When you reach retirement, your focus often shifts from growing your investments to carefully drawing from them to fund your lifestyle. However, there's a key challenge that many retirees underestimate: withdrawal rate risk—the possibility that you might outlive your savings.
Let’s walk through what this means and how careful planning can help protect your financial future.
What Is Withdrawal Rate Risk?
Withdrawal rate risk occurs when the rate at which you draw from your portfolio exceeds what is sustainable over your retirement years. In simple terms: if you take out too much too quickly, you risk running out of money.
For example, you might know that historically, stocks have earned around 8% per year. It can be tempting to assume you can safely withdraw 8% annually (plus a little extra for inflation). In reality, because of market ups and downs, a much more conservative withdrawal rate—closer to 4% or even lower—is often necessary to protect your portfolio over decades of retirement.
What Affects a Sustainable Withdrawal Rate?
A truly sustainable withdrawal rate isn’t the same for everyone. It depends on factors such as:
- How long your retirement will last
- Your portfolio’s asset allocation (the balance between stocks, bonds, and other investments)
- Realistic expectations for future investment returns
Determining a safe withdrawal strategy often requires the use of advanced financial planning software and professional advice, given the complexity of the variables involved.
The Importance of Flexibility
Markets don’t move in a straight line, and neither should your spending plan.
Being willing to adjust your withdrawals based on market conditions can make a major difference. If the market underperforms for a few years, reducing withdrawals temporarily can help preserve your nest egg and lower your risk of running out of money.
On the other hand, inflexibility—needing or insisting on a set income no matter what the markets do—increases the chances of portfolio depletion.
The Discipline Challenge (and the Risk of Spending Too Little)
Taking withdrawals from a portfolio provides flexibility—but that can be a double-edged sword.
Life events like helping children with a home purchase, paying for a grandchild’s education, or facing unexpected expenses can tempt retirees to stray from their spending plan. It’s important to stay disciplined in order to preserve financial security for the long term.
Ironically, being too conservative can also be a problem. Some retirees are so cautious about withdrawals that they don’t fully enjoy their retirement years—missing opportunities and experiences they could have afforded.
In retirement planning, the goal is to strike a balance between spending confidently and protecting against running out of resources.
How to Manage Withdrawal Rate Risk
The good news? With a thoughtful plan, withdrawal rate risk can be managed. Some key strategies include:
- Building a Withdrawal Plan Based on Research
Safe withdrawal rates are based on careful historical analysis. While in some years higher withdrawals could work, the safest plans are built to withstand even the worst market conditions. - Considering Risk Tolerance and Capacity
Your ability to take more or less risk depends on your unique situation. For example, retirees with guaranteed lifetime income sources (like Social Security and pensions) have more flexibility to adjust investment withdrawals. - Regularly Reviewing Your Plan
Ongoing meetings with your advisor can help keep your strategy on track. Regular reviews ensure your plan stays realistic and flexible enough to handle unexpected expenses. - Planning for Contingencies
A good withdrawal strategy also accounts for major irregular expenses—like healthcare costs, home repairs, or replacing a car—so they don't derail your overall plan.
Final Thoughts
Withdrawal rate risk is real, but it can be effectively managed with careful planning, flexibility, and regular monitoring. A thoughtful retirement income strategy doesn’t just help you avoid running out of money—it also helps you enjoy your retirement years with greater confidence and peace of mind.
If you have questions about building a sustainable retirement income plan, we're here to help.