What should be my safe withdrawal rate for retirement?

Published: October 28, 2023 at 6:00 am

A reader asks, “How can I calculate my safe withdrawal rate when I retire 25 years from now? I am 30”.

What does the term “safe withdrawal rate” mean? The safe withdrawal rate, or SWR, refers to the amount of money that can be withdrawn annually from a retirement fund in the first year of retirement. This rate is calculated by dividing the initial withdrawal amount by the total money available for retirement. Typically, backtesting is employed to determine a suitable SWR. By analyzing data from both equity and debt markets, we can establish the withdrawal rate that allows the retirement fund to last longer than the individual’s lifespan in most cases. It’s important to note that the SWR only represents the withdrawal rate in the first year of retirement, and subsequent years may naturally involve higher rates.

Based on US market history, backtests initially determined the SWR to be about 4%, although recent market data have indicated its limitations; for some history and why we need to look for alternatives, see: Why we need to stop using Safe Withdrawal Rate (4% rule) for retirement planning.

There is little point in backtesting using Indian market data because the history is too short. In any case, our retirement plan should reduce the sequence of returns risk with a combination of retirement buckets and annuities. This is so much easier to do when retirement is far away, as in your case.

The only use for an SWR is to determine if a retiree has enough corpus to distribute them into buckets to try and beat inflation or if she should buy an annuity and not take on market risk. For example, if the SWR (annual expenses in the first year of retirement divided by available corpus) turns out to be 6%, then an annuity is safest.

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Even though the income cannot match up to inflation with an annuity, there will be some income for the retiree’s lifetime. If, on the other hand, we hand taken on market risk with the corpus, it may get depleted before she passes.

But this is easy to deduce for high SWRs. What about 5% or even 4% (since widespread agreement exists that even this is high)? This is why our robo-advisory tool never bothers with the SWR.

We implement the income bucket approach to mitigate the negative impact of poor investment performance during the initial retirement years. This approach ensures a reliable income for the first 15 years of retirement, adjusted for inflation. Meanwhile, the remaining funds and an emergency fund are divided into separate low-risk, medium-risk, and high-risk buckets. This strategy reduces the need for constant adjustments and uncertainties in managing these buckets.

Detailed illustrations are available here:

In addition, two further options are available.

So our aim should not be to focus on some fixed SWR. It should be to ask, “How best am I prepared for poor returns from equity and fixed income after retirement?”

For what it is worth, we mention the withdrawal rates for the above scenarios using the freefincal robo advisory tool.

Assumptions and inputs

  • Age 30; Age of spouse: 28
  • Current monthly expenses that will persist in retirement: Rs 50,000
  • Retirement age: 55
  • Years to retirement 25
  • Total average monthly expenses (annual/12) 50,000
  • Percentage by which your monthly investments can increase each year (until you have accumulated enough for retirement) 10%
  • Post-tax return expected from equity investments 10%
  • Post-tax return expected from current taxable fixed income 5%
  • Rate of return expected from current tax-free fixed income 6%
  • Inflation before retirement 7%
  • The assumed life expectancy of the younger spouse: 90
  • Inflation during retirement 6%
  • Monthly expenses in the first year of retirement Rs. 2,71,372
  • Years in retirement (until younger spouse reaches age 90) 37
  • Corpus already accumulated is assumed to be zero for convenience.

Result 1: Corpus required with no income flooring or laddered annuity: Rs. 9.82 Crores. Withdrawal rate: 3.31% (withdrawal rate here only refers to the value for the first year in retirement).

Result 2: Corpus required with 100% income flooring (single monthly annuity = monthly expenses in the first year of retirement): Rs. 13.08 Crores. Withdrawal rate: 2.49%

Result 3: Corpus required with 100% income flooring (single monthly annuity = monthly expenses in the first year of retirement): Rs. 25.40 Crores. Withdrawal rate: 1.28%

This is an example. The steps can be altered as desired via the inputs in the robo tool.

Annuity ladder along with expenses after retirement. A screenshot from the freefincal robo advisory tool
Annuity ladder along with expenses after retirement. A screenshot from the freefincal robo advisory tool

Most people reading this would say this is an unachievable corpus. Yes, that is how it would seem when you get started.  As your corpus grows, so will your confidence to build stronger moats for your retirement castle. So aim for result one, and then as the years pass, you can modify your retirement plan.

In summary, please do not fixate on any particular SWR. Focus on investing as much as possible for retirement and plan to combat returns risk sequences first in the initial years of retirement and later beyond. As your wealth grows, so will your perspective.

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Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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