Retirement planning is now a crucial step in your overall financial planning regimen as more of individuals now wish to retire early in their life after having worked hard during their initial years. And it is not a one-step process but includes some of the stages such as accumulation phase, spending and the likes. You have to make a balance all through the process such that your ultimate retirement planning goal is achieved without compromising too much on your spending phase.
So, it is where the concept of safe withdrawal rate in retirement planning comes into play. The approach helps an individual to assess the amount of funds he or she can access from the corpus on a yearly basis such that they do not fall short of funds deployed for use during sunset years.
Explainer: How SWR enables you to ensure that your retirement corpus does not exhaust prematurely?
Any investment or financial planning exercise requires us to consider a few parameters which greatly influence the value of your investments in the long-run such as the macro and micro economic situation, inflation etc. And so to ensure, retirees are financially healthy in their after-work years, a formula of maximum 4% withdrawal is suggested i.e. a maximum of 3-4% can be withdrawn from such corpus for different expenses.
Formula of 4% rule devised by Financial Advisor William Bengen
He provided for a standard 4% rate of withdrawal and for the study he based his decision on different portfolios that combined both debt and equity. The research paper of Bengen was out in the year 1994. Also, during the study he took into account different economic factors such as the bear market condition of 1970s and Great Depression.
In the study he suggested a 4% withdrawal in the first year, where for the individual he assumed a retirement period of 30 years. Post the first year, he recommended inflation-adjusted withdrawals such that the corpus does not deplete earlier to retirement.
Drawback of SWR
The thumb rule in real sense is not practical as the rate of withdrawal also are dependent on some of the factors including asset allocation, investment avenues in the portfolio as well as the performance of the market.
SWR: How beneficial is the approach?
Nonetheless, as financial planners believe to achieve your retirement goal realistically, based on you current and future cash flows, you can assess the amount of funds you will need once you retire. And thus accounting for your current expenditure, current corpus situation and inflation rate, you will be able to adjudge the rate of return you need on your corpus until the time you live.