New Year, New You, New Withdrawal Rate

What is a safe withdrawal percentage I can take from my portfolio this year?

This time of year, many people look forward to the fresh start a New Year can bring. Many of us set resolutions focusing on quitting bad habits like smoking, avoiding junk food, or reducing screen time. Others aim for self-improvement, like eating healthier, going to the gym more often, or reading more books. Some even contemplate significant lifestyle changes to turn the page after a difficult year or simply because they’re ready for a new challenge. As we plan for the New Year and what we hope to achieve, we also review our financial goals, which may involve setting a budget and spending rate for those living off their investment accounts.

For retirees or those new to retirement, uncertainty about how much they can spend from their investments can create anxiety, especially after a year where markets or economic factors like inflation had a negative impact. Conversely, after two consecutive years of great market performance, some retirees are feeling bold and looking to spend more thanks to larger asset base. This is when many clients ask about a safe withdrawal amount, hoping for a clear and confident answer.

Seeking a rule of thumb for a safe withdrawal rate isn’t a new concept in the financial planning industry. In the early 1990s, advisor William Bengen published a study in the U.S. Journal of Financial Planning that led to the “4% Rule,” a simple way of estimating how long your investment portfolio might last. He examined different withdrawal rates over potential starting retirement years (1926 – 1976) using historical returns for a portfolio of stocks and bonds. With a 50% stock and 50% bond portfolio, he found that withdrawing 4% of your initial investment each year, adjusted for inflation, usually made the portfolio last at least 50 years. The worst-case scenario was around 30 years (starting retirement in 1976). If you increased the withdrawal rate to 5%, the chance of the portfolio lasting significantly shorter, even as little as 20 years, went up. On the other hand, a withdrawal rate of 3.5% per year meant the portfolio always lasted at least 50 years. This conservative approach helped address Sequence of Return Risk, which is bad timing when needing to take distributions in times when markets are down early in your plan.

A few key planning variables were not considered when deriving the 4% rule but apply in real life:

• Asset Allocation
The study aimed to test portfolio longevity, not considering how much money was left over in circumstances with very high success rates. Multiple asset allocations beyond 50% equities / 50% fixed income were tested, and those with higher allocations to equities provided similar success rates but more “wealth creation.” In fact, a 75% allocation to stocks included a scenario where a plan ended with four times the initial starting amount. It’s impractical to think someone would want to leave this much life on the table as time went on, and this surplus capital came into focus.

• Inflexibility
The 4% rule is inflexible, assuming that the same spending rate adjusted for inflation remains constant over the life of a plan. Life isn’t linear, so one-time additional expense needs, for both good (extra vacation or luxury purchase) or bad (extreme health event) reasons, were not accounted for. In the scenario where a plan was set to quadruple the initial starting value of capital, why wouldn’t the spending rate increase?

• Taxes
The study also did not account for potential tax obligations. The tax location of the portfolio matters, as income realized from tax-deferred retirement accounts and after-tax brokerage accounts can be subject to different tax rates.

So, does that mean that we should actually look at higher initial spending rates, especially for those of us willing to take on more equity risk? Maybe double the rule of thumb to withdraw an 8% rate like one financial planning pundit controversially claims is a sustainable rate?

The reality is that an 8% distribution rate could work in cases where someone has a very short time horizon and isn’t concerned about leaving a legacy to family or charity. It most likely does not work for most people, but financial planning has evolved over the last 30+ years to better answer this question regarding a safe withdrawal rate. Morningstar, a financial services and investment research firm, updates their study on safe withdrawal rates annually. They concluded that for 2025, thanks to higher equity valuations and lower bond yields, future projected returns for the capital markets have come down since last year. They believe 3.7% is the highest safe withdrawal rate after calculating a higher safe withdrawal rate of 4% in 2024.

Their updated analysis also looked at more practical withdrawal strategies, including the concept of Dynamic Withdrawal Strategies, which involves adjusting how much you can withdraw each year. In tough markets, take out less; in strong markets, you might be able to take out more. This flexible approach usually allows for higher withdrawal rates. It helps prevent spending too much when the market is down and gives you a bit of a raise when it’s doing well. Here are some examples of different types of dynamic withdrawal strategies based on timing:

• Retirement Spending “Smile”
Practically speaking, retirement spending tends to gradually decrease during retirement. As you age in retirement, people tend to do less and therefore need less income until the later-stage years when there is an increase in spending for long-term care or other medical expenses. This pattern of gradually reducing expenses that then increase later looks like an actual “smile” when plotted on a chart. This strategy accounts for increased spending later in life but allows for a higher initial withdrawal rate.

• Retirement Spending “Stages”
There are multiple phases of retirement. Spending patterns start off high at the onset of retirement, or the Go-Go Years, and then tend to decline as people slow down. Assumed spending can be reduced in phases to account for the Slow-Go Years and then again towards the end of a plan, or sometimes referred to as the No-Go Years. This strategy supports the thought that life is not linear, and in reality, we’ll want to spend earlier since we most likely won’t be able to be as active in the later stages of life.

• Guardrails
The Guardrails method, created by financial planner Jonathan Guyton and computer scientist William Klinger between 2004-2006, allows retirement spending to fluctuate with market performance for the specified timeframe. Each year, it adjusts withdrawals based on how well your investments are doing and the previous withdrawal percentage. The goal is to give you raises when the market is doing well but also lower withdrawals after market losses, aiming for a balance. This method allows for higher initial withdrawal rates but adheres to strict rules to make it work. Decision rules include when to adjust spending up to account for inflation and how to take distributions from your investments, dividends, and interest first, when markets dictate lowering your withdrawal percentage. Planners are testing alternatives or variations to the Guardrails method due to concerns that large changes in withdrawal rates from year to year based on market performance (2022 vs. 2023) might be difficult for clients to stick to.

As with most Rules of Thumb, the 4% withdrawal rule is a general principle that is mostly correct in predicting a safe withdrawal rate. But when it comes to your retirement, you may not be comfortable with being mostly correct. The best way to confirm your safe withdrawal rate is with your ACM Wealth Advisor. Planning how to withdraw money in retirement can be tricky, but there are various options to consider. How flexible you want to be with your spending depends on factors like whether you prefer a steady income, want to withdraw as much as possible, plan to leave money for your heirs, and how much of your regular expenses are covered by sources other than your investments, like social security, a pension, or other income sources. As part of your annual review with ACM Wealth advisor, it’s imperative to review your withdrawal strategy and know what changes you can make to stay the course towards a successful retirement.

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