How much money should you withdraw in retirement? Anyone who is getting closer to retirement needs to think seriously about how much income they will need in the years the?y are not working.
This is a crucial decision for two reasons. The first is that it will dictate how much income you will have after your finish work. The second is that for those who are planning for retirement, this figure will dictate the level of assets you need to accumulate for any given level of income.
Let's use the example of a couple who retires with $1.3 million in investment assets.
They are trying to work out what this means for them in retirement. Should they be
planning to spend $40,000 a year, $60,000 a year or $100,000 a year?
Spending investment income
A simple but very legitimate approach to this problem is to suggest that a retiree with a range of investments might choose simply to spend the income that their investments earn. With a well-balanced portfolio, this is reasonably sound thinking.
Let's assume that our couple with $1.3 million in investment assets decides that they are going to leave one-third in cash, one-third in Australian shares and one third in residential property. At the moment they should be able to get at least 3.5% income on their cash investments, find a residential property with an after-cost yield of 4% and receive income (including franking credits) of 5.5% on a portfolio of Australian shares.
Their total income: $56,290. What is wrong with just spending this amount each year? The answer would be not much. It is a reasonable way to look at your retirement situation. Over time you would expect the income from the Australian shares and property investment to increase, providing an important buffer against inflation and effectively increasing the income that you have to spend.
Having $433,000 in cash style investments provides a great deal of liquidity for any cash needs. Spending the income of the portfolio preserves the underlying investments (although inflation will eat away at the $433,000 invested in cash), meaning the portfolio will be well placed to fund a retirement over many years.
For the person thinking about the amount of money that they need for retirement, a drawing rate of 4% suggests a withdrawal rate of $400,000 for every $100,000 invested, up to a withdrawal rate of $5,000 for every $100,000 invested if you use a 5% figure.
The biggest risk in this situation would be an economic shock that saw very low interest rates and decreased share dividends and rental income. If you were prepared to cut your spending to cope with such an outcome, then this approach to funding your retirement is certainly sound.
In Australia, we have factors that might support a higher portfolio withdrawal rate, including franking credits that provide a tax return for most Australian share investments and an age pension system that provides a safety net for people, even with levels of assets of $1 million.
These factors might lead to someone being comfortable drawing at a higher rate for different reasons - franking credits because of the extra source of returns, and the age pension because of the safety net it provides if portfolio funds are depleted too quickly. With this in mind, an Australian investor may be able to withdraw 5.5% or 6% and still be reasonably comfortable with preserving their capital.
There are other non-financial factors that might cause a person to decide to withdraw at a higher rate early in their retirement including the assumption that they will spend decreasing amounts of money on things like entertainment and travel as they get older.
In conclusion, the rate at which you draw from your portfolio is a crucial personal finance decision. It will determine the type of lifestyle you will be able to enjoy in your retirement years.
If you would like a no obligation review of your retirement plan and your investment structures, please contact Dominique Schuh on 07 5480 4877 or at email@example.com