How to Use a Withdrawal Rate in Retirement Planning

Tracking your withdrawal rate is important in retirement. Here's why.

A giant number 5%.
If your withdrawal rate is too high for too long you could run out of money. xiaoke ma / Getty Images

A withdrawal rate is a calculation that tells the percentage of your invested assets you are spending, or could spend, each year in retirement.

Withdrawal Rate Example

Let's look at an example of how withdrawal rates work.

  • Assume at the beginning of the year you have $100,000 in an investment account.
  • Over the course of the year you withdraw $8,000.
  • Your withdrawal rate for the year is 8% ($8,000 divided by $100,000).

    A safe withdrawal rate is supposed to be the amount you can spend each year without ever worrying about running out of money. Depending on the risk level of your investments, the performance of the investments, and the need to increase withdrawals for inflation, a safe withdrawal rate can vary from 3% to 4.5% a year.

    Some studies have proposed that you must keep withdrawals at 4% or less to be safe. This 4% withdrawal rule can serve as a rough guideline to follow. Additional research has shown that by following a disciplined set of withdrawal rate rules that tell you when you get a raise and when you need to take a pay cut that you can spend a little more and withdraw 4%-6% a year instead of 3-4%.

    If you are not retired yet, one way to use a withdrawal rate is to approximate what you may be able to withdraw later. For example, at a 5% withdrawal rate you could withdraw $5,000 per year for every $100,000 you had invested.

    Of course some of that $5,000 would have to be set aside for income taxes in retirement.

    When you get serious about doing your retirement planning, rather than relying on a rule of thumb, you'll want to create a schedule or timeline that shows your anticipated withdrawals each year throughout retirement.

    Some years you may need more funds to buy a car or take a trip. Other years, you may need less. 

    Why You Want to Track Your Withdrawal Rate

    When in retirement, it is important to track your withdrawal rate each year and compare it to a plan that shows what it should be in order for your money to last throughout retirement.

    If your withdrawal rate is consistently above what you planned for and you still have a long life expectancy, you could run out of money. Tracking this metric is like going in for a physical. It is a way to check in and make sure your spending is at a healthy sustainable when compared to your portfolio size.

    Withdrawal Rate Successes

    Because the future is, well, the future and undetermined, you'll want to have a flexible plan that allows for some "wiggle room" in how much you withdraw each year. This type of flexible plan means you may be able to withdraw more in one year for a big purchase like a car, and less in another year where no big purchases occur.

    One way to make sure you don't withdraw too much is to set up a systematic withdrawal plan that direct deposits a set amount of money from your investments into your checking account. This serves as a "paycheck" and if you only spend what is deposited it can keep you from dipping in and spending extra money that was really earmarked for the future - not for the current year.

    Another successful approach is something called a time-segmented withdrawal approach where investments are made to match the time frame of when you will need them. For example a CD may mature each year to meet your spending needs for that year.

    If you have money in IRAs and 401(k) plans, one thing to keep in mind is how your withdrawals will change when Required Minimum Distributions begin. This regulation requires you begin withdrawing from retirement accounts at age 70 1/2, and each year you get older, you have to withdraw a bit more. 

    When withdrawing in retirement, the most important thing is to plan and then measure against that plan. Having and following a plan is the single most important thing you can do to make sure you have enough funds for all your retirement years.