FOR RELEASE:
August 9, 2007
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Beau Ballinger
Public Relations Manager
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DENVER…August 9, 2007…Research in recent years has established rule-of-thumb “safe” portfolio withdrawal rates for retirees so their nest egg doesn’t run out of money. But an article in the August 2007 issue of the Journal of Financial Planning, published monthly by the Financial Planning Association®, offers a method for retirees to establish their own retirement withdrawal profile and then apply withdrawal rate rules that allow them to accomplish that plan. They’re in control instead of being held to a one-size-fits-all rate.
Typically, an initial withdrawal rate is calculated that takes into account the projected length of retirement, such as 25, 30, or 40 years; the portfolio’s allocation; and the fluctuation of markets and inflation. The initial withdrawal rate, for example, might be 4 percent of the portfolio’s value at the time retirement starts. The initial amount withdrawn is adjusted upward for inflation each year, but the amount doesn’t change in real dollars. Some researchers have developed rules to boost an initial withdrawal rate as long as the retiree is willing to make withdrawal adjustments in later years to compensate for weaker portfolio returns or higher inflation rates than projected.
Under these approaches, “withdrawal rates are defined and retirees are forced to fit their lifestyles to the resulting withdrawal stream,” writes William J. Klinger in his article, “Using Decision Rules to Create Retirement Withdrawal Portfolios.” “A more natural approach would be for retirees to specify their desired retirement withdrawal profiles and have annual retirement rates defined to produce each profile.”
Klinger, co-author with financial planner Jonathan Guyton of a 2006 Journal paper on decision rules for withdrawal rates, defines three primary retirement profiles. Under the uniform profile, the retiree makes steady withdrawal amounts in real dollars throughout retirement. A retiree desiring to spend more money early in retirement and less in later years would choose an aggressive profile. A retiree wanting to increase withdrawal amounts in real dollars over the course of retirement would choose a progressive profile.
The retiree then chooses a success rate for that profile. For example, the retiree may choose a success rate of 95 percent, which means a 95 percent chance the portfolio won’t run out of money based on a particular withdrawal rate.
Only after the retiree chooses his or her retirement spending profile and the success rate is the initial withdrawal rate calculated. Klinger uses a 40-year retirement period for a $1 million portfolio. An initial “safe” withdrawal rate might be 2.5 percent, or $25,000. The retiree might then apply “decision” rules. These are special rules initially developed by Guyton, and later with Klinger, that allow the retiree to boost that initial withdrawal rate without jeopardizing the success rate. For example, the retiree with a progressive profile might not increase the amount of a withdrawal in a given year if the portfolio lost money the previous year. Or a “uniform profile” might actually boost the amount in real dollars if inflation is low and the portfolio performs really well.
Klinger applies three decision rules in his study and then calculates the maximum withdrawal rate for the sample retiree’s portfolio under each of the three retirement profiles. He finds the initial withdrawal rate for the uniform profile is 5.52 percent, which normally would be viewed as the “one size fits all” rate. But under the aggressive profile, the retiree could withdraw at an initial 6.36 rate, while withdrawing only 4.8 percent for the progressive profile.
To read the full article visit www.JournalFP.org.
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