One of the most frequent questions retirees ask is… “How much can I safely withdraw per year from my retirement account?” If they retire at age 65 they could easily need their retirement income for 25 or 30 years. Miscalculating the withdrawal rate could result in an involuntary return to the workforce, or being forced to move in with their children.
Unfortunately, there isn’t a great deal of research in this area (most analysts devote their time to the question of accumulating capital, not spending it), so there have been only a few studies on “safe” withdrawal rates.
Most of the studies use data from Chicago consulting firm Ibottson Associates showing returns from stocks, bonds, and cash since 1926 as the basis for their analysis. Even though the average annual rate of return over the past 80 years for the S&P 500 is about 9%, you can’t reliably withdraw an amount that large because of inflation and the ups and downs of the stock market. Reputable studies on “safe” withdrawal rates attempt to answer the question for you and your clients.
The Bengen Study
In the February 25, 1997 issue, the Wall Street Journal columnist Jonathan Clements reported on a study by San Diego based financial planner William Bengen. Bengen looked at year-by-year returns since 1925 for a 50/50 stock/bond portfolio. He assumed half the portfolio was in the S&P 500 and half in intermediate term government bonds. Using a 30 year holding period, he calculated that a 4.1% withdrawal rate would allow retirees to survive the worst market declines.
The Harvard Study
In 1973, Harvard University did a study to determine how much they could safely withdraw from their endowment fund without eroding the principal. Assuming a portfolio of 50% stocks and 50% bonds and cash, Harvard’s analysts calculated they could withdraw 4% the first year and then adjust the subsequent year’s withdrawals for inflation. For example, if there was 10% inflation, the second year’s withdrawal would be 4.4% of the initial portfolio value.
The Trinity Study
Dallas Morning News columnist Scott Burns has written extensively on a “safe” withdrawal study by three Trinity University (San Antonio, TX) researchers. The Trinity Study measures the “success rate” of various portfolios from 1926 to 1995. The “success rate” is the percent of time a retiree could sustain a given withdrawal rate without depleting his retirement assets. One portion of the Trinity study adjusted withdrawals for inflation/deflation, much like the Harvard study. This analysis showed that of the portfolios considered, the optimal asset mix is 75% stock/25% long term corporate bonds. For a 30 year payout period and a 4% withdrawal rate, this mix had a 98% success rate. At a 3% withdrawal rate, the 75/25 mix had a 100% success rate. Interpolating these results would give you a “safe” withdrawal rate of slightly less than 4%, virtually identical to the Harvard study.
The consensus seems to be about 4% per year, but how should people interpret those studies? The first thing to consider is that these studies are based on investment returns before expenses. If you’re paying an investment advisor an annual fee of 2% of assets and he has you invested in no-load mutual funds with a 0.5% expense ratio, your annual expenses are 2.5%. Your “safe” withdrawal rate is 4.0% – 2.5% = 1.5%
Another consideration is that most of these studies are based on historical data. The fine print here should read “past performance does not guarantee future results.” While there is every reason to believe that investment returns in the next 80 years will be similar to the previous 80 years, there’s little chance it will be EXACTLY the same. To say that 4.0% is a “safe” withdrawal rate and that 4.1% will leave you broke implies a measure of accuracy in the forecast that just isn’t there. It may make more sense to say that the “safe” withdrawal rate going forward lies somewhere in the range of 3.25% to 4.25%.
Considering the above studies, annual management fees, income taxes and the historical annual returns of annuities, what is the justification for putting a retirees income producing assets at risk in the stock market?
Isn’t it time for you to start a marketing campaign for retirees that centers on things like safety, saving taxes, locking in past returns and providing a guaranteed income they can’t outlive?
Only a combination of fixed and immediate annuities can provide safety guarantees and an income they can outlive.
Do you want to know more about how you can help seniors and boomers to have a safe and guaranteed income they can’t outlive, then become a member of the Insurance Marketing and Sales Resource Center™!
Yours In Success,
Jeremy Nason
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