I’m excited to finally unleash my Safe Withdrawal Rate overview as I believe this financial concept can be life changing, when used properly. Note that the safe withdrawal rate concept and its application, while awesome, are definitely not for personal finance beginners. Reader beware.
Answering the “How much do I need to retire?“ question is critically important for anyone who wants to retire some day. Last I checked, that demographic consists of oh… let’s estimate it at “everyone”. And when retirement number predictions go wrong, there are bad consequences.
For most people, winning the lottery, a generous pension, a massive windfall inheritance, or becoming the next Elon Musk will not be in the cards. In order to retire, for most, it’s going to take hard work and saving as much as you can over decades to get there. It also requires some guidance. And that’s where the Safe Withdrawal Rate concept comes in.
What is Safe Withdrawal Rate?
Safe Withdrawal Rate, or SWR for short, is the maximum percentage of financial holdings you can safely withdraw each year from a portfolio without running out of funds (technically, with a 95% probability of success).
The thought of running out of funds in retirement is absolutely terrifying, so knowing what a safe withdrawal rate is absolutely critical for retirees (and future retirees). It gives you a benchmark on what you can safely withdraw. And with that benchmark, you can then calculate how much you will need to safely retire, based on your annual spending estimations.
You can see why this would be valuable information to know, right? If you know what the safe withdrawal rate is and you know what your annual spending is, you can calculate how much you need to save and work towards that. And that is kind of the holy grail of personal finance, isn’t it? This is powerful stuff.
To fully understand safe withdrawal rate, you first need to understand what withdrawal rate is and how to calculate it.
What is Withdrawal Rate?
Withdrawal rate is calculated by taking the amount of funds withdrawn per year and dividing it by the size of the entire portfolio. It is typically expressed as a percentage.
Safe withdrawal rate and withdrawal rate are not the same thing. SWR is a back-tested and modeled successful withdrawal rate benchmark (with a 95%+ success rate), while withdrawal rate is what you actually withdraw from your portfolio in the real world.
How do you Calculate Withdrawal Rate?
Here is how you calculate withdrawal rate, by equation:
Annual withdrawal ÷ portfolio amount = withdrawal rate
For example: for an individual who planned to withdraw $30,000 a year from an initial portfolio of $1,000,000, their withdrawal rate would be:
$30,000 ÷ $1,000,000 = 0.03 (or, 3%)
What is the Recommended Safe Withdrawal Rate? 3% or 4%?
Now that we’ve established what “withdrawal rate” is, let’s discuss what the experts have concluded is a “Safe Withdrawal Rate”.
There have been many studies and plenty of research on what the recommended safe withdrawal rate is. There is not a general consensus, but we are pretty close.
One of the most oft-quoted retirement research studies is the Trinity Study, which was published back in 1998. Researchers back-tested market/bond mixes over 15 and 30 year periods from 1925 to 1995. They concluded,
“If history is any guide for the future, then withdrawal rates of 3% and 4% are extremely unlikely to exhaust any portfolio of stocks and bonds during any of the payout periods shown. In those cases, portfolio success seems close to being assured.“
More recently, one of the leading retirement researchers in this area, Wade Pfau, updated the numbers and modeled William Bengen’s SAFEMAX (maximum SWR without failure) concept for a conservative 50% stock/50% bond portfolio for a retirement starting in each year going all the way back to 1926 (through 2010). You can see that the maximum SWR to avoid failure did not go below 4% over any 30-year time period.
Pfau more recently also provided this helpful table of withdrawal rate success for various stock/bond portfolios over different time frames.
As you can see in this table, having a balanced investment portfolio is key to having a safe withdrawal rate. If you just withdraw from a cash-only or overly conservative balance, there is a high probability you will run out of money (unless you start from a ridiculously high balance). You can also see that both 3% and 4% withdrawal rates lead to 100% success over most time horizons with 50% stocks.
