Safe withdrawal rates and your retirement savings

In previous articles and blog posts we've tackled the inter-related issues of 'longevity' and 'withdrawal rates' (the amount of pension you take from your retirement savings).

The Financial Services Institute of Australasia (FINSIA) has recently released a new study on 'safe withdrawal rates' (How safe are safe withdrawal rates in Australia? An Australian perspective). The study's basic thrust is to challenge the safety of relying on the '4% rule' for determining a safe amount of pension to draw down each year.

It's a dry report, with lots of statistical analysis, so a quick summary for those who don't want to read the whole thing:

1. Australia may be the worst case study for testing safe withdrawal rates because of our strong equity market performance in recent decades. The study tests withdrawal rates across 19 countries.

2. From an Australian perspective a 4% withdrawal rate (with a 50% stocks/50% bonds portfolio) exhibits 82% success over 30 years. To put it another way, if you retire at 60, you've got an 18% (or roughly 1 in 6) chance of your money running out before 90. Interestingly, the percentage increases to 96% if the portfolio is 100% stocks (because of the strong returns on equities in the past)

3. The 'super safe' withdrawal rate (in an Australian context, with a 50/50 portfolio) is closer to 3%.

4. In other countries, the 4% withdrawal rate has performed terribly. In Japan, for instance, a 50/50 portfolio would see you run out of money in more than one third of cases (over 30 years).

A reasonable conclusion is that the safe withdrawal rate is more like 3%, not 4%, which may challenge the assumptions made by many Australian investors.

However, it's important to note the limitations of the research, including:

1. The analysis is backward looking, using market performance. If you outperform the market you'll do better.

2. Static portfolios are analysed. The possibility of adapting your asset allocation to the circumstances isn't taken into account.

3. Withdrawal rates are constant, not reduced to cope with lower than expected returns. If you've got flexibility to reduce withdrawals you can afford to take more risk day one with your withdrawal rate.

4. In Australia, we have the inter-play between super pension and the aged pension. If you're satisfied with the age pension as a back up, you can again afford to take more risk at the outset.

Despite it's limitations, the study highlights the dangers in over-reliance on heuristics, especially when they're developed by a finance industry with overly optimistic tendencies.