Over the past ten years financial experts have been studying how much you can annually withdraw from your savings with the least risk of running out of money. Here’s a summary of two of the main withdrawal methods they recommend.

Withdrawing a dollar amount that adjusts for inflation

One way to tap your savings for income in retirement is to set a percentage to withdraw initially, and then annually increase that dollar amount to keep pace with the general rate of inflation.

For instance, if you want to be fairly confident that your savings will last for at least 30 years, through both good and bad economic times, one academic study* concludes that you should set your initial withdrawal rate at about 4%.

For example, if you have $500,000 in retirement savings and you set your initial withdrawal rate at 4%, you would take out $20,000 the first year. The next year if inflation is running at 3%, you would withdraw $20,600 (3% of $20,000 = $600).

A 4% initial withdrawal rate may seem like a limited amount. But keep in mind that you have to start with a low rate so you can increase your withdrawals each year for inflation. If you don’t increase your withdrawals for the general cost of living, you may not be able to cover your future expenses.

For example, let’s say you start out withdrawing $20,000 a year. Even with a modest 3% average annual inflation rate, that amount will only have the purchasing power of $12,665 after 15 years.

Importantly, this 4% withdrawal rate assumes that your savings is invested in a portfolio made up of 50% stock investments and 50% bonds. It also assumes that you would dip into principal as necessary.

Obviously, including a large percentage of stock investments in your portfolio subjects your savings to market dives like the one from 2000 to 2002. But given the stock market’s superior historical returns over the long haul, investing in stocks also increases the likelihood that your money will carry you through your retirement years.  That’s assuming, however, that stocks continue to outperform inflation, bonds, and other investments over the long run.

Withdrawing a dollar amount that adjusts for inflation – with limits

Another conservative way to spend money from your savings is to set a percentage to withdraw initially, and then only annually increase that amount under certain conditions. For instance, one study* concludes that you can set this initial amount to 5.8% and expect your savings to last 40 years if you follow a set of strict rules.

These rules in general: You maintain a diversified multi-asset class portfolio that includes a 65% allocation to stock investments. In addition, in years when your total investment return is negative you would not increase your withdrawal amount and you would cap the amount you withdraw in years of high inflation.

Furthermore, you would have to follow specified rules for generating your spending money, including selling the top-performing investments each year to rebalance your portfolio’s target asset allocation when necessary.

* The Journal of Financial Planning: January 1994, December 1997, April 2001, May 2001, December 2001, May 2003, October 2004

Article is for educational purposes only and is not intended to provide specific tax or legal advice. For answers to tax questions, please see your tax professional. For legal questions, consult an attorney.

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