Retirement FundSaving for a comfortable retirement is what motivates many people to start their wealth management planning regimen. Whether you’ve been planning for retirement since you were 25 or 50, saving is only half the battle; after retirement, the real work begins. With your primary source of income gone, you have to figure out how to make your retirement fund last. That’s not as easy as it sounds.

In 2008, at the beginning of the financial crisis, Metropolitan Life conducted a survey asking people who were about to retire on their 401(k) plans what they thought a safe withdrawal amount would be. The answer, on average, was about 10% annually.

That number might have made sense years ago, when interest rates were high and retirees could bank on making money on fixed-income investments like Treasuries. But today, 30-year Treasuries are paying just 2.8% annually, and 10-year Treasuries offer a lowly 1.66%.

Interestingly, not even the financial crisis got people thinking more seriously about retirement withdrawal rates. In a 2011 Fidelity Investments survey, the mean annual withdrawal rate came in at a solid 8.4%; but the answers were all over the place, ranging from a conservative one percent to a no-holds-barred 25%.

In lieu of a one-percent, 10%, or 25% annual withdrawal rate, many advisors have been telling their clients that four percent is a safer number (adjusted for inflation). But is that sustainable? One study showed that an inflation-adjusted withdrawal rate of more than five percent significantly increased one’s risk of wiping out their retirement savings.

The following chart shows how long a hypothetical $500,000 retirement portfolio (containing 50% stocks, 40% bonds, and 10% short-term investments) fared from 1972 to 2011 with various inflation-adjusted withdrawal rates between four percent and 10%.

Portfolio Withdrawal Chart

Chart copyright © Lombardi Publishing Corporation, 2013;
Data source: Fidelity Investments, April 30, 2013.

As you can see, the risk of running out of retirement money is very real, and a withdrawal rate of five percent or more can increase the risk of coming up short. That doesn’t mean a four-percent annual withdrawal rate guarantees long-term success. Withdrawal rates have to take a number of different factors into consideration, including market performance, asset allocation, age, and health.

Granted, there is no magic number, but using a withdrawal rate of four percent can help those nearing or already in retirement get a clear understanding of what they should be striving for. And it’s not a bad starting point; new research suggests that an initial withdrawal rate of four percent in today’s low, low interest rate environment can lead to a 50% probability of success over a 30-year period. (Source: Blanchett, D., et al., “Low Bond Yields and Safe Portfolio Withdrawal Rates,” Morningstar Investment Management web site, January 21, 2013, last accessed April 30, 2013.)

While you can’t control the markets, you can control the amount you save over time and your withdrawal rate. And it’s a balancing act of not just making your retirement fund last longer than you, but of also enjoying retirement. It’s one thing to spend wisely; it’s another to be too frugal.