How Much Can You Safely Withdraw During Retirement?

My physician clients often ask me questions like, "Am I on track to retire when I want?” or "When will I know if I have enough money to retire?” Inevitably, those clients end up asking, “How much can I safely withdraw from my retirement account?”

People often read about a “safe withdrawal rate” of 4%, which was proposed by financial planner William Bengen in 1994 in the Journal of Financial Planning. He hypothesized that one could take an initial withdrawal from a retirement portfolio of 4% of the balance and then increase the initial amount by the inflation rate each year in order to keep pace with inflation.

For example, in the hypothetical case of a 65-year-old physician with a $3 million retirement portfolio, this methodology would say the doctor could withdraw 4% or $120,000 for the first year of retirement. If we assume that inflation was 2% for that year, then next year when the doctor is 66, he can take out $122,400 — his initial withdrawal indexed for inflation. By doing this over a 30-year retirement span, Bengen suggested that the chances of running out of money were very low, hence a safe withdrawal rate.

In the last few years, however, many experts have questioned whether this “Four Percent Drawdown Rule” method is accurate or useful. Some have argued 4% is too low an initial rate and the doctor would needlessly be living on less than he could. This school of thought suggests an initial withdrawal rate of 5% or 6%, particularly if the doctor is willing to forego inflation raises, or even cut back spending in years when the portfolio performs poorly or declines in value.

Others have argued the 4% withdrawal rate is too optimistic and was based on historical return assumptions from 1994 (a period of very favorable market conditions) and should not be generalized from the historical returns of the U.S. stock and bond markets almost 20 years ago.

In Bengen’s work, the historical return of common stocks he used in his analysis was 10.3%. For intermediate-term Treasuries, he used 5.1%. This resulted in a “balanced portfolio” of 60% stocks and 40% bonds returning 8.2% per year. These are return figures that financial planners in 2014 would be unlikely to project out into the future. These planners would argue a safe withdrawal rate of 2% or 3% is more prudent. That would result in an initial withdrawal of $60,000 or $90,000 on a hypothetical $3 million portfolio rather than the $120,000 initial withdrawal in our first example.

Who is right? With today's market valuation, which seems elevated, I am concerned about the investment returns doctors can expect going forward and would be reluctant to advise a 4% initial withdrawal rate.

Rather than relying on rule-of thumb projections that range from 2% to 6%, it appears more prudent to use a robust analysis that includes:

• An individual's sources of retirement income

• Expected longevity

• Expected portfolio return given his or her asset allocation

In addition, the analysis should be rerun every year or two as circumstances and inputs will change. This method can lead to a more reliable result than that from a shortcut estimate like the 4% rate, helping you to more accurately plan your retirement withdrawals.

Joel Greenwald, MD, CFP, is a physician-turned financial planner who exclusively provides financial advice to doctors. He has written many articles and been a frequent speaker on how physicians and dentists can achieve long-term financial security. More about Joel Greenwald and his Minnesota-based firm, Greenwald Wealth Management, can be found at www.joelgreenwald.com.

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