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Cooley suggests that retirees willing to accept a little uncertainty can take as much as 7% of their portfolio in the first year of retirement and continue to withdraw that same dollar amount in future years. That means the annual draw from a $1-million portfolio jumps to $70,000. But there's a catch. This system allows for no annual inflation adjustments if you want a high likelihood that the money will last as long as you do. And that can make a significant difference in buying power over time. Even if inflation increases by a modest 3% annually, an initial withdrawal of $40,000, adjusted for inflation, would increase to $41,200 in the second year, to more than $72,000 after 20 years and to more than $97,000 after 30 years. Alternatively, the buying power of that initial $70,000 withdrawal would fall to $68,000 after one year, less than $39,000 after 20 and less than $29,000 after three decades.
According to Cooley's research, the chances that a 7% withdrawal rate from a $1-million portfolio invested 50% in stocks will be sustainable over 30 years are about the same as for a 4% inflation-adjusted withdrawal rate. However, a lot depends on timing and luck. For example, Cooley found that a retiree starting with $1 million in 1963 who chose to withdraw $70,000 a year still had $784,000 left at the end of 30 years -- based on the actual market performance for that period. But someone who made the same choice early in 1962 would have run out of money after 27 years. That's the devastating impact of a market down 28% in the first six months of 1962 -- at the beginning of the payout period.
That example is also a worst-case scenario. Looking at the results of various 30-year periods since 1946, Cooley found that, on average, a $1-million portfolio invested equally in stocks and bonds was still worth $1.2 million after 30 years of $70,000 annual withdrawals. In the best 30-year scenarios, in fact, more than $6 million was left unspent.
A third withdrawal method, known as the reset method, charts a plan for you to withdraw a fixed percentage -- say 7% -- of your portfolio annually. That means your cash flow fluctuates from year to year as your portfolio increases or decreases, but you're guaranteed to never run out of money.
A 7% withdrawal from a $1-million portfolio would produce $70,000 in year one. If your investments grew to $1.1 million, the second-year payout would be $77,000; but if they fell to $850,000, you'd have to cut back to $59,500. Christine Fahlund, senior financial planner at T. Rowe Price in Baltimore, says most retirees would rather skip the roller-coaster ride in retirement and know exactly how much they can spend year after year, even if it's less than they had initially imagined.
"The reset method gives you an extremely bumpy ride," Fahlund cautions. Price endorses the more conservative 4% inflation-adjusted guideline. If you want a predictable stream of income and also want to take annual increases for inflation, even Cooley recommends that you stick with the lower initial withdrawal rate. But he and Fahlund both agree that any retirement-income strategy should be viewed as a plan, not as a contract. It also should be reviewed annually and adjusted as necessary.
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