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4 Factors to Finding Your Ideal Retirement Withdrawal Rate

By Diane Mtetwa - Mar 22, 2021 at 6:06AM

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Make sure you consider these four things before deciding how much money you should take from your retirement accounts.

The amount of money you spend in retirement is a crucial factor in determining the type of lifestyle you will live. But it's also important for ensuring you don't run out of money.

How much you can comfortably take out of your accounts each year is unique to you and needs careful consideration. But no matter what, the ideal withdrawal rate should always consider these four things. 

Mature couple looking at documents and using a calculator.

Image source: Getty Images.

1. Your expenses

How much will your financial needs differ in retirement from the ones you had while you were working? Lower expenses will lead to a smaller withdrawal rate and higher expenses to a bigger one. It could be the case that your withdrawals exceed or just match the amount of money you will need. But if the amount of money that you'll want for your bills is more than the amount of money that you can realistically spend, you could be facing a retirement savings deficit.

If the rate of withdrawal that you've calculated is too high and could lead to you running out of money, you should work toward eliminating unnecessary expenses before you retire. Reducing the amount of money you spend on discretionary activities like dining out and travel can help a lot. If there are essential expenses that you can also control like downsizing your home, you may succeed in greatly cutting down your shortfall.

2. Your rate of return

How much you earn each year on your investments will play a big role in how much you can spend. If your accounts earn 10% each year on average and you're taking out 4%, they will still be growing at a rate of about 6% each year. In this scenario, you can probably afford a higher withdrawal rate than if your accounts only earn 5% on average each year.

But the asset allocation model that drives your rate of return shouldn't be based solely on how much you plan on taking from your accounts. Investing in a portfolio that is too aggressive for your investor profile could also be risky. These portfolios may earn more on average but are more volatile. In years when the stock market does very well, they will perform better than other portfolios. But in years where the stock market doesn't do well, they will lose more. While you're working, this may not be a big deal because your accounts have plenty of time and can regain any losses. But in retirement, you don't have time on your side, and losses are intensified by the money that you're taking out. So in a year like 2008, when large-cap stocks were down 37%, a portfolio that is taking out 4% in withdrawals each year will close out 41% lower.  

This is why lowering your risk exposure once you near retirement or have already retired may be necessary. This should provide you with less volatility but your trade-off will be a smaller rate of return and potentially a lower withdrawal rate.

3. Inflation

Inflation means the products and services you buy will get more expensive with the time. And affording them in the future means you'll need more money than you do now. 

For example, because of inflation, what you could buy in 1989 for $500,000 would have cost you more than $1 million in 2019. If the next 30 years were similar to the past, you could need over $2 million to afford the same lifestyle that $1 million would provide you today. There really isn't much you can do about inflation, but account for it in your plan so that you're saving enough for it. You can model inflation into your retirement planning needs by using a calculator that will project how your current bills will grow with inflation between now and when you retire. 

4. Longevity

How long you'll live in retirement matters when deciding how much you will take each year. If you live for 15 years, your money will need to last for a lot less time than if you live for 30 years. And the longer the time period that your money will spread out over, the smaller the withdrawal rate you should take. 

Having a family history of living a long life could mean that you have a higher chance as well. Other considerations when determining this number are things like your current age and gender. However, there is no surefire way of determining exactly how long you'll live so assuming that you'll live a long and happy life and saving for it can help you avoid guessing wrong. 

How much money you save is important. But equally important in determining whether or not you could outlive your savings is how much you spend. And planning in advance for this number could be the difference between a stress-free retirement and one where you live in fear of running out of money. 

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