The document discusses strategies for withdrawing funds from retirement accounts during retirement. It presents three strategies: consumption, expected, and bequest. Consumption allows higher initial withdrawal rates but results in lower portfolio values later. Expected uses average life expectancies. Bequest prioritizes preserving funds for heirs with lower initial withdrawal rates. The appropriate withdrawal rate depends on the strategy and retiree's age, with higher rates recommended the older the retiree.

1. Withdraw 4% in Retirement?
Submitted by Larry Frank Sr. on Wed, 07/11/2012 - 12:00pm
The 4% rule for retirement income says you can safely withdraw that
amount of your portfolio value each year when retired. For example, for
each $100,000 you have in your retirement accounts, you can withdraw
4% or $4,000 per year (or $333.33 per month). But the longer you live,
the more money you can remove without depleting our assets. So you
can withdraw above 4% as you move deeper into retirement.
The 4% rule applies to early retirement years in general, but does not fit
older ages. The rule was also originally developed using 3% inflation
added to the “initial” withdrawal dollar amount each year. Thus, the
inflation adjustment for the example above would be $4,120 for the
second year, $4,244 for the third year and so on.
This creates a problem where the benefit paid is disconnected from the
actual value of the retirement portfolio that is supposed to support the
payment (much like pensions and annuities) and may lead to
dramatically reduced portfolio balances. Instead, a real withdrawal
amount – one that factors in inflation – should be used each year where
the real rate is applied to the actual value of the retirement portfolio.
Therefore, the benefit paid and the actual portfolio values remain
connected.
We’ll go into the particulars in a minute. Look at the top third of the chart
for the three groups: 1) Consumption(where the simulated lifespan, or
time period used for this year’s simulations for the current age, is
shortest and retirees remove more money), 2) Expected (traditional
lifespan expectations are used in the simulations and retirees withdraw
”normally”) and 3) Bequest (the longest simulated lifespans are used in
the this year’s simulations and retirees are even more careful about how
much they take out).
The older you get without dying, the more years you are likely to live.
Any calculation needs to have a time frame over which the calculation

2. covers. Simulations are no different. But how long a person might live is
uncertain. Therefore, longevity tables use percentiles to help determine
the length of certain possible lifespans. The bottom two-thirds of the
chart show how many years each group used in the simulations for each
age, and to what age they take the retiree.
As they age, they can safely take out more money from their retirement
accounts. So a 60-year-old in the Consumption group can withdraw
4.66% per year. By 80, he can remove 10.53%.
These conclusions come from peer-reviewed research – published
March 2012 in the Journal of Financial Planning by me and my
collaborators, John Mitchell from the University of Central Michigan and
David Blanchett from Morningstar.
The figure above is based on a 60% equity, 40% bond allocation. I
picked this allocation because withdrawal rates may be slightly higher for
more conservative allocations so these may be interpreted as
reasonable rates. More aggressive allocations tend to have lower
withdrawal rates.
The figure shows the three groups, or as we call them, objectives
because the numbers measure how much people plan to take out, when
and under what assumptions. The Expected lifespan is what people think
about when they talk about longevity. The Expected objective uses
expected longevity from the Social Security period life tables (joint). This
is where 50% of the population at the given age outlives the expected
lifespan, which is an average so it’s reasonable that half the age cohort
will outlive that number. That is why some people get to be very old. We
just don’t know, though, if we will be one who outlives the period or not
until we get to that older age.
The Consumption objective sets the longevity time frame such that 75%
of the people at the stated age outlivethe shorter simulated lifespan. In
other words, the time period from the table is shorter than expected. Why
would a retiree use a shorter than expected period?
For two reasons: First, and more importantly, a shorter period allows for
a higher consumption (hence the label Consumption). This may be a
realistic objective to spend more during the early years of retirement and
then reduce spending later in retirement. Now, this objective can be
measured and monitored. Second, the simulated period is only
temporary. The older you get, the longer your expected lifespan is. In the
figure above, at age 60 the simulated lifespan is 24 years to age 84. In
planning for the future, the retiree only uses that number for a few years,
and then they adjust to lifespans based on expected longevity, for
example (the yellow shading).

