WHAT IS Dynamic Updating
Dynamic updating is a method of determining how much to withdraw from retirement savings each year. Dynamic updating is different from other methods of calculating retirement account withdrawals, such as the safe withdrawal rate method, in that it reevaluates how much the person can take out each year based on changes in inflation, life expectancy and portfolio values. It also accounts for any income received during retirement.
The calculations behind dynamic updating try to keep retirees from running out of money before the end of their respective lives. The most important considerations in dynamic updating are a retiree’s expected lifespan, how that expectation changes annually, and a metric called the possibility of failure rate, which gauges the likelihood of running out of money given a particular withdrawal percentage.
BREAKING DOWN Dynamic Updating
Dynamic updating is notably more complex than simply choosing a static withdrawal rate that doesn’t change due to market conditions or life circumstances. For instance, many choose a withdrawal rate of 4%, based on inflation data going back to the early 1980s, which is less than that annual percentage during that multiyear span, on average. Conversely, dynamic updating takes into account how long a retiree’s nest egg is projected to last, and sets the withdrawal rate accordingly.
In some cases, dynamic updating is more aggressive than a standard 4% withdrawal rate. This is especially true early in retirement. What’s more, dynamic updating takes a more aggressive withdrawal rate when life expectancy takes a turn for the worse. For example, say doctors give a retiree only five years to live. This expected lifespan change can raise a retiree’s annual withdrawal rate under dynamic updating, providing a high quality of life during those years.
Conversely, dynamic updating also accounts for the after-effects of a recession, or a bear market that wipes value from a retirement account. As a result, the withdrawal rate declines in these circumstances using dynamic updating.
Pros and Cons of Dynamic Updating
Dynamic updating gives retirees confidence to spend more than the tried-and-true 4% a year without breaking any rules. Knowing that the withdrawal rate will change if a recession hits, for example, the system still keeps retirees from running out of savings before they die.
The pendulum swings both ways, however. When the market tanks, followers of dynamic updating typically find themselves in need of making lifestyle changes. For this reason, dynamic updating is less predictable than the standard 4% rule.
Not all dynamic updating systems are exactly the same. Some set initial withdrawal rates at 5% or less, which a number of financial planners still consider somewhat conservative, given, that the withdrawal rate contracts when necessary.