Retirement Withdrawals: an Analysis of the Benefits of Periodic “Midcourse” Adjustments

Abstract Much research has addressed the question of how much money can safely be withdrawn from a retirement portfolio without prematurely running out of money (shortfall risk). Instead of constant (inflation adjusted) annual withdrawals, this study uses withdrawal amounts (and optionally, asset allocations) that are modified every five years over a 30-year withdrawal horizon. A bootstrap is used initially to obtain the conditional probability rules. Further simulations demonstrate that periodic (every five years) adjustments can decrease the risk of running out of money as well as increase the amount withdrawn, as compared to a "constant withdrawal amount" strategy. © 2008 Academy of Financial Services. All rights reserved. Jel classifications: G10; J26 Keywords: Retirement; Withdrawals; Asset allocation; Bootstrap 1. Introduction The amount of money that may safely be withdrawn from a retirement portfolio has been the subject of numerous studies. Bengen (1994, 2004) is at the forefront of this research, followed by Cooley, Hubbard and Walz (1998, 1999, 2003). The majority of studies focus on finding a constant withdrawal amount (after adjusting for inflation) and a fixed stock/bond asset allocation that will sustain a retiree for 25 or 30 or 35 years. The consensus outcome is that (inflation adjusted or real) withdrawals of about 4% to 5% of the starting portfolio balance are sustainable for 30 to 35 years with stocks comprising 50% to 75% of the portfolio and bonds the remainder. Spitzer, Stricter and Singh (2007) build on these studies and provide broader guidelines. Others, including Guyton (2004) and Tezel (2004), indicate that by adding more asset types to the existing stock/bond portfolio, it is possible to increase the withdrawal percentage. Stout and Mitchell (2006) develop a dynamic withdrawal system that incorporates retiree mortality. Because the probability of running out of money before death is smaller than the probability of running out of money over 30 years, their method provides larger withdrawals than do fixed withdrawal models. Dus, Maurer and Mitchell (2005) compare and contrast several types of phased withdrawal strategies. Dus et al. and Spitzer et al. have excellent literature reviews on withdrawal strategies. The constant withdrawal amount strategies tend to provide large "average remaining balances," (although a retiree should not count on this in practice). Many retirees are concerned about their own lifestyle, not that of their progeny; they have little desire to leave a large estate. In relatively good health early in their retirement, many retirees would like to spend larger amounts than the 4% or 5% of starting balance recommended in previous studies. They expect that their consumption needs for entertainment, education, and travel will be much less when they are considerably older. Hence, they anticipate needing less money (in real terms) very late in retirement and more money early in retirement. Basu (2005) looks at the changing components of retiree spending during retirement and finds that leisure spending and living expenses decrease with age while healthcare expenditures increase with age. Bernicke (2005) demonstrates that retirees total spending decreases with age; the traditional constant withdrawal amount takes out too much money, greatly increasing the risk of shortfall. Guyton (2004), Guyton and Klinger (2006), Stout and Mitchell (2006), and Klinger (2007) each propose methods for varying the withdrawal amounts in a manner that provides more retirement income at the expense of a smaller estate. Each of these papers provides their own set of "rules." Some rules encompass dynamically changing asset allocation, changing asset mixes, setting withdrawal caps and limits, present value analysis, eschewing inflation adjustments under some circumstances, and so forth. Results indicate that these rules can be effective in providing larger withdrawals during retirement with the same level of safety as the constant withdrawal methods. …