You’ve worked hard your entire life and you’ve saved dili­gent­ly to make sure you’d have finan­cial free­dom in retire­ment. Now that you are either in retire­ment or get­ting close to it, you need to make sure your finances, i.e. what you have in your retire­ment port­fo­lio, lasts the rest of your life and pos­si­bly that of your spouse. And that may not be easy. As we have seen in the very near past, The Great Reces­sion and sub­se­quent recov­ery, the finan­cial mar­kets can be extreme­ly volatile.

No indi­vid­ual can con­trol the finan­cial mar­kets but there are actions we can take to man­age or con­trol the mar­kets impacts on our port­fo­lios. A key con­trol mech­a­nism is man­ag­ing how much we with­draw from our port­fo­lio each month to pay for expens­es. This, in finan­cial plan­ning jar­gon, is called the “sus­tain­able with­draw­al rate”.


What is a sustainable withdrawal rate?

A with­draw­al rate is the per­cent­age that is with­drawn each year from an invest­ment port­fo­lio. If you take $20,000 from a $1 mil­lion port­fo­lio, your with­draw­al rate that year is two per­cent ($20,000 divid­ed by $1 mil­lion).

How­ev­er, in retire­ment income plan­ning, what’s impor­tant is not just your with­draw­al rate, but your sus­tain­able with­draw­al rate. A sus­tain­able with­draw­al rate rep­re­sents the max­i­mum per­cent­age that can be with­drawn from an invest­ment port­fo­lio each year to pro­vide income with rea­son­able cer­tain­ty that the income pro­vid­ed can be sus­tained as long as it’s need­ed (for exam­ple, through­out your life­time).


Why is having a sustainable withdrawal rate important?

Your retire­ment lifestyle will depend not only on your assets and invest­ment choic­es, but also on how quick­ly you draw down your retire­ment port­fo­lio. Fig­ur­ing out an appro­pri­ate with­draw­al rate is a key fac­tor in retire­ment plan­ning. How­ev­er, this presents many chal­lenges and requires mul­ti­fac­eted analy­sis of many aspects of your retire­ment income plan. After all, it’s get­ting more and more com­mon for retire­ment to last 30 years or more, and a lot can hap­pen dur­ing that time. Draw­ing too heav­i­ly on your invest­ment port­fo­lio, espe­cial­ly in the ear­ly years, could mean run­ning out of mon­ey too soon. Take too lit­tle, and you might need­less­ly deny your­self the abil­i­ty to enjoy your mon­ey. You want to find a rate of with­draw­al that gives you the best chance to max­i­mize income over your entire retire­ment peri­od.

A sus­tain­able with­draw­al rate is crit­i­cal to retire­ment plan­ning, but it can apply to any invest­ment port­fo­lio that is man­aged with a defined time frame in mind. It’s also fun­da­men­tal to cer­tain types of mutu­al funds that are man­aged to pro­vide reg­u­lar pay­ments over a spe­cif­ic time peri­od. For exam­ple, some so-called dis­tri­b­u­tion funds, which are often used to pro­vide retirees with ongo­ing income, are designed to dis­trib­ute all of an investor’s assets by the time the fund reach­es its tar­get­ed time hori­zon. As a result, the fund must cal­cu­late how much mon­ey can be dis­trib­uted from the fund each year with­out exhaust­ing its resources before that tar­get date is reached.

Tip: Each dis­tri­b­u­tion fund has a unique way of address­ing the ques­tion of a sus­tain­able with­draw­al rate. Before invest­ing in one, obtain its prospec­tus (avail­able from the fund), and read it so you can care­ful­ly con­sid­er its invest­ment objec­tives, risks, charges, and expens­es before invest­ing.


What determines whether a withdrawal rate is sustainable?

  • Your time hori­zon: The longer you will need your port­fo­lio to last, the low­er the ini­tial with­draw­al rate should be. The con­verse is also true (e.g., you may have health prob­lems that sug­gest you will not need to plan for a lengthy retire­ment, allow­ing you to man­age a high­er with­draw­al rate).
  • Antic­i­pat­ed and his­tor­i­cal returns from the var­i­ous asset class­es in your retire­ment port­fo­lio, as well as its antic­i­pat­ed aver­age annu­al return: Though past per­for­mance is no guar­an­tee of future results, the way in which you invest your retire­ment nest egg will play a large role in deter­min­ing your port­fo­lio’s per­for­mance, both in terms of its volatil­i­ty and its over­all return. That, in turn, will affect how much you can take out of the port­fo­lio each year with­out jeop­ar­diz­ing its longevi­ty.
  • Assump­tions about mar­ket volatil­i­ty: A finan­cial down­turn that reduces a port­fo­lio’s val­ue, espe­cial­ly dur­ing the ear­ly years of with­draw­al, could increase the need to use part of the prin­ci­pal for income. It could also require the sale of some assets, drain­ing the port­fo­lio of any future income those assets might have pro­vid­ed. Either of those fac­tors could ulti­mate­ly affect the sus­tain­abil­i­ty of a port­fo­lio’s with­draw­al rate.
  • Antic­i­pat­ed infla­tion rates: Deter­min­ing a sus­tain­able with­draw­al rate means mak­ing an assump­tion about changes in the cost of liv­ing, which will like­ly increase the amount you’ll need the port­fo­lio to pro­vide each year to meet your expens­es.
  • The amounts you with­draw each year: When plan­ning your retire­ment income, your antic­i­pat­ed expens­es will obvi­ous­ly affect what you need to with­draw from your retire­ment port­fo­lio, and there­fore affect its sus­tain­abil­i­ty. How­ev­er, because this is one aspect over which you have at least some con­trol, you may find that you must adjust your antic­i­pat­ed retire­ment spend­ing in order to make your with­draw­al rate sus­tain­able over time.
  • Any sources of rel­a­tive­ly pre­dictable income, such as Social Secu­ri­ty, pen­sion pay­ments, or some types of annu­ity ben­e­fits: Hav­ing some sta­bil­i­ty from oth­er resources may allow greater flex­i­bil­i­ty in plan­ning with­drawals from your port­fo­lio.
  • Your indi­vid­ual com­fort lev­el with your plan’s prob­a­bil­i­ty of suc­cess.

As with most com­po­nents of retire­ment income plan­ning, each of these fac­tors affects the oth­ers. For exam­ple, pro­ject­ing a longer lifes­pan will increase your need to reduce your with­drawals, boost your returns, or both, in order to make your with­draw­al rate sus­tain­able. And of course, if you set too high a with­draw­al rate dur­ing the ear­ly retire­ment years, you may face greater uncer­tain­ty about whether you will out­live your sav­ings.

Example(s): Mary’s finan­cial pro­fes­sion­al tells her that giv­en her cur­rent with­draw­al rate and asset allo­ca­tion strat­e­gy, there is an 80 per­cent chance that her retire­ment sav­ings will last until she’s 95 years old. Mary has sev­er­al choic­es. If she wants to increase her con­fi­dence level–maybe she prefers a 95 per­cent chance of success–she might reduce her year­ly spend­ing, try to increase her port­fo­lio’s return by chang­ing her asset allo­ca­tion, direct a por­tion of her port­fo­lio into an invest­ment that offers a guar­an­teed life­time income, or some com­bi­na­tion. On the oth­er hand, if she’s a risk tak­er and is com­fort­able with hav­ing only a 75 per­cent chance that her port­fo­lio will last through­out her life­time, she might decide to go ahead and spend a bit more now. (This is a hypo­thet­i­cal illus­tra­tion only, not finan­cial advice).

Estimating lifespan

In gen­er­al, life expectan­cies have been increas­ing over the last cen­tu­ry. Life prob­a­bil­i­ties at any age are list­ed on the Social Secu­ri­ty Admin­is­tra­tion’s Peri­od Life Table, avail­able under the Actu­ar­i­al Pub­li­ca­tions sec­tion of its web site.

Tip: Reg­u­lar­ly updat­ed longevi­ty esti­mates are pub­lished in the Nation­al Cen­ter for Health Sta­tis­tics’ Nation­al Vital Sta­tis­tics Reports.

How­ev­er, be aware that aver­ages are not nec­es­sar­i­ly the best guide when deter­min­ing how long an indi­vid­ual port­fo­lio may need to last. By def­i­n­i­tion, many peo­ple will live beyond the aver­age life expectan­cy for their age group, par­tic­u­lar­ly those who have a fam­i­ly his­to­ry of longevi­ty. Also, aver­age life expectan­cies don’t remain sta­t­ic over an indi­vid­u­al’s life­time; a 30-year-old may have an aver­age life expectan­cy of 76, while a 76-year-old may have a life expectan­cy of 85.

Cou­ples will need to con­sid­er both indi­vid­u­als’ life expectan­cies when plan­ning a sus­tain­able with­draw­al rate.

The impact of inflation

An ini­tial with­draw­al rate of, say, four per­cent may seem rel­a­tive­ly low, par­tic­u­lar­ly if you have a large port­fo­lio. How­ev­er, if your ini­tial with­draw­al rate is too high, it can increase the chance that your port­fo­lio will be exhaust­ed too quick­ly. That’s because you’ll need to with­draw a greater amount of mon­ey each year from your port­fo­lio just to keep up with infla­tion and pre­serve the same pur­chas­ing pow­er over time. For a retire­ment port­fo­lio, that can become prob­lem­at­ic, since the amount with­drawn is no longer avail­able to gen­er­ate income in future years. An appro­pri­ate ini­tial with­draw­al rate takes into account that infla­tion will require high­er with­drawals in lat­er years.

Example(s): Jean has a $1 mil­lion port­fo­lio invest­ed in a mon­ey mar­ket account that yields five per­cent. That gives her $50,000 of income that year. How­ev­er, infla­tion push­es up prices by three per­cent over the course of the year. That means Jean will need more income–$51,500–the next year just to cov­er the same expens­es ($50,000 x.03=$1,500). Since the account pro­vides only $50,000 of income, the addi­tion­al $1,500 must be with­drawn from the prin­ci­pal. That prin­ci­pal reduc­tion, in turn, reduces the port­fo­lio’s abil­i­ty to pro­duce income the fol­low­ing year. In a straight lin­ear mod­el, prin­ci­pal reduc­tions accel­er­ate, ulti­mate­ly result­ing in a zero port­fo­lio bal­ance after 25 to 27 years, depend­ing on the tim­ing of the with­drawals. (This exam­ple is a hypo­thet­i­cal illus­tra­tion and does not account for the impact of any tax­es.)

Infla­tion is one rea­son you can’t sim­ply base your retire­ment income plan­ning on the expens­es you expect to have when you first retire. Costs for the same items will most like­ly con­tin­ue to increase over your retire­ment years, and your ini­tial with­draw­al rate needs to take that into account to be sus­tain­able.

Financial Literacy for CouplesThere’s anoth­er infla­tion-relat­ed fac­tor that can affect your plan­ning. Seniors can be affect­ed some­what dif­fer­ent­ly from the aver­age per­son by infla­tion. That’s because costs for some ser­vices that may rep­re­sent a dis­pro­por­tion­ate share of a senior’s bud­get, such as health care and food, have risen more dra­mat­i­cal­ly than the Con­sumer Price Index (CPI)–the basic infla­tion measure–for sev­er­al years. As a result, seniors may expe­ri­ence high­er infla­tion costs than younger peo­ple, and there­fore might need to keep ini­tial with­draw­al rates rel­a­tive­ly mod­est.

Market volatility and portfolio longevity

When set­ting an ini­tial with­draw­al rate, it’s impor­tant to take a port­fo­lio’s volatil­i­ty into account. The need for a rel­a­tive­ly pre­dictable income stream in retire­ment isn’t the only rea­son for this. Accord­ing to sev­er­al stud­ies in the late 1990s by Philip L. Coo­ley, Carl M. Hub­bard, and Daniel T. Walz, the more dra­mat­ic a port­fo­lio’s fluc­tu­a­tions, the greater the odds that the port­fo­lio might not last as long as need­ed. If it becomes nec­es­sary dur­ing mar­ket down­turns to sell some assets in order to con­tin­ue to meet a fixed with­draw­al rate, sell­ing at an inop­por­tune time could affect a port­fo­lio’s abil­i­ty to gen­er­ate future income. And a steep mar­ket down­turn, or hav­ing to sell assets to meet unex­pect­ed expens­es dur­ing the ear­ly years of retire­ment, could mag­ni­fy the impact of either event on your port­fo­lio’s longevi­ty because the num­ber of years over which those invest­ments could poten­tial­ly have pro­duced income would be greater.

Withdrawal rates and tax considerations

When cal­cu­lat­ing a with­draw­al rate, don’t for­get the tax impact of those with­drawals. For exam­ple, your with­draw­al rates may need to cov­er any tax­es owed on that mon­ey. Depend­ing on your strat­e­gy for pro­vid­ing income, you could owe cap­i­tal gains tax­es or ordi­nary income tax­es. Also, if you are sell­ing invest­ments to main­tain a uni­form with­draw­al rate, the tax impact of those sales could affect your with­draw­al strat­e­gy. Min­i­miz­ing the tax con­se­quences of secu­ri­ties sales or with­drawals from tax-advan­taged retire­ment sav­ings plans could also help your port­fo­lio last longer.

Yet anoth­er twist in deter­min­ing the with­draw­al rate is deter­min­ing when to switch to the Required Min­i­mum Dis­tri­b­u­tion (RMD) as required by the Inter­nal Rev­enue Ser­vice. The with­draw­al rate you come up with can be trumped by RMD rules and reg­u­la­tions.

What is a RMD? A RMD is the annu­al min­i­mum amount a retire­ment plan account own­er must with­draw begin­ning in the year he or she reach­es 70 ½. By far, most retire­ment accounts are sub­ject to this rule. Funds held in a Roth IRA are not sub­ject to the rules so long as the account hold­er is alive and funds held in a non-qual­i­fied annu­ity that is NOT held in an IRA are exempt from the RMD rule. How­ev­er, funds held in a Roth 401(k), 403(b) and 457(b) plans are all sub­ject to RMD’s as are annu­ities held in an IRA. The penal­ty for ignor­ing the RMD is quite severe. In gen­er­al, the RMD is tax­able in the year it is tak­en. If you decide not to take the RMD, the amount not with­drawn is sub­ject to a 50% tax.



As men­tioned ear­li­er, you con­trol how much you take from your invest­ment port­fo­lio each and every year. That amount will change over time due to life events. The more aggres­sive­ly one spends from their retire­ment sav­ings, the greater the risk they out­live their finances. The more con­ser­v­a­tive one is, the more like­ly it is they will be able to sur­vive mar­ket volatil­i­ty and live com­fort­ably to the end of their lives. If this seems daunt­ing and com­plex, talk to a finan­cial advi­sor such as Mack­ey Advi­sors.


Con­tin­ue on to read part 2