How much can you safely withdraw each year in retirement?

Bengen (1994) determined a retiree could safely withdraw 4% of their savings on an annual basis, assuming a minimum equity allocation of 50%. Employing the principles of sequence risk, i.e. the risk associated with the order and timing of returns, Bengen concluded that even in the worst historical economic circumstances a retiree would not run out of money for 30+ years.

Using the 4% rule, an individual can roughly estimate their retirement income by dividing their total nest egg by 25. For example, a $1 million account would yield a $40,000 annual income. Unfortunately, financial planning is not nearly so simplistic. Changing retirement needs, such as buying a new car, completing a house renovation, or utilizing long-term care, necessitate varying income from year to year. Therefore, while the 4% rule is a good heuristic, it lacks nuance.

Retirement timing can also play a large role in long-term retirement distributions. Market valuation, specifically the P/E ratio, has an inverse relationship with safe withdrawal rates. When the market is over-priced (i.e. high P/E ratio) at the time of retirement, safe withdrawal amounts are decreased. Greater diversification has been demonstrated to increase the safe withdrawal rate, while taxes, trading costs, and management fees have the reverse effect.

The 4% rule is a great starting point for young investors, but as retirement looms closer more variables need to be taken into account. Contact a Skyline advisor to start financial planning.

For more information on this topic, read the following studies:

Research note: Revisiting the '4% spending rule.' (Bruno & Jaconetti, 2009)

Retirement savings: Choosing a withdrawal rate that is sustainable. (Cooley, Hubbard & Walz, 1998) 

Sustainable withdrawal rates of retirees: Is the recent economic crisis a cause for concern? (Chatterjee, Palmer & Goetz, 2011)

How has the 4% rule held up since the tech bubble and the 2008 financial crisis? (Kitces.com/blog, 2015)