How much should you take out of your portfolio when you retire?

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Most people look forward eagerly to retirement, but it’s a change that requires many important choices, some of which can have pretty big consequences.

One of those forks in the road: How much money do you expect your life savings to provide you every year for living expenses?

This issue involves a very important underlying tradeoff. On the one hand, if you take out more money, your portfolio is at greater risk of eventually running dry. (There’s a technical name for that unfortunate condition: “going broke.”)

On the other hand, if you take out less money, you forego the retirement lifestyle and choices that you have looked forward to — and which I will presume you fully deserve.

To illustrate this tradeoff, I’ll rely on a set of numbers I have developed over the years to show what would have happened to somebody who retired at the start of 1970.

There’s nothing magic about that year except that we have good data for the subsequent years, a period that included lots of favorable and unfavorable economic trends, world crises, some years of substantial inflation, and serious unexpected ups and downs in the stock market.

So this period gives us a window into the wide range of things that might happen in the future.

To follow the numbers, imagine (even though you’re probably much too young) that you retired in 1970 with a $1 million portfolio.

I’ll assume you chose a first-year withdrawal of $30,000 or $40,000 or $50,000 or $60,000, and that you wanted subsequent annual withdrawals to go up reflecting actual inflation.

In order to limit the variables, I’ll further assume that your $1 million was invested equally (50/50, in other words) in the S&P 500 index SPX, -0.79%  and five-year U.S. Treasury notes.

That’s a pretty reasonable stock/bond allocation for retirees, and it reflects the overall risk level of my own investments.

So your choice in this exercise is whether you start by taking out $30,000, $40,000, $50,000, or $60,000.

You probably can imagine that if you chose $30,000 you would have less to spend but less risk of running out of money. And if you chose $60,000, you would have had much more to spend but a higher risk of running out of money.

And you would be absolutely correct.

Here’s a table to give you a snapshot of how you would have fared in the first 10 years of your retirement, depending on your rate of withdrawal.

Table 1: The first 10 years
Withdrawal rate 3% 4% 5% 6%
Withdrawal 1970 $30,000 $40,000 $50,000 $60,000
First 5 years withdrawals $164,975 $219,966 $274,957 $329,949
Balance 12/31/1974 $993,777 $940,248 $886,718 $833,189
Withdrawal 1975 $41,284 $55,046 $68,807 $82,569
First 10 years withdrawals $400,105 $533,473 $666,842 $799,851
Balance 12/31/1979 $1.34 million $1.15 million $960,032 $771,725
Withdrawal 1980 $61,091 $81,455 $101,819 $122,183

If your retirement were supposed to last only 10 years, you would be fine taking out the 6%. But the figures on the last two lines show that big trouble is ahead if you chose the 6% route.

At the start of 1980, you would remove $122,183 from a portfolio worth $771,725. That is a withdrawal rate of about 15.8%, obviously too much to last very much longer.

If on the other hand you were following the 3% route, in 1980 your portfolio would be worth more than it started with, but you’d be taking out much less for living it up in retirement.

Most people expect their retirement to last more than 10 years. So let’s look at the second 10 years of these four scenarios.

Table 2: The second 10 years
Withdrawal rate 3% 4% 5% 6%
Withdrawal 1980 $61,091 $81,455 $101,819 $122,183
First 15 years withdrawals $763,038 $1.02 million $1.27 million $1.53 million
Balance 12/31/1984 $2.04 million $1.5 million $958,243 $419,272
Withdrawal 1985 $83,900 $111,867 $139,834 $167,800
First 20 years withdrawals $1.21 million $1.61 million $2.02 million $2.03 million
Balance 12/31/1989 $3.51 million $2.2 million $832,131 No $$ left
Withdrawal 1990 $100,466 $133,955 $167,444 No $$ left

As table 2 shows, the 6% withdrawal rate meant this portfolio could not keep up with inflation for 20 years. By the end of 1986, the portfolio was flat broke.

Note also that the 5% withdrawal plan was in obvious trouble by the end of 20 years. The 1990 withdrawal of $167,444 amounted to 20% of the portfolio value; in fact, that portfolio ran out of money in 1994 — less than 25 years after you retired.

By the end of 1999, representing a full 30 years of retirement, the 4% portfolio was holding up just fine, worth $3.9 million. The 3% portfolio was worth a whopping $9.3 million.

I’m guessing that if you started out withdrawing 3%, at some point you decided to take out more — which you could easily afford to do by sometime in the 1980s.

But there’s a tradeoff in that choice, too. In your early years of retirement, when you were presumably more healthy and able to travel and otherwise be active, the 3% withdrawal rate left you with less money. By the time you loosened the purse strings, so to speak, you had more money but perhaps less ability to take full advantage of it.

If you’re interested in how all this played out year-by-year for these four withdrawal rates, check out this page with four tables on it.

There’s good news and bad news here.

One piece of bad news is that there’s no way to avoid the tradeoff between spending now or spending later. You can spend a dollar only once.

Another piece of bad news is that in most cases you cannot know in advance how long you will live. You could plan for a very long life and adjust your finances accordingly, only to fall seriously ill after only a few years of retirement.

The good news: There are very worthwhile options for dealing with this tradeoff.

The best option, assuming you have saved enough money, is to ditch the idea that your withdrawals have to go up with inflation regardless of how well or how poorly your portfolio is doing.

If your withdrawal every year is a constant percentage of what your portfolio is worth, then you will never go totally broke. This is called a variable distribution plan, and I’ll dig into this option in an upcoming article.

Another option is to change your allocation between stocks and bonds.

A portfolio with a 60/40 percentage mix of stocks and bonds and a 6% variable distribution plan held up nicely for 49 years…well beyond the typical span of anybody’s retirement. You can see this in this table of returns from 1970 through 2018.

Retirement can be tricky. But if you start with ample savings and make sound distribution choices, you can live it up without outliving your money.

For more, check out my latest podcast, “Ten things you should know about fixed distributions.”

Richard Buck contributed to this article.