Withdrawal rate key to figuring retirement lifestyle

Your retirement lifestyle will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio.

The annual percentage that you take out of your portfolio, whether from returns or the principal itself, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges.

Why? Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could.

A seminal study on withdrawal rates for tax deferred retirement accounts (William P. Bengen, "Determining Withdrawal Rates Using Historical Data," Journal of Financial Planning, October 1994), using balanced portfolios of large-cap equities and bonds, found that a withdrawal rate of a bit over 4 percent would provide inflation-adjusted income (over historical scenarios) for at least 30 years.

More recently, Bengen showed that it is possible to set a higher initial withdrawal rate (closer to 5 percent) during early active retirement years if withdrawals in later retirement years grow more slowly than inflation.

Other recent studies have shown that broader portfolio diversification and rebalancing strategies can also have a significant impact on initial withdrawal rates.

For many people, even a 5 percent withdrawal rate seems low. To better understand why suggested initial withdrawal rates aren't higher, it's essential to understand how inflation can effect your retirement income.

A simple example illustrates the problem. If a $1 million portfolio is invested in a money market account yielding 5 percent, it provides $50,000 of annual income.

But if annual inflation runs at a 3 percent rate, then more income - $51,500 - would be needed the next year to preserve purchasing power. Because the money market provides only $50,000 of income, $1,500 must also be withdrawn from the principal to meet retirement expenses.

That principal reduction, in turn, reduces the portfolio's ability to produce income the following year. In a straight linear model, the principal reductions accelerate, ultimately resulting in a zero portfolio balance after 25 to 27 years, depending on the timing of the withdrawals.

Your withdrawal rate, then, needs to take into account many factors, including, but not limited to, your asset allocation and projected rate of return, annual income targets (accounting for inflation as desired), and investment horizon.

Ultimately there is no standard rule of thumb; every individual has unique retirement goals, means, and circumstances that come into play in planning, implementing, and adjusting a retirement income strategy.

Patricia Bliss, CPA and CFP, is an investment adviser with Linsco/Private Ledger in Olympia. She can be reached at 360-754-0490 or