What is the safe withdrawal rate for retirees living off portfolios?
One of the most perplexing problems when planning for retirement is figuring out how much can safely be withdrawn from an investment portfolio for spending.
Withdraw too much and a retiree risks running out of money before death.
Withdraw too little and the retiree may crimp his lifestyle but end up leaving substantial wealth to heirs.
Three unknowns complicate the problem: how long you will live in retirement? what investment markets will gain or lose each year? and what will be the inflation rate?
The age problem is the simplest: to be conservative, assume a long life span, say 90.
The other two factors are more complicated. Studies have tried to come up with a safe rate using a wide variety of potential investment return and inflation scenarios. The consensus is that a rate between 4.5 and 5 percent is safe in virtually any period.
However, that doesn’t address the many periods when it may be safe to withdraw 6 percent, or even 10 percent during periods when inflation is low and investments appreciate.
A new study by Michael E. Kitces of Pinnacle Advisory Group in Maryland found a relation between stock prices at retirement and the safe withdrawal rate.
Specifically, when the 10-year average price to earnings ratio of the U.S. stock market is high, then the market is overvalued and new retirees should take as little as 4.5 percent from their portfolios.
When the P/E ratio is low, they can take anywhere from 5 percent to 10 percent of their portfolios, depending on how cheap the market is at the time.
Currently the 10-year average P/E is above 20, a historically high number that calls for a safe withdrawal rate of 4.5 percent per year, Kitces says.