Retirement can be a rewarding phase of life, but it also comes with its own set of financial challenges. How much money do I need in retirement? How much can I live off of to maintain my current lifestyle? Can I make my retirement goals a reality given my current investments and savings? Am I willing to change my existing lifestyle once retirement comes in order to realistically accommodate retirement affordability?
One of the most significant challenges is figuring out how much to withdraw from your retirement savings each year.
Let’s start off with a direct answer to the question, “How much should I be withdrawing from my savings and investments during retirement?
Simply put, the optimal withdrawal rate is typically around 3.5% to 4.5% per year. Here’s why:
First, let's look at average market returns. Over the long term, the average annual return for the stock market is about 7% to 8%. This means that, over time, your investments should grow faster than the rate at which you withdraw funds. Based on historical data, the likelihood of running out of money if you follow a 4% withdrawal rate is very low, even during periods of market volatility.
US Stock Market 10-Year Average Return
Annualized Return (including dividends): 12.475%
Annualized Return (including dividends) Inflation Adjusted: 9.569%
Annualized Return (no dividends): 10.433%
Annualized Return (no dividends) Inflation Adjusted: 7.579%
However, it's important to remember that your rate of withdrawal will depend on several factors, such as your age, portfolio size, and lifestyle expenses. In addition, sequence risk is a concern. Sequence risk is defined as the risk that you'll experience a market downturn early in retirement during when you are first withdrawing from your investment account. This can significantly impact your portfolio's long-term value that you are planning on pulling from for the foreseeable future during retirement.
Another consideration is the current interest rate environment. Fixed-income instruments such as bonds and Certificates of Deposit (CDs) are currently paying higher than typical fixed income yields that we’ve seen over the last 10 years, with some options offering 4% or more given the current inflationary and higher interest rate environment in 2023. This means that you may be able to withdraw more funds from these instruments without jeopardizing your long-term financial security.
Finally, some funds that contain "dividend stocks" can pay out more than 4% in dividends each year. While these investments do come with some risk as they may fluctuate in tandem with market volatility, they can be a useful tool for generating income in retirement.
In conclusion, the optimal withdrawal rate for retirees should be around 3.5% to 4.5%. While market returns can be unpredictable, historical data shows that following this rate should allow you to maintain your standard of living throughout retirement. However, it's important to consider factors such as interest rates, sequence risk, and your individual financial situation when deciding on a withdrawal strategy. Speaking with a financial advisor can help ensure that you make the best decision for you and your family’s needs, and ensure you can retire in style when the time comes.