Admittedly, this approach is somewhat arbitrary. A Monte Carlo analysis would not have had to resolve this problem. However, my approach has been to use historical patterns of returns, and I ask the reader to accept it for now.
Maximum Safe Withdrawal Rates
Once the model for future market performance is adopted, it is a simple matter to forecast maximum safe withdrawal rates. For the purpose of the analysis, I used spreadsheet models of 86 retirement investors, each retiring on January 1 of the years 1926-2011. I chose this period because it embraces three major market declines, as well as succeeding bull markets. Since the models of returns and inflation are repetitious, extending the analysis for retirees beyond 2011 would not provide any new information.
Chart 1 exhibits the outcome of the analysis. A tax-deferred portfolio was assumed (in order to simplify the analysis), as was the asset allocation of 63% LCS and 37% ITG. This asset allocation was selected because it represented a near-optimal mix for retirement clients, as discovered in my earlier research.
As you might expect, as desired portfolio longevity increases, the safe maximum withdrawal rate decreases. It is also clear from the chart that beyond a certain portfolio longevity-about 65 years-there is very little decline in the safe maximum withdrawal rate, no matter how much the longevity is increased. In fact, the curve in the chart seems to approach an "asymptote," or ultimate value, of about 3.5%.
The decline in safe withdrawal rates from 4.1% at 30 years of portfolio longevity to 3.5% at 75 years of portfolio longevity is only about 15%. This means our Methuselah client need not suffer too much in lifestyle if he or she has an extended period without earned income. So you can tell your clients that if they want to take half a century off from work, no problem!
For taxable accounts, withdrawals must be reduced about 10% to 20% (depending on the income-tax rate) from the corresponding withdrawal rates for tax-deferred accounts to achieve the same probability of success.
Higher Withdrawal Rates
Some of my clients opt to withdraw money at a rate higher than the safe withdrawal rate. I advise them of the historical risk of doing so through probability charts such as Chart 1. For this segment of my research, I created a number of such charts for extended portfolio longevities. Chart 2, as an example, was constructed for 75 years of portfolio longevity. This can be considered the "forever" chart, as we saw above that its corresponding maximum safe withdrawal rate of 3.5% would probably allow a portfolio to last 100, 500 or even 1,000 years, if history is an accurate guide.
It would seem that for each desired portfolio longevity, an additional chart would be required. However, the progression of probability bars in each chart is so similar when viewed across charts that some simple rules of thumb can be developed, as reflected in Table 1.