Retirement stress test part 3 - 4% rule
Don’t ignore expenses you know are coming (new roof, new car).
Retirement spending: choosing a sustainable withdrawal rate.
How much can you safely withdraw from your investments each month without outliving your money? This is a critical question for Canadians who are retired as well as those transitioning into retirement.
Many factors will affect the longevity of your retirement savings, including interest rates, cost of living increases, investment returns, health costs and ultimately how long you live.
In 1998, three professors at Trinity University published an influential paper on this topic titled “Retirement Spending: Choosing a Sustainable Withdrawal Rate.” They looked at each year between 1926-1995 and tried to determine the success rate of stock/bond portfolios with different withdrawal rates over a set time period (15 to 35 years). The study was recently revised by Wade Pfau, Professor of Retirement Income at the American College of Financial Services to include data up until 2017.
One of the main conclusions from the study is that a 50/50 stock/bond portfolio can provide 4% indexed withdrawals for 30 years with a greater than 90% probability of success. As a result, this study has resulted in the idea of the ‘4% Rule.’
For example, if you have a $1,000,000 investment portfolio and need income for 30 years, from age 65 to 95, the ‘4% Rule’ recommends a maximum $40,000 annual withdrawal every year in today’s dollars. Note that this assumes withdrawals increasing every year with inflation.
Another interesting conclusion from the study is the need for stock exposure. If you are withdrawing more than 3% annually from your savings, exposure to stocks within the portfolio will increase the likelihood of success.
Of course, keeping withdrawals at 4% does not guarantee that you won’t deplete your portfolio. We should think of it as more of a guideline than a rule. This is why it is important to work with your Financial Planner to adjust your income strategy to your specific lifestyle and expectations.
So what can you do to increase the likelihood of your retirement savings lasting?
Follow a sustainable withdrawal rate for your age. We think of the 4% rule as a good rule of thumb if you’re 65 and retiring. If you retire earlier, the safe withdrawal percentage will be lower and visa versa.
Keep a minimum of 50% of your portfolio allocated to stocks with a bias for larger more stable companies.
Don’t ignore expenses you know are coming (new roof, new car) and factor those into your sustainable withdrawal rate calculations
Please note that in periods of higher inflation the 4% rule may not longer be a safe withdrawal rate
This information has been prepared by Joe Basque, CFP®, CIM® who is a Wealth Advisor and for Westmount Wealth Management Inc. and an Insurance Advisor for Westmount Wealth Planning Inc. Westmount Wealth Management Inc. is registered as a Portfolio Manager in British Columbia, Alberta, and Ontario. Westmount Wealth Planning Inc. is a subsidiary of Westmount Wealth Management Inc.
This presentation contains the current opinions of the Author and such opinions and the facts on which they are based are subject to change over time without notice. This material is distributed for informational purposes only and is not intended to provide personalized legal, accounting, tax or specific investment advice. Please speak to a Westmount Wealth Advisor regarding your unique situation.
