The accumulation phase in retirement planning is important, but so is the spending phase. What if you spend too much in the initial years and run out of funds? The safe withdrawal rate (SWR) can solve this problem. It tells you how much you can withdraw each year from your corpus to ensure you don’t run out of money.
SWR is a conservative approach towards making sure your retirement corpus doesn’t get exhausted prematurely. When you’re saving for retirement, there is also a lot of uncertainty in terms of life expectancy, the markets, or how economic indicators such as inflation will pan out. All of these have a direct impact on your investments. So, be careful about how much you withdraw from it every year in order to meet your expenses.
How it works
SWR tries to protect your savings from such factors by inhibiting retirees to withdraw beyond a certain percentage from their corpus, typically 3-4%. The 4% rule was extracted from financial advisor William Bengen’s research paper in 1994, which said 4% should be the standard rate of withdrawal. He based his study on different portfolios made of combinations of equity and bonds. Bengen’s research took into account major economic events such as the Great Depression and the 1970s bear market. He assumed a retirement period of 30 years and said extracting at 4% in the first year, followed by inflation-adjusted withdrawals in subsequent years will ensure the corpus doesn’t get drained prematurely.
While SWR is a basic thumb rule you can follow, most financial planners prefer to analyse the needs on a case-to-case basis. Following this rule may work for one retiree but not for another as the withdrawal rate depends on your asset allocation, choice of investment tools and how the market performs.
Also, with increase in cost of living, expecting retirees to restrict themselves may not really work. Being too conservative could actually leave surplus money in your corpus which you could’ve used for a better quality of life during retirement.
SWR aims at emptying your corpus when you die or leave only as much as you’d want to give in inheritance, which generally isn’t possible as there are a lot of factors involved in how your corpus will get used up.
A better alternative to SWR is calculating how much you’ll require for your retirement based on the present and future value of your cash flows, which measures how much you will need in the future at a specified rate of return. Take into account your current monthly expenses, inflation and how much corpus you have. This will help you determine how much return you need on your corpus till you are alive. Accounting for future inflation will help you bring it to today’s value and get a realistic number. Most retirement calculators now use this principle to help you understand how much you’re required to save for a stable retirement.