Safe Withdrawal Rate

As more Baby Boomers enter retirement mode in the midst of major crises in financial markets, they are becoming more concerned that they may outlive their money. The financial advice community has begun to address this intensifying concern. New analyses of the Safe Withdrawal Rate (SWR) have been provided, and we offer our own analysis of the SWR here.

SWR may be understood by considering you have an IRA or 401(k) account from which you want to regularly withdraw a fixed amount of money. How big a fraction (called SWR) of the initial account value can you withdraw to be both useful for lifestyle and not deplete the account too soon?

More formally, an initial balance in a pre-tax account is assumed. The investor has an annual spending goal for a chosen time horizon of N years. The investor withdraws an amount of money equal to the initial balance times F, his initial withdrawal fraction, which amount presumably suffices for the investor’s purposes. The problem is to find the maximum F (called the SWR) possible for arbitrary values of N.

In the above set-up, both returns and inflation must be accounted for to determine the evolution of the account balances and a possible need to increase the amount withdrawn to compensate for inflation. We are not concerned with how those values of returns and inflation occur. Rather, we determine what SWR can be for various future states of the world as defined by returns and inflation.

For the geeks among us, our original, formal mathematical derivation of the SWR is here.  This paper also gives a set of references for those who wish to see other approaches to SWR.

A presentation of the key math concepts is here (also for geeks).

Our deeper analysis of the Safe Withdrawal Rate captures the effect of a financial crash or “shock” event occurring at some random time during the planning horizon. Unsurprisingly, a return-shock has a substantial effect, and we quantify this effect.


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