Monday, April 25, 2011

Safe Savings Rates & Current Withdrawal Rates

Update: Dan Moisand discusses the contents of this blog post in his May 18 column at Financial Advisor magazine,  "The Unsafe and the Unreal"
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Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle,” is still somewhat of a work in progress.  I have written a blog entry about it, and the full paper can be downloaded from RePEc. The paper will be in the May 2011 issue of the Journal of Financial Planning

One issue for now, I would like to provide some more details about current withdrawal rates over the retirement period.  One aspect of the paper that people find a bit unsettling is that on occasion a retiree begins with a rather high withdrawal rate at the retirement date.  It may be hard for real retirees to stomach this, and the purpose of this blog entry is to just provide a bit more detail about this issue, and about the evolution of the current withdrawal rates (the withdrawal amount for a given year divided by the wealth remaining in that year) over the retirement period.  


I will look at the case of 4 retirees:


1918 retiree: In the baseline case of the paper, this retiree experienced the worst overall situation in history, as the savings rate needed to finance retirement expenditures was higher than any other retiree. The 1918 retiree set 16.62% as the safe savings rate.

1921 retiree: This retiree is unique for having retired with the lowest wealth accumulation in history. With a 16.62 percent savings rate, the wealth accumulation at retirement was only 5.52 times final salary for the 1921 retiree. For that unfortunate 1921 retiree, the low wealth accumulation implies a required withdrawal rate of 9.06 percent to be able to withdraw the desired 50 percent replacement rate of final salary. However, 1921 was not the worst-case retirement, because, indeed, the actual MWR for the 1921 retiree was 9.78 percent. 

1966 retiree: This retiree is unique for having experienced the lowest MWR in history (4.08 percent). But with a 16.62 percent savings rate, the 1966 retiree accumulated wealth of 14.71 times final salary, which required that she only use a withdrawal rate of 3.4 percent to meet her retirement spending goals.

1980 retiree: This retiree did not set any records, but she is a more recent retiree with a relatively low wealth accumulation at retirement (6.96 multiples of final salary), and a relatively high MWR (7.95%).

First, here  is the evolution of wealth for these 4 retirees from the beginning of their savings period (30 years before retirement) to the end of their retirement period (30 years after retirement) using the 16.62% safe savings rate. Because 1918 was the worst-case year that set 16.62% as the safe savings rate, the 1918 retiree precisely ran out of wealth in the 30th year of retirement.  All of the other retirees still had remaining wealth after 30 years. The 1921 is the most startling other case. After saving at 16.62%, the 1921 retiree had accumulated only 5.52 multiples of wealth and had to use a 9.06% withdrawal rate to obtain her desired retirement spending level. But even using a such a high withdrawal rate, she still had  2.41 multiples of final salary left as wealth at the end of 30 years.



Now, regarding current withdrawal rates, I think this is an important avenue for future research. I began exploration of this matter in my paper, "Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History? A Progress Report after 10 Years," and I hope to return to this issue again.  For now, let me provide some details about current withdrawal rates. 


First, here is the path of current withdrawal rates for the 1918 retiree using a 16.62% savings rate, which set her actual initial withdrawal rate equal to her maximum sustainable withdrawal rate (7.28%). A note about these figures: I split them into two parts, the bottom is zoomed in on withdrawal rates between 0 and 10 percent, and the top zooms out on withdrawal rates above 10%. The current withdrawal rate is 100% in year 30 because the remaining wealth is spent that year.


Next, this figure shows current withdrawal rates for the 1921 retiree when using 15.41% as the savings rate, which is the savings rate that calibrates the initial withdrawal rate for the 1921 retiree equal to her actual maximum sustainable withdrawal rate (9.78%):



And here is the case for the 1921 retiree when using the higher 16.62% savings rate, so that the initial withdrawal rate is 9.06%. This is the case shown in the first figure for wealth, in which more than 2 multiples of wealth remain after 30 years:




Next, the 1966 retiree experienced the lowest MWR. This figure shows current withdrawal rates for the 1966 retiree when using 13.86% as the savings rate, which is the savings rate that calibrates the initial withdrawal rate equal to the actual maximum sustainable withdrawal rate (4.08%):


And here is the case for the 1966 retiree when using the higher 16.62% savings rate, so that the initial withdrawal rate is 3.4%:

 Finally, the 1980 retiree.  Here, the 1980 uses 15.03% as the savings rate, so the initial withdrawal rate again matches the 7.95% maximum sustainable withdrawal rate:




And here is the case for the 16.62% savings rate. Now the initial withdrawal rate is 7.19%: