What is a Safe Withdrawal Rate?
When you retire, you will need to switch your thinking from being a saver to being a spender. The trick is to balance your withdrawals from spending too little and potentially dying with too much money and spending it so quickly that you run out of money.
What is the withdrawal rate?
The term that describes how much money you take out of your portfolio is the withdrawal rate. It is the amount of income that you are going to draw off your investments. If you have $100,000 in your portfolio and you have a withdrawal rate of 5%, you would withdraw $5000 per year for income. You can adjust your withdrawal rate as you need. I like to think of your portfolio as a bucket of money and when you need income, you are going to punch a hole into the bottom of the bucket and put a tap on it to regulate that income. You would adjust the withdrawal rate by opening the tap bigger or making it smaller.
Choosing the right withdrawal rate is a bit of an art and science. Although we all would love more income, opening the tap too much might cause your bucket of money to drain too fast. Keeping the withdrawal rate low can keep your portfolio intact or even grow it but it means less income.
The good old days
Back in the 1980’s retirement would have been a lot easier from the simple perspective that you did not have to think too much about your investments. Back then, you could stick your money in a GIC at 10% to as high as 21%. You could keep your capital guaranteed and live off the interest. Investing was pretty simple.
From 1990 to today, interest rates have fallen over 75% and GIC investors have had to look for alternative investments. People looking for income flocked in droves to income trusts, REITs and income paying mutual funds earning yields of 6% to 10% or more. Not bad either in a low interest rate environment but that did not last either. In 2006, Finance Minister Jim Flaherty announce that there would be a change in how income trusts would be taxed and income trust investors everywhere were left in disarray.
Back in the good old days, it was not uncommon to see projections using withdrawal rates of 7% or more. At the time, 7% actually seemed quite reasonable.
Tougher times today
Unfortunately for retirees of today and tomorrow, the future is uncertain. One one hand, inflation can cause interest rates to rise. On the other hand, with the amount of debt in the system at all levels, it is tough to envision really high interest rates staying for a long period of time. If retirees look to the stock market to find investments that produce income, they see more volatility and concern.
What is a Safe Withdrawal Rate (SWR)?
Most would agree that the days of a withdrawal rate of 7% or more are long gone unless you are OK with draining your bucket of money quickly. In fact, I remember conservative projections used to use a 5% withdrawal rate. Today, many experts and studies suggest that a safe withdrawal rate is about 4%. The point of choosing a safe withdrawal rate is to minimize or avoid the risk of running out of money
Depends on how long you want the money to last
Choosing the right safe withdrawal rate depends on a few key factors. The chart below looks at how long you want your money to last. Common sense suggests that you might be able to use a higher safe withdrawal rate if you only need money to last 20 years and you might need a lower safe withdrawal rate if you need your money to last 35 years.
Safe Withdrawal Rate - Chance of losing money
|Withdrawal rate||35 years||30 years||25 years||20 years|
Let’s say you retire at 60, you have $100,000 and you want your money to last at least 30 years. If you choose a withdrawal rate of 4% or $4000 per year, you have a 21% chance of running out of money before you turn 90.
On the other hand if you retire at 65 and only want this $100,000 to last 20 years, your chance of running out of money before the 20 years drops to only 5%.
This data is based on running hundreds of return scenarios using a safe withdrawal calculator.
Related article: Variable returns can work against you in retirement
Depends on how you invest
If you put all your money in GICs, you might earn 1.5% to 3.5% depending on the term. Let’s say for simplicity sake you earn 2.5%. Logic would say if you earn 2.5% and you take out 4%, your capital will deplete in about 23.5 years. If you are 65, that takes you to almost 90 years of age.
Most investors will not invest 100% into GICs. Instead they seek to find some balance in their portfolio and diversify some into stocks, mutual funds, EFTs and alternative investments.
The problem with market-based investments is there are no guarantees. The market does what the market does. You cannot control the market and you cannot predict where the market is going to go.
As a result, most retirees need to find a balance in their portfolios. I call it goldilocks investing. Not too aggressive (hot) and not too conservative (cold). This is the key to success. Build a portfolio with some cash to create liquidity and short-term income, some fixed income to create income for the next 5 years and the balance can go into equities.
The higher the withdrawal rate, the more equities are needed in the portfolio to reduce the risk of running out of money too early. However, the more equity you have, the less control and predictability you have over your future income. With equities, there is a high probability you may need to decrease your income in tough times and give yourself a raise in good times.
The point is simple: make sure you choose your withdrawal rate carefully.
Safe Withdrawal Rates and RRIFs
It’s also important to note that RRIFs have a minimum income schedule determined by law. This overrides the ability to have complete control over your withdrawal rate. In a RRIF, you can take more income than the minimum but not less.
