My wife and I are both 56. We have around $1.2 million saved – approximately $450,000 in company 401(k)s, $650,000 in a managed account, and approximately $70,000 in personal stocks. We also have approximately $22,000 in savings. Our home is worth $700,000 or more and we owe $197,000 with a 3.875% interest rate. Our advisor says we will be in good shape by 60. We will withdraw 5-8% from our investments and then take Social Security at 62. Do you think will we be able to withdraw between $60,000 and 80,000 annually and still be OK as long as our advisor makes us at least 5% to 8% per year?
While it appears that you and your wife have done a good job of saving over the years, the strategy your advisor is proposing sounds risky to me. It certainly could work out for you, but there are two main reasons why I would consider a more conservative approach, which I’ll get into below. (And if you need additional help planning for retirement, consider speaking with a financial advisor today.)
Reason #1: Annual Returns Will Vary
While 5% to 8% is a reasonable expectation for the average long-term return of a low-cost, diversified investment portfolio, you cannot expect your advisor to produce those returns every year. Market returns can fluctuate widely from year to year. For example, the S&P 500 produced a positive return of 28.47% in 2021, only to lose 18.01% in 2022.
No matter how good your financial advisor is, your portfolio is going to be subject to these kinds of ups and downs. You can of course manage that risk through your asset allocation, but you will still have good years and bad years.
If your financial advisor is telling you that he or she can consistently produce returns between 5% and 8% or better, you need to be incredibly wary. Research shows that even professionals struggle to beat the market consistently, so the best you can hope for might be a portfolio that tracks market returns, in accordance with your asset allocation, with as little cost as possible.
The bottom line is that you cannot count on consistent 5% to 8% returns. Your withdrawal strategy needs to account for the fact that your returns will vary, as well as the possibility that the market will suffer a downturn in the early years of your retirement. The latter is known as sequence of returns risk and it can severely impact the long-term viability of your savings. (Talk to a financial advisor to build a retirement plan suitable for your circumstances.)
Reason #2: You’ve Proposed an Aggressive Withdrawal Rate
You may have heard of the 4% rule, which states that you can safely withdraw 4% from a balanced portfolio each year, adjusting upward for inflation, with little risk of running out of money over a 30-year timeline. A recent study by Morningstar does a good job of diving a little deeper, testing safe withdrawal rates that range up to 10% for various asset allocations and time horizons.
Your total investment portfolio balance is $1.17 million. Applying the 4% withdrawal rule to that balance, you could safely withdraw about $46,800 per year.
However, your plan is to withdraw between $60,000 and $80,000 per year, which equates to a withdrawal rate of 5.1% to 6.8%. According to the Morningstar study, those withdrawal rates could give you a 90% chance of making it 15 to 20 years, assuming just 40% of your assets were invested in equities. However, your success rate would go down as you extend your timeline out to 30 or 40 years.
In other words, you may be able to get away with withdrawing that much each year, especially if you are lucky and the stock market is up in the early years of your retirement. But it’s an aggressive strategy with lower odds of success than I would typically recommend. (A financial advisor can help you plan your withdrawals and build a retirement income plan.)
What Are Your Alternatives?
If I were your advisor, I would suggest a few alternatives to the plan you’ve presented.
One option is to reduce your expenses so that you can live on smaller withdrawals. If you can get your annual withdrawal closer to that $46,800 amount, you’ll increase the odds of your portfolio lasting you through your retirement.
Another option is to work longer. That will give you more time to save, more time to accumulate Social Security benefits and fewer years of retirement to support.
You can also consider how you claim your Social Security benefits. There are strategies you can use to maximize those benefits, which could reduce the amount you need to withdraw from your investment portfolio. (And if you need help optimizing your financial plan for retirement, consider speaking with a financial advisor.)
Your advisor has much more insight into your situation than I do, so it’s certainly possible that I am missing something and that your plan is solid. But based on the information you’ve provided, you may want to proceed cautiously. If you are overaggressive with withdrawals, particularly in the early years of retirement, it could cause problems down the road.
Retirement Planning Tips
- Your income needs typically fall in retirement, but by how much? T. Rowe Price recommends that you start by aiming to replace 75% of your pre-retirement income. You can then adjust that percentage up or down based on your savings rate during your working years and your expenses in retirement.
- A financial advisor can help you save and plan for retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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