What Is the Safe Withdrawal Rate (SWR) Method?
The safe withdrawal rate (SWR) method is a way retirees can calculate how much money they can use from their accounts each year without running out of money.
The safe withdrawal rate method is a conservative approach that tries to balance having enough money to live comfortably without depleting their retirement savings prematurely. It is based largely on the value of the individual's portfolio at the time they retire.
Opinions differ but most financial advisers say that you can safely spend 3% to 4% of the total balance in your retirement fund at the time of your retirement, adjusted annually for inflation. If invested conservatively, that means you should be spending mostly the returns on your investments, not the principal in your account.
Key Takeaways
- The safe withdrawal rate (SWR) method calculates how much retirees can draw annually from their accumulated assets without running out of money.
- The SWR method employs conservative assumptions, including spending needs, the rate of inflation, and how much annual return investments will return.
- One drawback of SWR is that it fails to take into account changes for better or worse in your portfolio performance over time.
Understanding the Safe Withdrawal Rate (SWR) Method
There are many unknowns to calculating how much you can withdraw from your retirement savings. They include how the market will perform, how high inflation will be, whether you need to meet extraordinary expenses, and your life expectancy.
The longer you expect to live, the longer the time you need to stretch your savings, which means you may experience still more unknowns, or factors that you can't control.
The Worst-Case Scenario
The safe withdrawal rate method tries to prevent worst-case scenarios from happening by advising retirees to take out only a small percentage of their assets each year, typically 3% to 4%.
Knowing what safe withdrawal rate you’d like to use in retirement also informs how much you need to save during your working years. If you want to withdraw more money per year, then clearly you'll need to have more money saved.
However, the amount of money you might need to live on might change throughout your retirement. For example, you might want to travel in the early years and, therefore, need more money then. Your safe withdrawal rate might be structured so that you would withdraw 4% in the early years and 3% in the later years.
The 4% rule is a guideline used as a safe withdrawal rate, particularly in early retirement, to prevent retirees from running out of money.
How to Calculate the Safe Withdrawal Rate
The safe withdrawal rate helps you determine a minimum amount to withdraw in retirement to cover your basic expenses, such as rent, utilities, and food. As a rule of thumb, many retirees use 4% as their safe withdrawal rate—the so-called 4% rule.
The 4% rule states that you withdraw no more than 4% of your starting balance each year in retirement, adjusted each year for inflation. This doesn't guarantee you won't run out of money, but it does help your portfolio withstand market downturns by limiting how much is withdrawn. In this way, you have a much better chance of not running out of money in retirement.
Although there are a few ways to calculate your safest withdrawal rate, the formula below is a good start:
- Safe withdrawal rate = annual withdrawal amount ÷ total amount saved
Let’s say as an example, you have $800,000 saved and you believe you’ll need to withdraw $35,000 per year in retirement. The safe withdrawal rate would be:
- $35,000 ÷ $800,000 = 0.043 or 4.3% (or .043 * 100)
If you believe you'll need a higher or lower amount of income in retirement, here are a few examples:
- $25,000 ÷ $800,000 = 0.031 or 3.0% (or .03 * 100)
- $45,000 ÷ $800,000 = 0.056 or 5.6% (or .056 * 100)
So, if you only needed $25,000 per year in withdrawals, you could safely withdraw it since it would only be 3% of your balance each year.
If you believe you would need $45,000 per year in retirement and you want to only withdraw 4% of your retirement balance, you would need to save more money. In other words, $45,000 per year in withdrawals from a balance of $800,000 would yield a 5.6% withdrawal rate, which might lead you to run out of money.
To calculate how much in retirement funds you'd need to satisfy the 4% rule and be able to safely withdraw $45,000 per year, we would rearrange the formula as follows:
- Annual withdrawal amount ÷ safe withdrawal rate = total amount saved
- $45,000 ÷ 0.040 = $1,125,0000
Now you know that you would need to save an additional $325,000 beyond your current balance of $800,000 to be able to satisfy the 4% rule and withdraw $45,000 per year safely.
If you lower your withdrawal rate–all else being constant—your funds will last longer. However, if you want a higher withdrawal rate, you'll need to be sure that there will be enough funds to last 20 to 30 years since you might run the risk of depleting your funds.
Limitations of the Safe Withdrawal Rate Method
A shortcoming of the safe withdrawal rate method is that it is dependent on economic conditions at the time you retire. A 4% withdrawal rate may be safe for one retiree yet cause another to run out of money prematurely, depending on factors such as asset allocation and investment returns during retirement.
Retirees shouldn't be overly conservative in choosing a safe withdrawal rate. It could mean settling for a lower standard of living than is necessary.
Alternatives to the Safe Withdrawal Rate Method
Using the safe withdrawal rate method means keeping your savings steady through the years, in good and bad economic times. That's risky, and can increase the possibility of failure (POF) rate, or the percentage of simulated portfolios that fail to last a lifetime.
An alternative to the safe withdrawal rate method is dynamic updating. This allows for a regular reevaluation of your withdrawal amount based on changes in inflation or your portfolio's value.
How Do I Determine My Safe Withdrawal Rate for Retirement?
Your safe withdrawal rate is based on the total balance in your retirement funds at the time you retire. In your first year of retirement, you would withdraw 3% to 4% of that total. In year two, you would take out the same dollar amount adjusted by the current inflation rate.
What Is the Drawback of the Safe Withdrawal Rate?
The safe withdrawal rate is based on the balance in your retirement accounts at the time of your retirement. If your investments do spectacularly well, you could be spending at a higher level. If they do very badly, you would be wise to cut back.
To be fair, the safe withdrawal method assumes a conservative approach to retirement investment: investment-quality bonds or dividend-paying stocks, not growth stocks or cryptocurrency.
How Long Will My Money Last Using the Safe Withdrawal Rate?
The safe withdrawal rate assumes a 30-year horizon. That is, you should still have roughly the same amount of money to live on for 30 years beyond your retirement.
Some say that's an old-fashioned view. Many people now want to retire early. Many hope to live for way more than 30 years after retiring. Others want to continue working longer, maybe at a slower pace. If the 4% rule doesn't work for you, you need to adjust the plan to fit your needs.
The Bottom Line
The safe withdrawal rule is a classic in retirement planning. It maintains that you can live comfortably on your retirement savings if you withdraw 3% to 4% of the balance you had at retirement each year, adjusted for inflation. Assuming your money is invested conservatively, you should have a steady income for about 30 years.
