What Does This Article Cover?
- What is a withdrawal rate, and how can it affect my retirement?
- How can I be certain my retirement portfolio will last throughout my retirement years?
- How can fixed annuities help smooth out my retirement income?
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"How much can I afford to withdraw from my retirement savings annually without eating away at my principal? How do I make it last as long as I need it to?" Both are key questions for anyone who is retired or contemplating retirement.
Even people who have accumulated $1 million, long considered a "safe harbor" amount for retirees, are concerned. If they withdraw too much, they may exhaust their savings; too little and they can unnecessarily lower their standard of living. These concerns have been exacerbated by the recent bear market that reduced the earnings of, or in some cases depleted, millions of portfolios.
Everyone's situation is different; no single withdrawal rate is right for everyone. People without heirs may wish to withdraw more aggressively than those looking to pass assets on to future generations. Moreover, the more a portfolio is responsible for retirement income, that is, the less a retiree receives from Social Security and pensions, the more conservative the withdrawal rate should be to ensure that retirement savings last 30 years or longer.
The Trinity Study
In what has become known as the Trinity Study, three professors from Trinity University in San Antonio, Texas, studied actual historical stock and bond returns to determine sustainable withdrawal rates. The study, first published in 1998 in the Association of American Individual Investors Journal, has gained renewed significance in light of recent turbulent economy.
Using data from 1926 to 1995, the professors looked at five possible portfolio compositions, from 100 percent stocks to 100 percent bonds - the three other portfolios were: 75 percent stocks/25 percent bonds, 50/50 stocks and bonds, and 25/75 stocks and bonds - and evaluated the impact of fixed annual withdrawals ranging from three percent to 12 percent. Stocks were represented by the S&P 500, while long-term high grade domestic bonds were used for the bond portfolios.
Payout periods were in five-year intervals, from 15 to 30 years. In the study, the professors considered a portfolio successful if it ended a particular withdrawal period with a positive value.
The study produced a number of conclusions, including:
- Withdrawal periods longer than 15 years dramatically reduced the probability of success at withdrawal rates exceeding five percent.
- Bonds increase the success rate for lower to midlevel withdrawal rates, but most retirees would benefit with at least a 50 percent allocation to stocks.
- Retirees who desire inflation-adjusted withdrawals must anticipate a substantially reduced withdrawal rate from the initial portfolio.
- Stock-dominated portfolios using a 3 to 4 percent withdrawal rate may create rich heirs at the expense of the retiree's current standard of living.
- For a payout of 15 years or less, a withdrawal rate of 8 to 9 percent from a stock-dominated portfolio appears sustainable.
Figures quoted are for illustrative purposes only and are not necessarily indicative of past or future results of any specific financial product. Your individual situation may vary, please consult with your professional advisors, including a financial professional, regarding your own retirement situation and strategy.
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