If you are going to retire early you will need to have an Early Retirement Withdrawal Strategy to fund your retirement and next phase of life. Few of us are blessed to have earned a pension large enough to fund our early retirement lifestyle. Most of us will rely on our investments and savings.
We must figure out an Early Retirement Withdrawal Strategy to give us the funds we need to live our new lifestyle. But also one which has a chance of it lasting as long as we continue riding planet-earth. It can be complicated.
Understanding the various withdrawal approaches to use can help us feel more confident about the strategy we choose to tap our assets and let us get down to enjoying our early retirement. The goal is to create our early retirement withdrawal strategy that balances both spending and safety.
When reviewing the various approaches please keep in mind that each has its own strengths and weaknesses. The idea is to understand what they are and find the right one or mix that is right for you.
Classic 4% Rule: A Fixed Withdrawal Strategy for Early Retirement.
This is by far the most popular and well-known withdrawal strategy. You retire, look at your overall portfolio and safely withdraw 4% of your total assets (hopefully it covers your budget). Then every year you can increase your initial 4% withdrawal amount by the rate of inflation. This allows you to maintain a constant spending and lifestyle rate over time by increasing your withdrawal amount yearly with the inflation quotient.
- Advantages: It is simple to come up with your spending amount. It has been researched. If you have the right time span and portfolio allocation based on history you should be fine for a 30 year retirement. You get exactly the same spending power year after year, at least until you exhaust your funds.
- Disadvantages: History may not repeat itself. This set-it and let it go with yearly inflation increases during down investment cycles may cause serious funding longevity troubles. For the early retiree, 30 years may not cover your retirement. Thus forcing you to consider using 3% as your starting withdrawal rate which may not be enough to fund you early retirement lifestyle. Even without market turmoil, the inflexibility of fixed withdrawals may not accommodate your spending needs over the years.
There is disagreement about the 4% Withdrawal Rate
Some say that 4% is too risky in today’s low interest environment. That we should use 3% for longer retirements and for safety in general. Use 3% to replace the 4% Rule. Others say you have a probability of safety with up to a 5% withdrawal rate. That is great news for those who can’t get by on a 3% or 4% rate to live on. But they must be willing to accept that higher sustainability risk and riskier portfolio allocation to try to support it. Even this most simple 4% rule has its cons and disagreement over the exact safe withdrawal rate.
No Yearly Inflation Approach: To counter the disadvantages of the 4% rule you can change the flavor slightly. Just forgo your inflation adjustment in the year following any year when your portfolio total has dipped. It is said that by simply following this approach you can safely start your retirement with a higher withdrawal rate of 5%.
Endowment Withdrawal Approach: A Variable Withdrawal Strategy for Early Retirement.
This is where your withdrawal strategy is different from taking 4% and increasing it yearly with inflation. Instead you simply take out a fixed percentage of your portfolio each year. For instance 5% of total assets.
- Advantages: Automatically provides withdrawal flexibility because it tracks portfolio performance. When the market is up you can withdraw more. When it is down you withdraw less. Since you only withdraw a percentage of your portfolio it should never go to zero.
- Disadvantages: The retirement account survivability is awesome. But who can live with an unknown and fluctuating amount year to year? Especially when the market under performs. Not I. But if your 5% withdrawal amount allows you to fund your lifestyle and still put some of that money aside. Then that saved money could subsidize your smaller 5% withdrawal in a down market year. Although this is a variable withdrawal strategy it isn’t a flexible one because your withdrawals are at the mercy of the market.
Life Expectancy Withdrawal Approach: A Variable Withdrawal Strategy for Early Retirement.
This is a variable withdrawal strategy based on your IRS Single Life Expectancy table. You would withdraw the inverse in years of your life expectancy. So when you retire you look up your life expectancy based on your current age. If it was 26, you would withdraw 1/26th of your assets or 3.8% (1 divided by 26). Then the next year repeat, 1/25th of total assets.
- Advantages: You will never run through your assets but you have no idea what you will have in your later years. You are just dividing your money by how long you expect to live based on statistics.
- Disadvantages: You may be taking too small of an amount early on when you can enjoy your young active self in retirement. Only to be taking higher withdrawals in your late years. The biggest drag about this approach is you will statistically end up taking too little in early retirement and back-loading your retirement funding for the end. When ever that may be.
Hybrid 95% – 4% Rule: A Variable Flexible Withdrawal Strategy for Early Retirement.
This is an example of combining different elements of the various approaches and coming up with something that may work for you. A withdrawal strategy to take advantage of benefits and reducing pit falls while keeping flexibility. This is where you start with 4% (or anywhere between 3% to 5% based on your needs, risk tolerance and portfolio allocation) and you set a small stop-loss. A stop-loss where in the next year you take the higher of either your 4% of total assets or 95% of your previous year’s withdrawal amount.
- Advantages: In bad market years you don’t experience any more than a 5% lifestyle drop in any given year. You are adjusting withdrawals down to accommodate bad performance years.
- Disadvantages: You are withdrawing an amount based on market performance and may not be able to support your lifestyle. A 5% decrease over multiple sequential down years may leave you short.
To make this Hybrid approach even more sustainable you could also apply withdrawal rules that sets a 5% withdrawal ceiling. Any year that your portfolio has had significant gains you would withdraw the lower of 4% of total assets or your previous year’s withdrawal amount plus 5%. More or less limiting any increases to 5% year to year when your portfolio is climbing.
Are there any Alternative Strategies?
There may be a place for a small percent of your portfolio allocated to purchasing an immediate annuity. If living and spending by market uncertainty is something that keeps you up at night then an annuity might be your answer. Annuities aren’t for everyone but there could be effective strategies that could include them. Having a lower investment longevity annuity (QLAC) to kick in if you beat the statistical longevity odds may allow you to take a little more early on in retirement.
The idea of this page isn’t to push you one direction over another but is to offer some of the known withdrawal strategies. Hopefully you can see what would work best for you.
Myself I don’t believe in any one strategy as a set-it and forget it plan for everyone. Any of the percentages mentioned are guidelines. You could certainly try to make a plan work with a 4.5% withdrawal rate as an example. Then monitor your strategy and asset sustainability impacts as you go.
You might decide to withdraw 5% for the first few years and 3% once Social Security begins. Take your withdrawal amount and asset total and use the FIRECalc Monte Carlo type retirement calculator to see your chances of making it work.
Any strategy you choose should be constantly evaluated. You should be willing to make changes as necessary. Catching things and making adjustments earlier than later should always be your goal.
I have a couple of posts that describes my Early Retirement 4 Percent Withdrawal Strategy and my plan for Funding Early Retirement for the Long Haul that gives more details into my creating an Early Retirement Withdrawal Strategy.