The ideal retirement portfolio withdrawal rate

Shelly Gigante

By Shelly Gigante
Shelly Gigante specializes in personal finance issues. Her work has appeared in a variety of publications and news websites.
Posted on Jun 28, 2019

It’s a major source of stress for most retirees: Managing their portfolio withdrawal rate to ensure that they don’t outlive their assets.

Indeed, once they leave the workforce, seniors are faced with the challenge of converting their savings into a sustainable income stream. That's no small task considering their financial nest egg often consists of a mixed bag, which can include tax-favored retirement accounts, such as individual retirement accounts (IRAs) and 401(k)s, personal savings, taxable brokerage accounts, home equity, annuities, and cash value life insurance. Adding to the angst, many retirees realize too late that they undersaved, which threatens their ability to make ends meet as they age.

A 2018 retirement survey by MassMutual found that 9 percent of retirees and 44 percent of pre-retirees, who are still accumulating wealth, believe their income may not last as long as they live.1

Your withdrawal rate in retirement must be carefully calculated based on expected longevity, the size of your portfolio, your expenses, and the amount of retirement income you have coming in. In most cases, that requires working closely with a financial advisor who can help you:

Calculate your income needs

Your withdrawal rate reflects the percentage that you may be able to take from your portfolio each year without depleting your money. In essence, it measures how long your money may last.

Some basic math can help you determine the withdrawal rate that’s right for you.

Start by calculating your annual expenses. Then assess how much you’ll be able to cover with guaranteed sources of income, including Social Security, pensions, annuities, and required minimum distributions (RMDs) generated from your IRAs and 401(k)s.

Any shortfall that exists is the amount you will need to fund with personal savings and investments.

Multiply that amount by the number of years you expect to live in retirement, or your joint life expectancy if you are married.

Finally, compare that figure with the amount you have saved and adjust your annual withdrawal rate as needed to ensure that your money lasts as long as you do. For many retirees, that rate ranges from 2 percent to 5 percent.

No one knows with certainty how long he or she may spend in retirement, of course, but life expectancy tables offer guidance.

According to the Social Security Administration, a man reaching age 65 today can expect to live, on average, until age 84, while a woman turning age 65 today can expect to live, on average, until age 86.5. But those are merely averages. Roughly one-third of 65-year-olds today will live to age 90 and about one in seven will live past age 95.2

As such, Mitchell Kraus, a financial planner with Capital Intelligence Associates in Santa Monica, California, said he likes to calculate his clients' withdrawals past age 100 for his initial analysis. “If the money does not last that long, I want my clients to understand the risk,” he said. “Although we may not make any changes at age 65 based on the money lasting until only age 90, retirees will want to keep a closer eye on their portfolio over the years and adjust where needed.”

The 4 percent rule of thumb

Financial advisors have long relied on a 4 percent withdrawal rate as a rule of thumb. The idea is that most retirees can siphon off about 4 percent of their portfolio in the first year of retirement and adjust annually for inflation without running out of money.

For a retirement portfolio that earns at least 6 percent per year, that strategy would ensure that retirees would only ever spend their interest, leaving their principal untouched — a surefire way (in theory) to preserve assets. It also enables retirees to maintain purchasing power as it leaves room for cost-of-living adjustments due to inflation, said Kristi Sullivan, a financial advisor with Sullivan Financial Planning in Denver, Colorado.

Sullivan emphasized, however, that the 4 percent rule of thumb is intended for those who retire in their mid-60s. “If you retire earlier, the withdrawal rate needs to drop,” she said. “Or, if you retire later, the withdrawal rate can potentially increase.”

In recent years, the 4 percent rule of thumb has been challenged by many in the financial community.

Some say it is outdated. Why? People are living longer with the help of medical advances, which means they may need to reduce their withdrawal rate to 2 percent or 3 percent to accommodate a longer retirement. The 4 percent withdrawal rate also assumes that retirees earn an average of about 12 percent on their stock investments and 5 percent on their bond investments per year, which may be more aggressive than many retirees' risk tolerance .

