,000)

and still have $96,000

(not factoring in investment fluctuations or mutual fund expenses, fees, commissions, etc.)

But if that remaining $96,000 fell down to $80,000...

Then the mutual fund hypothetical illustration he showed was essentially 4% of the remaining $80,000 or $3,200 being taken for income, rather than the original $4,000.

These are the questions to ask:

• Are you trying to have a set amount of income each year?

• Could you afford to have a 20% pay-cut in retirement because of the stock market? ($3,200 / $4,000 = 80% of what you were relying on before.)

If you are comfortable and able to vary your income as the market varies... then by all means, do so. Your portfolio can last a lot longer.

But if we're really trying to solve for a set amount of income, and you can't afford to take a 20% pay cut from your portfolio, then there are other ways that can provide that income using safety, security, and guarantees. There may even be a way to take advantage of stock market volatility, if you wanted to do so!

When volatile investments are used to prepare for retirement income, it follows that one should prepare for unreliable income streams.

So, just be aware of what you may be looking at. That hypothetical showing 4% might not be what you need it to be each year.