My wife and I are hoping to retire soon. What percentage of our investments can we withdraw each year? And, do you recommend a high-yield investment portfolio to create the necessary cash flow during retirement?

Studies suggest that for people retiring between the ages of 62-65, a withdrawal rate of 4% of their assets is safe, but 5% significantly increases the likelihood of running out of money during their lifetime. Unfortunately, those studies are not specific enough for real financial planning questions.

Not everyone is between 62 and 65. Nor do everyone’s withdrawal choices move in neat intervals between four and five percent. Real clients want to know the specifics: “What percentage of my assets can I safely take out this year and still be able to provide for my spouse and me each year for the rest of our lives?”

As a result, we’ve developed safe withdrawal rates for ages 0 to 100. Our rates are based on age-appropriate asset allocation mixes and assume that withdrawal rates will go up each year to meet the needs of inflation. Withdrawal rates should also be conservative enough to allow for inflation-adjusted increases even when the markets have a poor year.

Reproduced in this table are some of the results:

Age	Withdrawal Rate
62	4.11%
65	4.36%
70	4.77%
75	5.35%
80	6.22%
85	7.66%

 

To illustrate this point, let’s take an example. Wally and Wilma Wahoo are 75 with a $1 million portfolio. If they withdraw $53,500 or 5.35% from their account at the beginning of the year, and their portfolio grows by 9% over the next 12 months, then at the end of the year their account would be worth $1M -$53,500 = $946,500 + 9% growth = $1,031,685.

Next year, when they are 76 years old, their new withdrawal rate according to our table is 5.49%–slightly more. Since their account value and withdrawal rate are now larger they would get a raise. Following this plan, at the beginning of year two they would receive a 5.9% raise or $3,139 more for the year. (5.49% of $1,031,685 = $56,639 for the year.)

Since their allowance increased, their standard of living can keep up with inflation and then some. If they want to be safe, they could simply not increase their standard of living for a few years to compensate for feared downturns.

Many people make the mistake during retirement of thinking that they need to have mostly interest-paying and dividend-paying investments to generate cash for withdrawals. This is incorrect.

People often have an unwarranted fear that they can’t “touch the principal” and therefore, should not sell stock to generate cash. For retirement income, it doesn’t matter if you receive $50,000 in interest and dividends or if you receive $50,000 by selling assets that realized a capital gain. Either way, $50,000 is $50,000.

Let’s consider an example. If 100 shares of a stock double in value and then, the stock splits and you sell half your shares, have you “touched the principal?” The truth is, you are left with 100 shares of the exact same stock at the exact same value, plus a pile of cash. There is no difference between this case and getting paid that pile of cash in dividends.

What if the stock does not split, so you still have 100 shares, but the value has doubled since you purchased it? Then selling 50 shares means you are left with fewer shares, but the value of your position is back where you purchased it. You have not “lost money” by selling half your shares. The number of shares is less important than the value of those shares in your account.

Putting everything in one type of investment is usually more volatile than diversification. Therefore, we do not recommend an exclusively interest and dividend-paying portfolio. But, having said that, I must add that some good dividend-paying stocks, sometimes called “value” stocks, get a higher return and at the same time are less volatile than “growth” stocks. We often recommend overweighting value stocks, even in a non-retirement portfolio.

Retirement plans should be reviewed annually. Doing a projection every year will help you determine how much you should be saving or, if you are retired, how much you can spend. A handy goal to aim for is to save 24 times your salary by the time you retire.

The original version of this article was published on March 6, 2006. Photo used under Flickr Creative Commons license.