Month: July 2021

Episode 5: What is a safe rate of withdrawal in retirement?


What is a safe withdrawal rate in retirement?

What is a safe rate of withdrawal in retirement

Kevin Lao 00:12

Hello everybody and welcome to the Planning for Retirement Podcast. I’m Kevin Lao [phonetic 00:15]. I’m your host. I’m also the owner of Imagine Financial Security, a fee [phonetic 00:22] only financial planning firm based here in Jacksonville and St. Augustine, Florida. Just a quick note, this is not intended to be financial advice so please consult your own advisors or financial planning needs before making any decisions on your own.

But today’s topic is super exciting for me personally because it’s super relevant especially today. But it is creating a safe withdrawal strategy or a safe withdrawal rate during retirement. And so the reason this is exciting for me is because typically folks I work with are planning for retirement or they’re recently retired and they’re trying to navigate a 20 or even 30 plus year retirement plan adjusted for inflation, which is a big concern for just about everybody now. Given the recent news, June of this year 2021, where the rate of inflation over the last 12 months has been 5.4%, the highest it’s been since August of 2008.

The 4% Rule

So naturally, people will do a little bit of research on their own, and they’ll find the 4% rule. But the problem and this is… I think a fine guideline. But the problem with it is that everybody has unique objectives. Everybody has a unique risk tolerance for their investment strategy. So the 4% rule should not be followed by everybody. And in fact if you follow the 4% rule over the last 10 years, your net worth is probably grown, which is fine if that’s your goal during retirement. But some people want to enjoy retirement, they want to spend in retirement, they want to travel, they want to gift to their grandkids, they want to pay for their college, they want to enjoy their lifestyle, they want to… they don’t want to feel like they’re just living you know paycheck to paycheck. So to speak in retirement years, they want to enjoy what they’ve accumulated. And what I’ve found is that many folks are very concerned about outliving their assets, and therefore, they kind of tighten up their spending in retirement. And so one of the things that I like to do for all of my clients is, once we’ve matched up their financial objectives and their risk tolerance and their financial goals, coming up with the rate of withdrawal [phonetic 02:25] that’s comfortable for them.

And ultimately that helps free them up to spend what they’ve worked hard to accumulate, and enjoy retirement, be happier in retirement, sleep better at night and so that’s what I’m all about. So what I’ve done is I’ve created a formula that should be followed… I think by just about everybody and every financial advisor out there. And certainly at our firm, we follow this formula. And the formula is very simple.

Our safe withdrawal rate formula

It’s financial goals plus risk tolerance minus income sources minus risk intolerance equals your rate of withdrawal. I’m going to repeat that again. Its financial goals minus income sources minus risk tolerance minus your income sources equals rate of withdrawal.

It starts with your retirement goals!


So I like this, because it starts with financial goals. And that’s what we’re all about here. Given we are a financial planning firm. First, we always start with the financial plan and the financial objectives. And so what I find is that people typically have three categories that they fall into as they retire and that’s replacing their income but preserving their principal. And this could be just for emergency purposes you know for health care costs down the road or long term care. Maybe they want to preserve a little bit you know to leave to their children or grandchildren. Maybe that’s not their primary goal. But it’d be nice to do that. But they like the security of preserving principal. But they want to say a nice withdrawal rate that still can replace their income, their pre-retirement income. So that’s the first category people typically fall into.

The second category is maximizing the wealth transfer or the legacy goal but still replacing income. Now, these are folks that… Yes, they want to replace their income but they also want to potentially grow their assets if possible over time to leave behind to their kids or grandkids maybe even a charity. So that’s another category… the second category that I find people fall into. The third category, which is really fun [laughter] in terms of working with these clients, is maximize spending and leave zero or bounce your last check so leave nothing behind. And this is obviously a little unnerving as a planner because we have to have an assumed end of plan dates meaning a certain age where they’re no longer living, and if they live past that date. We’re kind of screwed because we assume that they’re going to have zero at that point in time… so a little bit unnerving. It’s certainly something we have to kind of leave a little bit of a buffer for. But I typically find you know folks also fall into this category as well. And sometimes there’s a combination of these three categories but these financial goals are going to drive the random withdrawal.

Do you want to maximize your intergenerational wealth goals…or maximize retirement spending?

So for folks that want to maximize the legacy wealth [phonetic 05:13] transfer, their rate of withdrawal might be a little bit smaller or lower than someone who wants to maximize their spending and leave zero behind. So if we’re going to use the benchmark of 4% let’s say someone who wants to maximize the legacy and what’s left behind, they may want to err [unintelligible 05:30] at 4% or maybe even 3% a year in terms of the rate of withdrawal versus someone who wants to maximize their spending might be even closer to 5, 6, 7 or 8% a year, on average throughout the duration of retirement. Now obviously for those folks over time, what’s going to happen is your right of withdrawal is going to go up because you’re going to have fewer years to live. And so if you’re only taking a percentage of your portfolio for a year… you’re probably not going to burn through all your assets by the time you pass away.


So as you get older your right of withdrawal is going to go up obviously take into consideration, you want to have a buffer for the unexpected. But again, the financial goals are going to drive significantly the rate of withdrawal impact. But it’s not the only thing like we talked about. The second thing is the risk tolerance. Now someone who’s more conservative or concerned about market volatility is probably going to have a lower targeted withdrawal rate based on their financial objectives. Now, let’s use an example. Let’s say they want to preserve principal, okay, and they are very conservative with their investment strategy. They don’t want to see a lot of market fluctuations. And now that they have retired or they’re very close to retirement, the estimated return on a very conservative portfolio is less than 4% a year just because again, we’re now in this prolonged interest rate, low interest rate environment.

You know… yes, Powell has announced that interest rates could tick up now before 2023. But still, we’re in a very low interest rate environment, the 10 year sits right now at about 1.4% so there’s not a lot of places to get yield. So those folks that are very conservative, might only be getting 3 to 3.5% a year on average returns. So in order to preserve the principle, they should only be taking 3 to 3.5% a year as a rate of withdrawal. Conversely, as someone is more comfortable with taking risks you know maybe they’re more comfortable being in an equity position to the portfolio, maybe closer to a balanced portfolio or a 60, 40 blend, which is a very popular mix for my clients that are retired at drawing income, the estimated returns there, might be closer to 5% a year. So for those folks that want to preserve principle but are comfortable with being a little bit more aggressive in their accounts, they might be closer to that 5% a year in terms of rate of withdrawal.

Other income sources play a role…

So again, the financial goals work in conjunction with the risk tolerance in order to create that ideal withdrawal rate. Now the third part of the equation like I mentioned, let’s not forget about it, is the income sources. If you have Social Security coming in maybe also a nice pension whether it be from the military or the government or a company you work for a long period of time, you may not need a lot of money from the portfolio. So therefore you have more flexibility to figure out you know do you give this money during lifetime? Do you do some Roth conversion strategies to be more tax efficient in your legacy wealth transfer down the road? But this is a key component when figuring out the rate of withdrawal because for those folks that don’t have a pension maybe they just have social security and then their investment assets, they might need to rely a little bit more heavily on their investment portfolio to replace their income.

Okay so in essence that also might drive your risk tolerance in retirement. If you are relying solely on your investment portfolio and Social Security, you may not be very comfortable with a lot of market volatility in your investments and therefore that will drive your rate of withdrawal. On the flip side, if you have a nice pension, social security, and that’s covering a lot of your expenses… you may not be as concerned about short term volatility and therefore you might be more comfortable with taking on a little bit more risk in the portfolio.



Okay. And that will help potentially with that legacy wealth transfer goal that you might have, or charitable goal that you might have. Which brings me to another point I was reading an article the other day, beginning of July sometime and, the headline was at the end of this year, the first… at the end of this year’s first quarter… I’m sorry… Americans aged 70 and above had a net worth of nearly $35 trillion dollars according to the Federal Reserve data. $35 trillion of net worth for Americans ages 70 and over. There is no way Americans 70 and older are going to spend all of that money for the next however many years they live.

Okay, so there’s going to be this massive wealth transfer from now until they the baby boomers start to leave these assets to the next generation. I talked about this in an earlier podcast, the tax trap of these traditional 401ks [phonetic 09:35] and IRAs and the way they’re going to be treated now that the inherited IRAs are now going by the wayside, and there’s going to be a significant tax penalty leaving these assets behind. What I will tell you is if you have a goal to maximize your legacy transfer, and you are in this category of… you’ve accumulated more than you’ve needed for retirement, you’ve done a good job saving and investing. Be smart now from a tax standpoint… okay, a lot of the tax reform that was put in force in 2017 you know coming off the books in 2025… be smart for the next 3, 4, 5 years and do strategies with your tax plan or with your advisor to convert some of these assets into more tax efficient strategies because you know tax rates are not going down. Let’s put it that way. You know that’s… I don’t think that’s a bold prediction there. So be smart with those assets that you’ve accumulated especially in these retirement accounts… these qualified retirement accounts, 401ks, 403bs, IRAs, before tax reform rolls off the books. And frankly it could change earlier you know there’s already about you know changing those tax you know tax rates earlier than 2025.


So be smart now but again, let’s recap. Financial goals plus risk tolerance minus income sources equals a safe rate of withdrawal. I hope this is helpful for everybody. I’m happy to talk to anyone who has questions about their own situation or you know… wants to you know run something by me you can always contact me directly at [email protected]. If you like this podcast, please subscribe. Maybe even leave a review only if it’s five stars, and hopefully you can tune in for more episodes to come. Thanks, everybody.