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What is a Safe Drawdown Rate?

Published in Retirement Withdrawal Rate 2 mins read

A safe drawdown rate refers to the percentage of your retirement savings you can withdraw each year without significantly risking running out of money during your lifetime.

The 4% Rule: A Widely Known Approach

One of the most widely cited approaches to determining a safe drawdown rate is known as the 4% rule. Based on research by financial planner William Bengen, this rule suggests a specific strategy for retirement withdrawals.

According to this approach, investors could safely set their annual withdrawal rate to 4% of their initial retirement pot and adjust it for inflation without running out of money over a 30-year time horizon.

How the 4% Rule Works

The core idea behind the 4% rule is simple:

  1. Calculate 4% of your total retirement savings on the first day of retirement. This is your withdrawal amount for the first year.
  2. In subsequent years, adjust the previous year's withdrawal amount for inflation.
  3. Continue this process annually.

Example:

Year Initial Pot Year 1 Withdrawal (4%) Inflation Adjustment (e.g., 2%) Year 2 Withdrawal
1 $1,000,000 $40,000 N/A N/A
2 N/A N/A +$800 $40,800

Note: The portfolio value will fluctuate based on investment performance, but the withdrawal is based on the initial balance and adjusted only for inflation in subsequent years.

Factors Influencing a Safe Rate

While the 4% rule provides a starting point, the actual "safe" rate for an individual can vary based on several factors:

  • Investment Portfolio: The asset allocation (mix of stocks, bonds, etc.) significantly impacts potential returns and volatility. The 4% rule was based on a portfolio mix, typically including stocks and bonds.
  • Time Horizon: The rule is often cited for a 30-year retirement period. Longer or shorter retirements might necessitate adjustments.
  • Market Conditions: Starting retirement during a market downturn can pose challenges ("sequence of return risk").
  • Spending Flexibility: Having the ability to reduce spending in poor market years can increase the sustainable withdrawal rate.
  • Other Income Sources: Pensions, Social Security, or part-time work can reduce reliance on portfolio withdrawals.

Is the 4% Rule Still Relevant?

The 4% rule remains a popular guideline, but some financial planners and researchers debate its continued applicability in the current economic climate (e.g., lower bond yields). Some suggest slightly lower rates (like 3.5%) or more dynamic withdrawal strategies that adjust based on portfolio performance.

Ultimately, determining a truly safe drawdown rate requires personalized financial planning considering all individual circumstances.