Consider Modest Withdrawals in Retirement’s Early Years

Saving for retirement takes decades of hard work, dedication and discipline – so it’s a great feeling when you finally reach that point where you feel you have saved enough. 

But the job of retirement planning is far from complete once you achieve that goal. You need to make sure you manage those funds prudently so an adequate amount is available to meet your needs for the rest of your life. You have to determine how much spending money is to be withdrawn each year. 
Keep in mind that retirement may last longer than you think. According to Statistics Canada, the average life expectancy for a 65-year-old is 84, implying that half of all retirees will live longer than 84.  There’s a 40-per-cent chance one spouse in a couple will reach the age of 90. In addition, remember that inflation will cause your expenses to rise during all those years. As a result, the younger you are, the lower your withdrawal rate should be. Then you may gradually take out more each year. 

Incorporating an annual increase for inflation, an initial withdrawal rate of four per cent from your portfolio may be a good rule of thumb for a 65-year old retiree. Nonetheless, there is no one rate that works for everyone, so it’s important to speak with your financial advisor to determine what specific withdrawal rate is best for you. (Remember that this withdrawal rate applies to your portfolio as an overall entity – not to any singular investment, which may appropriately have a higher withdrawal rate.) 

Keep in mind that if you own mostly fixed-rate investments such as bonds and GICs – rather than growth-oriented investments like stocks or stock-based mutual funds – you will likely have to withdraw smaller amounts each year. That’s because a fixed-income investment will give you just that — fixed income — which will not increase along with your expenses. 

Market performance is another major factor in determining your withdrawal rate. If you build in expectations that are too high, it could cause you to withdraw more than you should. You might find it’s helpful to plan for long-term stock market returns of about eight per cent and bonds returning about five per cent. (Keep in mind these rates are not guaranteed and represent guidelines for portfolio scenarios only. Prices of both stocks and bonds fluctuate and past performance does not guarantee future results.) 

Of course, as we saw in 2008, it’s essential to appreciate that the market rarely has “an average year.”  Some are up and some are down – and some can be dramatically up or dramatically down. As a result, sequence is especially important in choosing withdrawal amounts. In particular, market declines in the first few years after you retire could potentially having a much bigger impact than if they occurred 15 years after you retired. 

Unfortunately, no one knows when the market will have good and bad years, so it pays to be more conservative with your withdrawals. If you don’t need the full amount you have planned for in one year, re-invest that amount so it continues to work for you, especially in today’s markets. And make sure you maintain a cash balance early in retirement, which could protect you in case the market is down in your first few retirement years. 

Work with your financial advisor to weigh all of these factors so you can make the most prudent decisions possible. And ensure that you review it all on a regular basis, year after year. 

Edward Jones, Member Canadian Investor Protection Fund.