As important as withdrawal rates are, the ideal withdrawal rate for any given retiree is necessarily an educated guess, based on what is known about market history. As is the case with asset allocation, the optimal withdrawal rate will be apparent only in hindsight. Reassuringly, there is a broad consensus in the retirement-planning community about many withdrawal-rate matters. Following is a roundup of some of the widely agreed-upon points.

Much of the research on retirement withdrawal rates centers on the notion that retirees would like their incomes to be stable in retirement—similar to what they had when they were earning a paycheck. Indeed, supporting a stable standard of living is what financial planner Bill Bengen had in mind when he developed the widely used 4% guideline for retirement-portfolio withdrawals. Thus, the 4% guideline assumes that a retiree takes out 4% of his portfolio in year one of retirement, then inflation-adjusts that dollar amount in ensuing years. For example, a retiree with an $800,000 portfolio who is employing the 4% guideline would take $32,000 initially, $32,960 in year two of retirement (assuming a 3% inflation rate), and so on.

That said, anyone who has managed a household budget knows that spending is not a flat line. There might be several years when spending clusters in a tight range, as well as budget-busting periods when there are splurges for the big-ticket vacation or multiple unplanned expenses—car repairs, big outlays for home repairs or improvements, medical bills, and so on. Retirement is no different. In fact, due to lifestyle factors, retiree spending may be even more erratic than spending during the working years. Morningstar research has identified a pattern it refers to as the “Retirement Spending Smile.” Their research has found a tendency for retirees to spend more during the early years of retirement on things such as travel, followed by a period during which they spend a bit less during the middle years of retirement, followed by a period of accelerated spending toward the end of life, when healthcare and long-term care outlays often increase (but not enough to completely offset lifestyle-related spending declines). How retirees expect their lifestyles to evolve during retirement should play a role in their spending plans.

In addition to expected spending levels and patterns, anticipated portfolio performance will also factor in determining an appropriate withdrawal rate. An open question, therefore, is whether the market environment assumed in establishing the 4% guideline is a good representation of the future. Given the current low interest rate environment and the likelihood of rates continuing to trend higher, investors employing overly conservative portfolios (that is, holding 50% or more of their portfolios in bonds) ought to also be conservative when setting their withdrawal rates. Moreover, the combination of low starting bond yields and relatively high equity valuations make this a particularly challenging time for sequence-of-return risk—that is, that new retirees could encounter a challenging confluence of events at the outset of their retirements that in turn could crimp their portfolios' sustainability. Taking too much out of a portfolio in a weak market environment can deal a portfolio a blow from which it might never recover. That argues for recently retired and soon-to-be retirees taking a cautious tack on their upcoming withdrawals, beginning with withdrawals of less than 4% and being willing to rein them in further if a calamitous market drop materializes early on in their retirements. Retirees who have been drawing for their portfolios for several years already are less at risk for a market shock; they will have losses amid an equity-market downturn, too, but they have already made it through their most vulnerable years.

One final consideration is the type of funds withdrawn from a retirement portfolio(s). Spending a portfolio's bond and equity-dividend income counts as a “withdrawal” as much as spending capital gains and principal; but the effect of doing so on the long-term viability of the portfolio(s) is not the same. It is wise, therefore, for retirees to stay flexible on their portfolio's source of cash flow, being willing to harvest income distributions as well as to engage in rebalancing to help source the cash flow needed. In addition, employing a cash “bucket” of retirement assets to provide liquidity in years when tapping principal or harvesting income is ill-advised (like when the market is down), is a savvy move.

Each retiree’s anticipated spending needs, retirement portfolio(s), risk tolerance, and time horizon are unique. Accordingly, each retiree’s withdrawal rate is unique. To better understand your ideal retirement withdrawal rate, talk with your Wintrust Wealth Management financial professional.