Others make the counterargument, suggesting that a 4 percent withdrawal rate may be too conservative depending on a retiree’s portfolio returns in the early years of retirement.3

They say that's fine if you aim to leave a large inheritance, but not so good if you plan to live large and “bounce the last check” — or use your savings to help loved ones and charities you care about while you are alive.

At the same time, a growing contingent of financial advisors suggest that a proportional withdrawal strategy, in which a retiree would take withdrawals from every account in their portfolio based on each account’s percentage of their overall savings, may be more tax-efficient in the long run for some retirees. (Learn more: Retirement and taxes )

While rules of thumb are a handy reference for quick calculations, Sullivan said it is no substitute for a customized financial plan that factors in all known variables, uses realistic projections, and maximizes tax efficiency.

Tax-friendly withdrawal strategies

To extend the life of your portfolio, conventional wisdom dictates that retirees should deplete their taxable brokerage accounts first, which gives their tax-advantaged accounts more time to deliver growth.

They can then move on to tax-deferred accounts, such as their traditional IRA and 401(k), leaving their Roth, which generates tax-free growth, for last.

As you run the numbers to calculate your ideal withdrawal rate, remember that the percentage you draw down each year is subject to change. To ensure that your money lasts a lifetime, you may need to adjust it annually to account for market performance.

Kraus said retirees can potentially create a more predictable income stream by maintaining a cash cushion that equals up to two years’ worth of living expenses. Cash reserves can be used to pay the bills when the stock market underperforms, which prevents retirees from having to liquidate stocks in a down market and gives their portfolio time to recover. It may also give retirees the peace of mind to avoid costly knee-jerk reactions to market swings, which may help their investment portfolio outperform over time.

“I think the best way for retirees to stretch their withdrawals is to have enough in safe investments to ride through bad markets and the flexibility in their expenses to cut unneeded items during these bad market cycles,” he said, noting a larger cash position also means those dollars will not deliver growth.

Ways to stretch your savings

If your ideal withdrawal rate is insufficient to cover expenses, there may be ways to stretch your savings.

You can potentially work longer, generate part-time income during retirement, reduce your living expenses by downsizing to a smaller home, or move to a lower-cost locale.

Homeowners who are age 62 and older might also consider a reverse mortgage, which allows eligible seniors to convert a portion of their home equity into cash without having to sell their property. ( Learn more: Reverse mortgages: What you need to know )

And, if you own a permanent (whole) life insurance policy, it may be possible to tap your cash value to help cover expenses. Just remember that access to cash values through borrowing or partial surrenders will reduce the policy’s cash value and increase the chance the policy will lapse. If this happens, it may result in a tax liability.

(Learn more: Tips for maximizing your retirement income )

The Social Security delay

For those who can afford to wait, it may also be possible to withdraw slightly more in the early years of retirement if it enables them to delay claiming Social Security — arguably, the most effective way to boost guaranteed retirement income, said Sullivan.

For each year you delay Social Security beyond your full retirement age, your benefit permanently increases by a fixed percentage until you turn age 70, when the benefit of delaying any further disappears. That locks in a higher benefit for life. Claiming Social Security later can also benefit a lower earning spouse, too, who may be entitled to a higher spousal and, later, survivors benefit based on the breadwinning spouse’s benefit. ( Learn more: Filing for Social Security retirement benefits )

Kraus said, however, that the wisdom of such a strategy is case specific. Someone with a health condition or immediate need for income may not benefit by delaying Social Security.

Trial run

Finally, financial advisors suggest pre-retirees take a trial run with their withdrawal rate before they quit their jobs. Practice living on the equivalent of your guaranteed retirement income and your monthly portfolio withdrawals for at least six months.

If it cramps your lifestyle, you may need to consider other options, including working longer, slashing your living expenses, tapping your home equity or life insurance, or using financial strategies that may enable you to safely elevate your withdrawal rate without running the risk of depleting your savings.

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Need financial advice? Contact us

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MassMutual, “MassMutual Retirement Income Study,” June 2018.

Social Security Administration, “Benefits Planner: Life Expectancy.”

Kitces.com, “The Extraordinary Upside Potential of Sequence of Return Risk in Retirement,” Feb. 20, 2019.

The information provided is not written or intended as specific tax or legal advice. MassMutual and its subsidiaries, employees, and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of MassMutual.