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Implementing a Withdrawal Rate Strategy

A reader writes in to ask,

“My sister is 63 and recently retired. She has a pension that pays her basic living expenses, and she has not yet started taking Social Security.

Last year she withdrew 4% from Vanguard Target Retirement 2015 Fund (VTXVX). But over the last year, the fund only earned a return of 1.48%. Since this is generally her sole source of “extra money” beyond her pension, my conclusion is that she should scale back on the 4% withdrawal due the lack of a “keep even” return.

But with less money in her hand I fear she will feel strapped. She loves her travel.”

SWR: Safe-ish Withdrawal Rates

The original studies showed that a 4% inflation-adjusted withdrawal rate was successful over most historical 30-year periods for a balanced stock/bond portfolio in the United States. But mostly safe in the past is a long way from completely safe in the future. In addition, your sister might live longer than 30 years. Both of those points would suggest that perhaps a withdrawal rate of less than 4% would be wise.

That said, one year of a slightly-negative real return (1.48% nominal return, minus 3.9% inflation over that period) isn’t necessarily a catastrophe.

Indeed, during the historical period on which the 4% guideline is based, there were plenty of years when the return of a balanced stock/bond portfolio would have been less than the amount withdrawn (and plenty of years when the real return would have been worse than -2.42%), yet the 4% guideline was still mostly safe.

In other words, it’s not typically one year of slightly-negative real returns that spells disaster for a 4% withdrawal rate. Rather, it’s a market collapse right at the beginning of the period or several years of slightly negative returns that you have to watch out for.

Is Portfolio Depletion a Problem?

For this particular investor though, I’m not sure that we need to be worried about portfolio depletion at all. She has a pension that pays all of her basic living expenses, so income from her portfolio will be used purely for discretionary spending.

And she hasn’t started claiming Social Security benefits yet, so if she keeps her discretionary spending constant throughout retirement, the amount she’ll need to withdraw from her portfolio each year will decrease after a few years once she starts claiming Social Security.

In addition, some experts argue in favor of intentionally front-loading discretionary spending in the early years of retirement when:

  1. You’re most able to enjoy it, and
  2. You’re most likely to be alive to enjoy it.

As you can see, this question doesn’t have a right or wrong answer. It’s a lifestyle decision. Different people would make different choices here, and either choice (cutting back or not) could be perfectly reasonable.

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  1. You’ve effectively summarized dozens of studies in a few sentences. It’s remarkable!

    The question doesn’t clearly state whether the “pension” refers to Social Security, or another pension. But at any rate, as you say, Social Security will help to reduce the required withdrawal rate from savings, so the reader’s sister should be in good shape without needing to cut back.

  2. Hi Wade,

    That’s my fault. The original email was very clear that the person in question has a pension aside from Social Security, and that the pension is sufficient to meet her basic living expenses.

    As with most reader emails, I cut it down somewhat to just the essentials before including it in a post. In this case, perhaps I cut a bit too much.

  3. Ditto Wade’s kudos on the succinct and effective explanation of the withdrawal studies. And I really appreciate the comments on front-loading withdrawals. While I don’t think about it specifically in those terms, I really believe that it is prudent to project that certain expenses (such as travel in this situation) will be greater in one’s 60’s and 70’s while declining as we age because of two factors: 1) health and energy declining over time and 2) in most cases, once one has ‘been-there, done-that, got-the-Tshirt’ the desire to continue those activities at a high pace declines.

    Meaning that withdrawals for truly discretionary things like extensive travel can be legitimitely be planned to be 2-3% of assets in younger years and 1% or less in later life.

    Thanks for the insightful writing, and have a great Thanksgiving.


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