An Introduction to Withdrawal Rates Part 1 of 2

For those facing retirement, there is a topic that should be extremely important, and yet from what I could find in terms of internet searches receives relatively little interest: withdrawal rates or how do I turn this nest egg that I have been saving into a source of income for the duration of my retirement.

In the simplest of terms, one could run through the hypothetical example of a man who stashed $1 million in his mattress. Each year he would pull out $30,000 and think to himself, “I have over 33 years that I could live like this and not have any trouble.” As long as pulled out $30,000 per year, he would be absolutely correct. Unfortunately, withdrawal rates in practicality are not that simple.

Three of the main issues that face the person wanting to be able to withdraw from the portfolio until they pass away include inflation, longevity, and rate of return.


The Issue of Inflation

One of the main problems  that this hypothetical man found was that things were more expensive as time went on, whether health care or food costs and so each year he would end up pulling out 4% more from his mattress than he did the year before. Imagine the surprise he felt when he found out in year 22 that he did not have enough money. The lesson to be learned is that inflation matters when it comes to withdrawals.

Now, just for the sake of argument, what if this same man had put his money in CDs and had averaged a 2% return on his money during the period of time. He would now have money that lasted over 25 years. If this same gentleman had put his money in an investment that averaged 5%, his money would have lasted him over 40 years.

An important note to ponder is this, whatever your investment, it has to be able to combat both inflation and your withdrawal rate if you are not to eventually run out of money.


The Issue of Longevity

One of the problems with this factor is that most of us do not know when we are going to die. As it has been pointed out in the news, in the early 1900s only 1% of the people in the United States lived past 65.  According to the actuarial tables provided by the Social Security Administration, the average person born is expected to live to over 75 years old if they are male and over 80 years old if they are female. The average male who is 65 is expected to live to 82, and the average female who is 65 is expected to live past age 84.

And of those who live to those ages, half of those are expected to live to be age 89 and 91 respectively.  Now if you have a 25% chance of living until 90, would it not seem wise to plan for it?

The problem of longevity of course is more complicated than this including what sorts of genes you have, what sort of lifestyle you live, in how good of health you are etc. Though admittedly not perfect, the previous numbers at least give you a gauge to ask some questions in regards to planning for retirement.