Finding a safe withdrawal rate for your retirement portfolio

Now more than ever, people are dealing with uncertainty – COVID-19, the economy and the political landscape, just to name a few issues.

When it comes to retirement income, uncertainty is the last thing we need. Let’s discuss how you might feel more secure when taking retirement income from your hard-earned savings.

How the 4 Percent Rule works

The idea behind the 4 Percent Rule is straightforward: Withdraw 4 percent of your nest egg the first year of your retirement, then increase that amount each year by enough to account for inflation. This way, your money will potentially last for at least 30 years, assuming you stay invested half in stocks and half in bonds.

Here’s how it might work. Say you retire with a $1 million portfolio. In your first year of retirement, you would withdraw $40,000, the product of $1 million x .04. Next year, you’d withdraw $41,200, $40,000 plus an additional 3 percent for inflation, followed by $42,436 the year after that, $41,200 plus an extra 3 percent for inflation. And so on.

Although investors and financial planners have used the 4 Percent Rule for decades, there’s talk that it may be outdated. With bond yields at historically low levels and equity returns uncertain, some retirement experts now believe that the 4 percent withdrawal rate is too high and could cause investors to run out of money during their retirement. That said, others argue the 4 Percent Rule is still relevant, or even too conservative. The truth probably lies somewhere in between.

Flexibility is key

Rather than adhere rigidly to a 4 percent withdrawal rate, consider using the rule as a starting point while also staying flexible by taking advantage of new developments as conditions change. Here are three dynamic ways to manage your spending in retirement:

1. Develop a retirement plan and update it regularly. Online retirement calculators can help you determine a sustainable portfolio withdrawal rate based on your specific situation. Likewise, a professionally created retirement plan can give you an even more detailed analysis. But whether you do the math yourself or work with a pro, review the numbers regularly to ensure you remain on track. Go to schwab.com/retirement-planning-tools/retirement-calculator.

2. Adjust your withdrawals based on the market’s performance or your own personal changes. A static withdrawal rate doesn’t factor in the market’s inevitable ups and downs, or personal changes that may occur that demand flexible cash flow management. Therefore, you might withdraw a bit less when financial asset prices are down and increase your withdrawals when the markets are on a roll. Or you might skip making inflation adjustments to your withdrawal rate during those years when your portfolio experiences losses. These types of moves may mean your budget fluctuates each year, but they’ll also help increase the probability that your savings will last throughout your lifetime.

3. Consider an annuity. Annuities are not for everyone – they can be complex, costly and illiquid – but annuity contracts are one of the only types of financial vehicles that can ensure you have guaranteed income for life. With an ongoing stream of payments coming to you, you may feel more comfortable that you’ll have the income needed to cover essential expenses in retirement, even if you outlive your investment portfolio.

If you are retired and living off investment income or nearing that point in life, consider getting professional advice related to a sustainable portfolio distribution strategy. A second opinion might provide tax-saving tips, techniques or opportunities that may increase your probability of success. Strive to eliminate uncertainty and enjoy your retirement journey; you deserve it.