How to Draw Down Your Savings: The Flexible 4% Guideline

You’ve likely spent much of your career saving for retirement. Watching that nest egg grow gives most investors a sense of security and a feeling of achievement—saving over many decades is no easy task. It’s no wonder, therefore, that the prospect of drawing down those funds in retirement can be intimidating. The good news: Considering an initial 4% withdrawal amount that adjusts for inflation each year can help ensure your savings will last throughout your retirement.

You can apply the 4% guideline in a flexible way that accounts for your own personal circumstances and lifestyle. "The 4% figure serves as a starting point for your withdrawal strategy," says Judith Ward, CFP®, a senior financial planner with T. Rowe Price. "It’s a way to put your retirement portfolio into the context of a 30-year payment stream."

Any drawdown strategy should be based on the amount of annual income you’ll need to sustain your retirement. T. Rowe Price recommends aiming to replace 75% of your preretirement annual income in your first year of retirement. After all, most retirees’ expenses drop, given that they no longer need to make retirement savings contributions or fund work-related expenses, such as commuting costs and payroll taxes.

Another important component of your income plan details where that income will come from. For example, say you earned $100,000 in your final year of work. In your first year of retirement, you might aim to draw $75,000 from a variety of sources, including:

50% or $50,000 from your retirement savings accounts.

20% or $20,000 from your Social Security benefits. (See Managing It for more on Social Security strategies.)

5% or $5,000 from other sources of income, such as part-time work.

The 75% target is just a starting point, however. You may need less income in retirement, or more, depending on your desired lifestyle. The percentage provided by each income source also may vary. For example, the portion from Social Security may be a lower or higher percentage of the total income, depending on your preretirement salary and desired annual income.

Withdrawing your assets too quickly could jeopardize a career’s worth of savings. Fortunately, the 4% guideline provides an effective way to estimate the income stream your retirement savings may produce, taking into account that you will need to increase your withdrawals throughout retirement to keep pace with inflation. For example, with $500,000 in retirement savings, the guideline suggests you could withdraw $20,000 in your first year, followed by $20,600 in your second year, and $21,218 in year three, assuming a steady 3% rate of inflation.

A recent study by T. Rowe Price confirmed that a 4% initial withdrawal amount is still a viable guideline for most retirees. The study looked to identify an initial withdrawal that, when adjusted for inflation, could be sustained for 30 years with a 90% probability the investor won’t run out of money. "After examining returns for a diversified portfolio of 60% stocks and 40% bonds over rolling 30-year periods beginning in 1926, we identified 4% as a feasible initial withdrawal rate," notes Ward. That rate was sustainable at a 90% confidence level regardless of the value of stocks and bonds at the investor’s time of retirement.1

Though the 4% guideline offers a sound basis to help you plan your withdrawal strategy, the figure is not set in stone. In fact, T. Rowe Price encourages investors to adjust the guideline based on your personal circumstances—if, for instance, you continue to work part time as you transition into retirement. You may want to withdraw less than 4% from your retirement savings in those first few years, which could mean you’ll be able to withdraw more from your retirement accounts later on, when you are no longer working.

You can also adjust your withdrawal amount annually based on the performance of your investments. For instance, consider withdrawing less income following a bear market, to reduce the risk of prematurely depleting your savings. The T. Rowe Price study found that investors have the flexibility to withdraw more in their first year if they don’t increase withdrawal amounts for inflation in years after their portfolios drop in value.2 "While we may caution you about withdrawing more than 4% without carefully evaluating your needs and sources of income, the results of this study are very good news for most preretirees ," says Ward. "Many times, retirees may start by withdrawing 4% of the portfolio, but then find that they need to take additional withdrawals over and above what is available in their emergency fund. This study suggests they will have some room to withdraw more than the 4% withdrawal plan amount from time to time without increasing their risk of running out of money."

Keep in mind, however, that once you reach age 70½ you’ll need to withdraw enough from your qualified retirement accounts to satisfy your required minimum distributions (RMDs), regardless of the 4% guideline. Reinvest any excess withdrawals in a taxable account.

Reaching your retirement savings goal is a great achievement. As you approach retirement, plan how you’ll draw down your savings. The 4% guideline offers a way to balance your need for income in retirement with your desire to avoid outliving your assets. T. Rowe Price strongly encourages investors to revisit their withdrawal strategy each year. Circumstances change and your portfolio balance will change, so you may need to make adjustments. Making sure your portfolio lasts throughout your retirement is too important to depend on a "set it and forget it" strategy.

1, 2Assumes the portfolio is rebalanced monthly.
This historical study conducted by T. Rowe Price covered 690 30-year withdrawal periods from January 1926 through June 2013. In the study, investment-grade bond returns were from Ibbotson and were represented by the U.S. IT Government Index 1926–1972, the Lehman Brothers Government/Corporate Index 1973–1975, and the Barclays U.S. Aggregate Bond Index from 1976–present. Stock data were represented by the S&P 500 Index, from Ibbotson. Historical inflation data were used, from the Federal Reserve Bank of St. Louis. Past performance cannot guarantee future results. All investments are subject to market risk, including possible loss of principal. It is not possible to directly invest in an index.

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