What Happens If You Outlive Your Safe Withdrawal Rate Time Horizon?

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

The inspiration for today's blog post comes from recent conversations I've been having with researcher Wade Pfau at the National Graduate Institute for Policy Studies in Tokyo, Japan (it's a pain trying to schedule our calls!), about safe withdrawal rates, and in particular about something that safe withdrawal rates pioneer Bill Bengen mentioned in a recent article about his work in Forbes, which in turn is being discussed/debated on the Bogleheads forums. Specifically, Bengen mentioned that even if someone starts at a 4.5% withdrawal rate and goes for 30 years, there is still a 96% chance (based on historical analysis) that the client will still have 100% of his/her original principal remaining to fund the extra years.

Wait, what? The safe withdrawal rate, which we've been taught is how low spending has to be to sustain in bad economic environments, also still leaves over more than the original principal a whopping 96% of the time? Shocking, but true. In fact, Wade verified it (not that we doubted Bengen's word). The results are at the end of this post.

Assuming starting wealth of $100, it is in fact true that final wealth is still over $100 in about 96% of the scenarios; in only 3 instances is wealth lower than the $100 starting amount, including 1937, 1968, and 1969 (the latter being the scenario when the account winds down to $0 by the end, and is thus why ~4.5% is the "safe" limit). On the other hand, as mentioned earlier, in almost 96% of the remaining cases, final wealth is at least $100. In fact, the median wealth level after 30 years is a whopping $460! That's right, 50% of the time you do your lifetime spending at a 4.5% withdrawal rate, and more than quadruple your account balance on top of it!

On the other hand, it's worth noting that these are nominal dollars, not real dollars. While it's nice to more-than-quadruple final wealth, spending has also risen dramatically over this time period. Accordingly, the results below also show final wealth on an inflation-adjusted basis; nonetheless, median final wealth is still about $161 (after starting at $100), and in 69% of the scenarios the final wealth is still more than inflation-adjusted dollars too! That's quite a "cushion" for extra longevity! (Editor's Note: These projections assume withdrawals at end-of-year; if the withdrawals are beginning-of-year instead, starting principal is preserved 89% of the time based on nominal wealth, and 55% of the time in real wealth.)

The bottom line is that while safe withdrawal rates ratchet spending down to the point where a retiree can survive a terrible sequence of returns (and/or a substandard period of total return), in the overwhelming majority of cases, the outcome is not nearly so dire. In point of fact, most of the time the safe withdrawal rates approach is a path to significant wealth accumulation, and/or an adjustment period several years into retirement where spending can be increased to account for rising wealth. Nonetheless, for retirees who do not want to ever face the risk of cutting their spending, safe withdrawal rates provide a rising-floor approach that allows for spending or wealth to rise, without anticipating cuts. But while it's the conservative measure needed to protect in bad markets, be cognizant that in "merely average" - not to mention, good - markets, your client's greatest problem may be what to do with all the extra money.

So what do you think? Does this change your thinking about how conservative or aggressive safe withdrawal rates are? Is a 96% chance of having 100% of principal left over a comforting factor when trying to manage the risk of unanticipated longevity?