Related article: RRIF Minimum income rules
I don’t think we should blindly accept the 4% Safe Withdrawal Rate rule and invest only according to that. I really think that would be naive and here is why I think that : 8 reasons why the Safe Withdrawal Rate is not that safe after all http://whatlifecouldbe.eu/2015/10/24/8-reasons-why-the-safe-withdrawal-rate-is-not-that-safe/
I hope it makes sense and we all start a proper discussion about it rather than blindly accept a theory based on past trends. Don’t get me wrong. It’s a very good strategy…but should be ONE of your several investment pillars rather than the only one.
Hmm… this is the first article I’ve read on your site and you have almost lost me with the “it was so easy back in the days of unrealistically high interest, you just put your money in the bank and life off the interest” because those were also the days of rampant inflation and your savings buying power was diminishing day by day. Are you sure those were the good ol’ days? What was the spread between inflation and interest rates?
Similar to economics, there are all kinds of opinions and potential probabilities. However, I’m not sure about the logic that states “the higher the withdrawal rate, the more equities are needed”? In 2008 the market crashed and it took over 10 years to come back. I’m not sure I would want to be 60 or 65 and have a chunk in equities at that time. My 100k would be attempting to come back from 65k or 70k. Now that would affect my retirement big time. I realize there are all kinds of philosophies and approaches, but generally speaking I believe the majority of your risk taking by far should be done before you retire. In retirement you need some level of certainty and that doesn’t come from equities regardless of your withdrawal rate. Thank you for the article.
As a 72 year old retiree the withdrawal rate is a no brainer since you are dealing with government mandated RIF withdrawal rates
Depending on your CPP and OAS entitlements, you can aim for a higher withdrawal rate early on and lower then these programs come into play. A couple that waits until 70 to collect CPP and OAS could easily collect $50,000/year. Plus, you’ll be forced in high withdrawal rates at age 71 if RRSP/RRIF is your main source of income. My suggestion would be to put excess withdrawals into a TFSA, withdrawal rate doesn’t have to mean spending it all, it just crystalizes the taxation on it.
Unfortunately mandatory RRIF withdrawal rates exceed your recommendation.
Everyone has an opinion 🤦🏼♂️
This article is a handy Rule of Thumb. It is not carved in stone.
It helps the average layperson understand financial investing and planning.
Great article Jim, thank you!
*I retired in 1990 at the age of 64 and recd a sum which I was able to put 80,000 into a RRIF @ 11.21% guaranteed to age 90. I do not remember the inflation rate but dont think it was similar to today’s rate.The income allowed us to assist in the education of 6 grandchildren and when it matured 4 years ago there was still $100,000 in the fund. The rule of 9 provides the evidence in such a case.
This article does not address the mandated withdrawal rates for RRIF accounts, which will be the primary investment vehicle for many retirees. Of course, withdrawal does not necessarily mean spending, so any excess savings could possibly be placed in a tax free account. Further examination of this beyond the 4% approach would be of interest.
For me, my safe withdrawal rate will be spending whatever dividends we receive and withdrawing only them. I expect to receive more than we need. I also expect that once in a while I might have to sell some shares for outsized expenses / experiences. When added to my wife’s DB pension and deferring our CPP to age 70 I think that will provide plenty of buffer. Today we receive about $42k in annual dividends and my goal is to double that by retirement. I feel like that’s pretty safe.
There is so much conventional wisdom here. Fixed income, bonds, GICs, and some equities. It is different for everyone, but it can be made so much more simple. Canadian dividend payers like banks, utilities, telcos, and some others will pay a consistent dividend of 4-5% and increase them almost every year. No need to worry about withdrawal rate. Just take the dividends and leave the capital. Add CPP, OAS, and your all set. I have been retired now for 5 years and my portfolio, as well as income are higher now then when we started withdrawing. Dividends are 46% higher now then 5 years ago. See dividendcafe.ca
I plan to base my withdrawals by tax bracket. I am saving my charity receipts and will also use them to reduce my taxable income. I will be 65 in mid 2024.
If you have a house but have very little income, will I be able to receive GIS?
Where can I look for more detail information regarding GIS?
Thanks for this chart. I retired early and with longevity being a family trait, I appreciated this tool for risk management on withdrawals. W
one way to safely and reliably increase your effective withdrawal rate is to lower the fees you pay for investing. moving from a high fee bank product to a lower fee alternative can save at least 1%. so more money in the retiree’s jeans rather than the bank’s vaults.
A much more flexible and safe approach in my opinion is the Variable Percentage Withdrawal method. If you follow it carefully, it will adapt your optimal withdrawal amount from year to year based on how your portfolio is performing, your remaining time horizon, and other fixed income streams, like employer and government pensions. All this while virtually guaranteeing you will not outlive your money.
What would be really nice is a software package that can be used to plan for one’s wind down and decumulation phase of retiremement. Regrettably, there are none ..that address Canadian issues like taxation, that don’t have glaring shortcomings such as the ability to handle the death of one spouse, that are easy to validate the correctness of the underlying formulas , that don’t make invalid or inappropriate assumptions, and that have some form of succession planning for the product. I.e. not a one man show leaving the product in a lurch when you need fixes or updates in a few years even though you already paid a bundle for it
If you do suggest a potential solution, please make sure it meets all of these requirements.