DEFINITION of Safe Withdrawal Rate (SWR) Method
The safe withdrawal rate (SWR) method is one that retirees use to determine how much they can withdraw from their accounts each year without running out of money before reaching the end of their lives. The safe withdrawal rate method is a conservative approach that tries to balance having enough money to live comfortably with not depleting retirement savings prematurely. It is based largely on the portfolio’s value at the beginning of retirement.
BREAKING DOWN Safe Withdrawal Rate (SWR) Method
Figuring out how to use your retirement savings isn’t easy because there are so many unknowns, including how the market will perform, how high inflation will be, whether you will develop additional expenses (such as medical), and your life expectancy. The longer you expect to live, the faster you could draw down your savings; in addition, the worse the market performs, the more likely you are to run out of money.
The safe withdrawal rate method tries to prevent these worst-case scenarios from happening by instructing retirees to take out only a small percentage of their portfolio each year, typically 3% to 4%. Financial experts recommended safe withdrawal rates have changed over the years as experience has illustrated what really works and what doesn’t work and why.
Knowing what safe withdrawal rate you’d like to use in retirement also informs how much you need to save during your working years. If you want a SWR of 4%, you need to save more than if you want a SWR of 3%. The rate you choose affects how aggressively you need to save and how long you need to work.
A shortcoming of the SWR method is that depending on when you retire, the economic conditions can be very different from what initial retirement models assume. A 4% withdrawal rate may be safe for one retiree yet cause another to run out of money prematurely, depending on factors such as asset allocation and investment returns during retirement. In addition, retirees don’t want to be overly conservative in choosing a safe withdrawal rate because that will mean living on less than necessary during retirement when it would have been possible to enjoy a higher standard of living. Ideally, though this is rarely possible because of all the unpredictable factors involved, a safe withdrawal rate means having exactly $0 when you die, or if you want to leave an inheritance, having exactly the sum you want to bequeath.
An alternative to the safe withdrawal rate method is dynamic updating, a method that, in addition to considering projected longevity and market performance, factors in the income you might receive after retirement and reevaluates how much you can withdraw each year based on changes in inflation and portfolio values.