3. Spending more early comes with a cost, though. Your portfolio value is
reduced faster by spending more, which means that later portfolio values
are less than they would be using Expected time frames (or even the
Bequest time frames discussed later). So, even though the withdrawal
rates can go up slowly at later ages, the portfolio values are lower with the
result of less monthly income at those later ages. The longer the higher
consumption rates are used, the stronger this effect.
Lastly, the Bequest objective determines the time period from the
longevity table for each age based on the time frame where 25% of the
population outlives the simulated lifespan (blue highlight that transitions to
yellow). This results in longer than expected lifespans and
therefore lower withdrawal rates. Now, a retiree can measure and
determine a retirement supplement income and have portfolio values
deplete at a much lower rate for either their bequest wishes, or to retain
the assets for their health, or other needs, later in their retirement years. In
other words, this has the opposite effect from Consumption discussed
above; and Expected is the mid-point between these two measurable
goals.
Note that a withdrawal rate near 4% in the figure is found near age 60 in
general. The rate increases past age 65 and older because the simulated
lifespan slowly gets shorter as retirees age. In other words, now there are
different rates for different retiree goals and situations which are much
more realistic than shoehorning all retirees into one 4% rule.
A general observation from the figure above is that both time periods and
withdrawal rates change as the retiree ages. Each retiree may choose
which strategy to use, and may change the strategy as they age. Indeed,
changing from Consumption, through Expected, to Bequest is suggested
to have some portfolio value preserved for the possibility of getting even
older. Also, even a Bequest goal may temporarily change to the
Consumption goal for a year or two, and now with a measurable method
of how to do that, and then change back again.
My message: Each year is determined separately as opposed to the
classic thought of set-and-forget retirement. Life and retirement
withdrawals are more dynamic than set-and-forget. The above
demonstrates that there is a range of choices between which you can
interpolate each year. For example, if you are a 65-year-old retiree, you
may withdraw between 4.11 and 5.29% of your current portfolio balance
depending on your overall objective to consume or conserve your
portfolio. The withdrawal percentage changes each year you age. And,
when you reach 80, you may withdraw between 6.35% and 10.53% of the
portfolio balance (we don’t know what that value might be when you are
80 because nobody knows what any market might do over the next 15
years).
Also, notice the older a retiree gets, the older they are expected to live.
For example, in their 60s a retiree’s (joint) expectations are about 90 while
in their 80s expectations have changed to late 90s. Males and females as
singles would have slightly younger ages than those above, so using joint

4. ages makes the time period slightly longer, which makes the withdrawal
rates illustrated conservative.
Finally, all the calculations were based on 10% of the simulations (Monte
Carlo method) not reaching the end of the period. This last point leads to
the subject of my next article: How to measure your retirement when the
markets go down, and when to make a decision about what to do when
that happens.
Note: Withdrawal rates reflect a temporary percentage that may be
removed from a portfolio given a specific set of parameters at that
specific moment in time; they are not rates of returns.
The above article is third in a retirement series. The first series
article: Retirement Planning Mistakes. The second series article: Moving
Your Retirement Goal Posts? Other articles for the not-yet-retired: In
What Should the Young Invest? And Consistent Savings Tops Returns.
Follow AdviceIQ on Twitter at @adviceiq.
Larry R Frank Sr., CFP, is a Registered Investment Adviser (California) in
Roseville, Calif. He is the author of the book, Wealth Odyssey. He has an
MBA with a finance concentration and B.S. cum laude in physics with
which he views the world of money dynamically. He has peer-reviewed
research published in the Journal of Financial
Planning. www.blog.BetterFinancialEducation.com.
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Topic:
Retirement Planning
Spending
Withdrawals from 401Ks