Retirement income withdrawal rates in a low interest rate environment translate surprisingly low in the effort to reach a 90% success rate.
Over a retirement period of 30 years with 40% of a portfolio invested in stocks, a 2.8% annual withdrawal rate will yield a 90% success rate for retirement.
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The model used for analysis was an initial interest rate of 2.5% based on today’s rates and Barclays Aggregate Bond Index as of January 1.
An assumption was made that rates would rise to normal levels after a five to ten year period.
Thirty-day Treasury bills were used as a proxy for cash. The Ibbotson Intermediate-Term Government Bond Index was used as a substitute for bonds.
Over a 30-year period, the model assumed a 3.02% return on cash, a 5.14% return on bonds, bond yields at 5.01%, stock returns at 9.89%, and inflation at 3.14%.
Those assumptions combined with the traditional 4% retirement income withdrawal rate yielded a success rate of only 48.2%.
The first five to ten years after an employee retires are vitally important when it comes to shortfall risk.
The way some suggest to achieve higher yields is to raise the duration of the bond segment of the portfolio. But that exposes the portfolio to greater risk if interest rates begin to rise in
Raising the allocation to equities doesn’t really affect the withdrawal rate so taking more risk doesn’t’ necessarily pay off.
Clients need to have more conservative expectations about how much they can withdraw during retirement. Delaying retirement or supplementing income may be options clients have to
consider if they don’t think they will have enough money to live on.
The model also suggests that asset allocation as well as withdrawal rate have a direct bearing on a client's retirement income level.
Since the lower withdrawal rate combined with a 40% allocation to equities yielded a higher success rate, clients may need your guidance in what to expect after they retire based on their personal circumstances.