The Safe Withdrawal Rate

By John Lumbard.

  The “safe withdrawal rate” is the amount of cash a retired person can withdraw from an IRA or other investment account without someday running out of money.  It’s not an easy figure to calculate, because you need to project your investment returns and your cost of living for the next 30 or 40 years.  Many experts have been revising their expectation of future returns downward, even as they fret that inflation will run hotter as a diminished pool of workers tries to care for a much larger population of retirees.  If you think plumbers are expensive now, check back with us in 20 years . . . . .

In fact, it might be a good idea to start with a lower rate, expecting to raise it as time goes on.  The days of robust inflation adjustments to Social Security will probably end as soon as the  Baby Boomers retire in numbers, and you can be certain that Medicare will be scaled back.  Taxes will be higher.  Yet it’s actually confusing to frame the problem in terms of taxes and benefits, because the real problem is that we’ll never again (in our lifetimes, anyway) have the luxury of supporting a relatively-small retired population with a huge labor force.  Even if we were socking money away in the Social Security Trust Fund, it would only be money—or bonds, stock certificates, or gold.  In 2040 we won’t need gold;  we’ll need roof repair, electricians, nurses, garbage collection, and cruise-ship crewmen.  Well, you can forget the cruise ships;  few Baby Boomers will be able to afford them. 

What we can do, as individuals and as a nation, is refrain from borrowing.  We’ll feel pretty stupid (not to mention hungry) if we find ourselves sending our food overseas to pay back debts incurred when we were young and rich. 

Most other developed countries will be in the same demographic fix.  Everybody knows that this is true for Europe and Japan, but China’s demographic problem is far worse.  The U.S. has the option of importing workers from Mexico, but—oh yeah— we did a lot of that in the boom years when we didn’t really need the help.   30 years from now those workers will be in nursing homes collecting benefits . . . . .

But let’s go back to that safe withdrawal rate.  Many experts have cut it back, from 4% to 3%—a number that sounds harsh, after all those years of assertions that stocks “pay” 10%.  Still, it’s far above the rate paid on CDs, and it’s far above the stock market returns of the last 10 years.   

We’d like to add that age is an important factor here.  If you have ten years to live, you can certainly withdraw 10% of your account each year and spend it.  And we’re confident enough in our own investment returns that we’re not recommending that our clients cut back their withdrawals.  Still, if you are newly retired and your return for the last decade was 3%, you might not want to take more than that in the next decade.  You can always look forward to bumping it up every 5 or 10 years, and pulling out big hunks of principal when you get older. 

Savings and frugality are the new mandates for individuals, and they’re the new mandates for government.  We got ourselves into this fix, and now we’re just going to have to work our way out.

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