There are lots of variables at play here, including present stock and bond valuations, inflation, and yields on Treasuries, which will influence returns in the coming years. And the series of returns (e.g. does the market crash in the first few years of your retirement or is there a big market run-up right after you retire?) have a significant impact on success rate. The thing is, the safety of any withdrawal rate can only be back tested, not future tested. There are not any future guarantees here, so no SWR (outside of 0%) is 100% safe. On the other hand, being too conservative (e.g. using a 2% withdrawal rate) means you’d potentially be saving significantly more than you’d ever need to save to comfortably retire.
With current high valuations in equities, Pfau recently concluded that a 3% SWR might be more appropriate than 4%. Some agree, but others in the field disagree and think 4% is still adequate.
You’ll hear many people in the field refer to SWR as the “4% rule”, as 4% was generally accepted as the maximum safe withdrawal rate based on prior research. Many of my personal finance blog peers have generally accepted 4% as the gospel SWR.
I tend to lean conservative on these matters, so for me personally, 3% is the SWR number I am most comfortable with. And, if I have room for error and outlive my portfolio, I’m just fine with that.
What if you Retire Early and have Longer than a 30-Year Retirement?
According to financial advisor and SWR researcher, Michael Kitces, it wouldn’t impact how much you need to save.
Notably, it appears that the safe withdrawal rate does not decline further as the time horizon extends beyond 40-45 years (given the limited research available); the 3.5% effectively forms a safe withdrawal rate floor, at least given the (US) data we have available.
In other words, if you’ve saved up enough for a 30 year retirement, your investment returns safely cover additional years of retirement (e.g. 40-45+ years). How cool is that?
How do you Apply the Safe Withdrawal Rate to Get a Retirement Number?
This entire article leads up to this. Let’s assume that you fall into the conservative 3% SWR camp.
Next, calculate what your annual spend is (and will likely be in retirement). Once you have this number, multiply the spend by 33.33 to calculate how much you would need (100% of your portfolio ÷ by your withdrawal rate of 3% = 33.33).
If your annual spend is $30,000, for example, your required portfolio number for retirement would be $1 million ($30,000 x 33.33).
Safe Withdrawal Rate Calculators
There are a number of SWR calculators out there to help you run some projections. A few of my favorites are:
- FireCalc: if you know your annual spending, your portfolio number, and the withdrawal time, it runs some success rate projections for you.
- CFireSim: runs similar projections, but with more variables.
YOU are the Ultimate Variable
We can vary on what the best safe withdrawal rate is and how much you need to retire, but here’s the thing – you control a lot of the variables. There is no rule that you have to statically begin withdrawing funds from your portfolio, without adjusting to current circumstances like huge market losses or huge inflation increases. For example:
- you could sell off belongings
- you could cut your withdrawal rate for a number of years and re-load until your balance returns
- you could go back to work if there is a market downturn
- you could generate income from real estate investments
- you could change your investment portfolio, based on market valuations
- you could change your spending habits (in fact, it’s typical that your expenses decline in retirement as commuting and other costs decline)
- you could earn income through hobbies to cover expenses
If you can get to a 3% withdrawal rate, exercise flexibility, and have some safety margin there’s a very good chance you’re not going to outlast your savings.
A Word of Caution on Safe Withdrawal Rate
As I noted at the start of the article, safe withdrawal rate is powerful stuff. And as such, you have to really know what you are doing in order to use it safely.
Here’s an example of where SWR can go wrong. Let’s say you have a lot of wasteful spending habits and spend $90,000 a year when you could easily trim that to $30,000. If you were to use the SWR exercise highlighted here, you would calculate that you need to save 3X as much money over your lifetime – which changes EVERYTHING. It might mean you need to work 3X as many years to get to your savings goal.
Before you ever think about using SWR, you need to boost your personal savings rate to the max and trim as much fat from your expenses as possible – and keep it there.
You also want to keep your expenses low and not be overly aggressive in your estimate of how low your expenses will be (e.g. going from employer sponsored health insurance to paying for yourself).
Also – you have to invest your funds and stay diligent by not trying to time the market, which is not for the faint of heart.
That is why SWR is really just a guide to give you ballpark retirement number estimates and withdrawals – the rest is up to you.