Safe Withdrawal Rates in Retirement

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January 2025

By Jean Strock, Financial Adviser

Retirement – is a time of excitement for the future but also a cause of anxiety, as you part with the security of a regular salary. You finally have the time to take on more leisure activities and draw up your travel plans.

The anxiety comes from knowing that ‘This Is It’. Whatever the size of your retirement pot, it now has to last as long as you do – however long that may be.

Longevity is the great unknown in financial planning but we do know that on average we are living much longer than ever before and as we age our likely lifespan increases.

Stats NZ have a tool to calculate your personal life expectancy here: How long will I live?

If you underestimate your lifespan, you risk running out of money. If you have overspent in the early years, it is difficult to undo the impact across the remainder of your life.

If you overestimate your lifespan, you can scrimp too much and compromise on all the fun things of retirement. The kids get to go business class while you went nowhere!

There is also the question of whether to spend your entire fund, so the kids just get the house, or leave a significant bequest.

Safe draw down rates have been studied extensively – the most common being the 4% rule. This was developed by US Financial Adviser Bill Bengen in 1994(1) and intended as a ‘worse case scenario’ for retirees. Bengen found that a 4% withdrawal rate adjusted each year for inflation would see a Balanced(1) portfolio last for 30 years and so the 4% rule was born.

This means that if you require a net income of $50,000 per year from your portfolio at a 4% withdrawal rate you divide $50,000 by 0.04 which implies you need to start with a $1,250,000 portfolio.

The 4% model implies a static level of spending across your entire life and we know that this does not happen in reality. The average retiree spends more in the early years, mostly on travel, less in the middle years and less again in the much older years with a spike in healthcare costs towards the end. Home owners may require less income than renters.

New Zealand does not have a well developed annuity market and as KiwiSaver balances grow there will be a greater focus on the ‘decumulation’ phase. The NZ Society of Actuaries have revised their previous work in a 2023 report titled ‘Drawdown Rules of Thumb.(2)

The drawdown rules of thumb apply to investment assets such as KiwiSaver and/or a portfolio of assets. These assets are generally invested with ‘medium risk’ to generate capital growth and mitigate inflation over very long time periods.

6% Rule: Each year you draw 6% of the starting value of your retirement fund. This provides a higher level of net income in the early years when you are more active. Your income is not inflation adjusted and there may be a greater chance of running out of funds.

Inflated 4% Rule: Take 4% of the starting value of your retirement fund and increase that amount each year in line with inflation, as per Bill Bengen’s original research. For example, if inflation is 2% and you draw $40,000 in the first year of retirement, you will draw $40,800 in the second year. You will have a lower income in the early, active years but your income keeps pace with inflation and you are less likely to outlive your funds.

There are two other Rules of Thumb published which you can read here: Drawdown Rules of Thumb 2023

Morningstar in their 2023 ‘State of Retirement(3) report also investigated flexible drawdowns where retirees adjust their spending by reducing their draw down when markets are weak and drawing more during bull markets. I find that people often do this intuitively but it is also where having a cash buffer can help fund unexpected expenses without needing to draw a lump sum from a diminished portfolio. Flexible drawdowns were also found to enhance portfolio longevity.

In my experience the following actions make a lifelong income more achievable:

  • Pre – retirement, try to quantify what your annual expenses are likely to be. Take off pre retirement expenses such as income and trauma insurance, investment contributions and hopefully mortgage payments. This gives a guide to the level of retirement income required.
  • As above, ideally pay off any debt and ensure big ticket home maintenance is complete. You may wish to upgrade your vehicle.
  • Consider working past age 65, even if part time. You may be able to save your NZ Super payments. If you delay drawing on your funds you may be able to draw more for longer when you do fully retire.
  • Establish a pool of low volatility savings for emergencies, either in short term deposits or a Conservative Fund. These funds must be highly liquid.
  • Include Growth assets in your retirement portfolio. At 65 you could have a 25 year investment time frame, a Conservative fund may not last the distance.
  • Take financial advice to maintain flexibility in your retirement planning. An adviser can help you navigate the course as needed and maybe allow you to spend more. Actual returns and inflation will change as will your personal circumstances so review your plan regularly. Good financial planning can help you to navigate these changes as you move through the years.

 

Notes

  1. FPA Journal Determining Withdrawal Rates using Historical Data, Bengen, W: October 1994 
  2. NZ Society of Actuaries, Retirement Income Interest Group: Drawdown Rules of Thumb: August 2023
  3. Morningstar State of Retirement Income Report 2023. Benz, C. Rekenthaler, J. Ptak, J

Determining Withdrawal Rates

The views expressed in this article are the views of the author. The information provided is of general nature and is not intended to be personalised financial advice. You may seek appropriate financial advice from a Financial Adviser to suit your individual circumstances