Increasing the Safe Withdrawal Rate, Part III
The third general approach to increasing your Safe Withdrawal Rate (SWR) above the recommended 4% is pretty straight forward. It requires that you be flexible in your spending from year to year. In this approach you increase your withdrawal rate when the financial markets are doing well and you reduce your withdrawal rate when the markets are doing poorly. This is the basic approach I use because it allows you to, potentially; spend more money in your earlier retirement years.
This withdrawal approach works best for people who have an employer pension that covers most or all of their basic living needs. For example you may have estimated your retirement expenses including all discretionary expenses at $60,000 per year. However, if your basic living expenses (housing, groceries, healthcare, and transportation) are estimated to be about $40,000 annually and your employer pension and social security is around $40,000 per year, you are in a better position to exceed the recommended SWR of 4%.
However, many people do not have an employer pension in retirement and only have social security as guaranteed income, which for most people covers less than 50% of their basic living needs. These retirees need to be more careful in evaluating their retirement withdrawal rate. My wife and I will not collect any social security payments for 10 years, so we have no guaranteed income for 10 more years. We have addressed this uncertainty through our fixed income ladder we set up a few years ago. You can read about my thoughts on fixed income ladders in an earlier post. I do recommend that everyone set up some sort of fixed income ladder for at least the first few years of retirement, even if you have an employer pension. For retirees the period right after retirement is the highest risk period from the standpoint of portfolio longevity.
So what is the general approach I use to increase my SWR? First off let me say that I firmly believe that in today’s low yield environment, for anyone retiring in their 60s with reasonably good health, 4% is the maximum SWR if you want to have the same income in real dollars every year and also want to be reasonably certain of having your portfolio last 30 years.
Because I would like to spend a little more money in my early years of retirement, I have chosen a slightly higher SWR of 4.5%. This higher rate is only possible because I am willing to accept a lower level of spending in future years if necessary. I have set up my 10-year fixed income ladder based on this initial 4.5% withdrawal rate.
My process is pretty simple. Every January I withdraw 4.5% inflation adjusted amount from my retirement portfolio (these funds are actually provided by that year’s fixed income ladder component which is a maturing Bank Certificate of Deposit (CD)). Throughout the year I manage my portfolio just like I have described in many previous posts; that is, re-balancing my portfolio if the markets warrant it. However, each January when the next laddered income CD matures, I may make an adjustment based on the past year’s market returns. Using $1,000,000 as an example retirement financial portfolio (i.e., not including real estate equity or income), I may adjust my withdrawal amount as follows:
- At the beginning of year 1, I withdraw $45,000 or 4.5% of the $1,000,000 portfolio. I place these funds in a money market account and draw the funds down monthly.
- At the beginning of year 2, I would be scheduled to withdraw the second inflation adjusted withdrawal which, assuming 3% inflation, is $46,300. However, if the equity market has gone down, I would likely reduce this year’s inflation adjusted withdrawal down between 5% and 10% from the previous year’s withdrawal amount depending on how much the equity market dropped that year. I would invest this 5% to 10% difference in the worst returning equity asset of the past year. This serves not only to reduce spending when the market has had a bad year, but it also contributes to portfolio re-balancing.
- If, in the following year, the equity markets have gone up, I would increase my withdrawal amount and try to get back on track of my original 4.5% inflation adjusted amount which, in year 3, would be $47,700 again assuming 3% inflation. If the markets have gone up quite a bit in one year, I may take some small profits from the highest returning equity asset and spend a little more than that year’s original 4.5% inflation adjusted amount (i.e., more than the bank CD that matures for that year).
This approach allows me to take more money out of my portfolio in the early more active years. But let me reiterate, you can only use an approach like this if you are willing to spend less money in some years when the market is down.
There are many disciplined approaches that financial planners recommend as a way to increase your SWR above 4% adjusting it periodically when the markets warrant it. Ben Stein and Phil DeMuth in their 2005 book, Yes, You Can Still Retire Comfortably!: The Baby-Boom Retirement Crisis and How to Beat It, detail an approach that I consider to be one of the best to conservatively increasing your SWR. Their approach is good for people who want a simple “rules-based” approach to retirement income withdrawal. I will describe their approach in my next post.
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