Increasing the Safe Withdrawal Rate, Part I
In my last post I discussed how the 4% recommended Safe Withdrawal Rate (SWR) can be increased, if you are willing to accept a higher probability that your financial portfolio will not last 30 years. In this post I will provide some thoughts on one of the ways that you can increase the SWR without significantly increasing your portfolio failure rate.
The most reliable way to increase the SWR will not be a very attractive option for most people. However, it may be the only option for many who have not been able to save money at a high enough pace during their working years. This option is simply to work longer.
By choosing to work longer, you reduce the number of years that your portfolio will have to support you in retirement. The table below provides the initial withdrawal rates associated with the different number of retirement years while maintaining a 90% probability of portfolio survival.
Retirement Years versus Initial Withdrawals Rates
|
Number of Years in Retirement |
Allowable Initial Withdrawal Rate |
|
50 |
3.38% |
|
45 |
3.44% |
|
40 |
3.58% |
|
35 |
3.81% |
|
30 |
4.10% |
|
25 |
4.46% |
|
20 |
5.03% |
|
15 |
6.14% |
|
10 |
8.75% |
Calculations based on FireCalc.com algorithm
Assumptions:
-Based on 50%/50% equity/fixed income ratio, rebalanced annually
-Average annual portfolio management fees = 0.50%
-Annual withdrawals are inflation-adjusted based on CPI
-90% probability of portfolio survival
Based on the data in the table, if you work until age 70 or 75, a 20 year retirement plan might be reasonable. In this case your SWR can be increased to about 5%.
Knowing that the average life expectancy is about 80 years in the US, one might ask, “If I retire at age 65, can’t I use a 6% SWR since my retirement time frame is only about 15 years?” The answer to this question is “no.” While it may be true that the average life expectancy of all Americans is currently about 78 to 80 years, that is just an actuarial average for all people born in the US. This average includes everyone who has died early in life due to car accidents, foreign wars, rare diseases, etc.
If you have already made it to age 65, your life expectancy is greater than the life expectancy of everyone from birth; your life expectancy is now about 83 to 84 years. Additionally, your current life expectancy is just an actuarial average for everyone who is your age. In other words, whatever your current life expectancy is, there is a 50/50 chance that you will outlive your current life expectancy. If you and your wife are currently both age 65, there is about an 18% chance one of you will live to age 95. This is why most financial planners use 30 years as the number of years to determine your portfolio SWR.
Continuing to working to age 75 may not appeal to many people, but it is the most predictable way to increase your SWR over 4% and be reasonably certain you will not run out of money in your later years. Are there other options? Yes, but you have less control over these other options. I’ll discuss one of them in the next post.
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