Once upon a time, Canadian retirees used their nest egg to fund particular expenses such as a new car, home renovation or a special trip. Some people will still be able to make irregular withdrawals like that, but it is more likely that today’s (and future) retirees will be relying on their own investments for a good part of their retirement cash flow needs.

The challenge now is figuring out how much is a safe withdrawal rate that will last you for life. A high withdrawal rate early on can quickly deplete your savings, especially if the stock market goes down and stays down for several years.

What is a safe withdrawal rate?

A commonly accepted rule of thumb is the “4% withdrawal rule” which has been used for a while as a convenient way to draw down assets. It was developed in the 1994 by William Bengen and based on long-term capital market assumptions for a model portfolio of 50% stocks and 50% bonds. The reasoning is that if you retire at 65, the 4 percent rule should provide 30 – 35 years of income and continues to be a benchmark.

There are two different ways to make the calculations:

  1. Constant Dollar, inflation adjusted (the original): Determine 4% of your retirement savings balance (that is, in your first year of retirement) and withdraw that amount. The next year, draw the same amount but include inflation. e.g. If you have $500,000 saved you would withdraw $20,000 the first year. The second year you would take out $20,400 (assuming 2% inflation), the third year, $20,808, and so on.

The drawback here is the built in assumptions may no longer apply. Bond yields have been low. A steep market decline could deplete your savings too early. People tend to make terrible investment decisions and not even get market returns. You may not enjoy the growth you need to fund 30+ years of spending.

  1. Constant Percentage: With the second method you withdraw 4% of your portfolio balance annually.

The disadvantage is the uncertainty about how much income you will have each year as it depends on your portfolio balance.

Early retirement

While the 4% safe withdrawal rate can be a good starting point, no simple financial rule can take into account all the variances and complexities of real life. If you retire early, especially before you are eligible to collect pension benefits, you need to be much more conservative in your withdrawal levels.

Consider Cindy (53) and Martin (58). Martin was recently let go from his sales job and has had difficulty finding comparable work. Discouraged, he decided he might as well take early retirement and will begin to collect reduced CPP at age 60. Cindy works part time in a small boutique and will continue working until age 65, then collect her CPP. They want to have $6,000 of income a month.

You can see from this diagram that, with not much income coming from other sources, the majority has to come from their savings (in blue). They will burn through their savings by two-thirds or more within the first ten years if they are not willing to scale back.

Safe withdrawal rate

Spending in retirement

Statistics Canada studies have shown that the average 65 year old spends about 25% more than the average 80 year old. In fact, the average retiree can expect three phases of retirement and it’s logical to assume that spending patterns will also change:

  • Early years – a period of travel, hobbies and adventure and spending more freely
  • Middle years – some activities, more socializing and relaxation
  • Later years – a time of winding down, discretionary expenses fall significantly, may be restricted to spending most days at home.

Final thoughts

Selecting a long-term strategy for withdrawing retirement assets can be a daunting task. It is unreasonable to believe that your initial strategy will still fit circumstances in later years.

You need to have a plan that fits you and your specific lifestyle needs to ensure your retirement years will be everything you want them to be. Careful planning will safeguard your future.

Related: A financial assessment for your retirement

Because the future is based on assumptions (and your life may not turn out to be “average”), you should monitor the performance of your portfolio closely and think about what you will have to do if your investments lag behind your expectations. No one knows where interest rates, house prices, stock market returns or inflation are headed.

Be flexible and reassess your plan at least annually, or as circumstances change, to ensure your savings are not dwindling beyond a reasonable amount too quickly.

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16 Comments

  1. Malcolm Palmer on February 19, 2016 at 7:39 am

    You should know that Jim (Cemil) Otar did a similar study in his book, “High Expectations, False Dreams” which tested out various fixed income / equity combinations against 100 years of actual financial data (inflation, stock market returns, etc.). His results are similar to the 4% results from the US study. Also, Derek Foster’s approach, using a constant dividend stream that never ends, is worthwhile.

  2. The Drivers on February 19, 2016 at 7:57 am

    How much was the nest egg that Cindy and Martin started with, when Martin retired? I don’t see any data for that in the graph or article.

    • boomer on February 21, 2016 at 12:10 pm

      @ The Drivers. The chart just illustrates that the majority of their income is coming from their savings in the first few years.

      People who want to retire before pension benefits start, and have little or no other income, have no choice but to withdraw from their savings. A $80,000 a year withdrawal rate is $400,000 in 5 years, not likely a concern if your portfolio is $2-3M, but if it’s $600,000 there are going to be problems. Something you need to address right at the start.

  3. Gary on February 19, 2016 at 9:07 am

    This certainly is a difficult problem and while we’ve been retired for almost 10 years we haven’t really found the solution. We are doing pretty good now but my biggest worry is if one of us expires our income (CPP & OAS) will be reduced considerably. I mention this so that retirees and future retirees keep this in mind when they make their plans. Thank you Marie for your posts.

    • boomer on February 21, 2016 at 12:12 pm

      Thank you Gary. That is a something not often addressed, but certainly a concern as we get older.

      • KC on February 23, 2016 at 7:47 am

        That’s why people always say not to rely on OAS or CPP totally. Plan without it and if you get to enjoy either or both of these, a bonus.

        Personally, I’d say don’t plan for OAS if you’re young (I can’t see this being around 30 years later for me) but CPP will always be around but I’m planning for half the amount that I expect to get to force me to save more. If I happen to get more than half, I’ll put it in the TFSA for a rainy day 🙂

        • My Own Advisor on February 28, 2016 at 9:31 am

          Exactly how I think KC. We’re trying to save and invest and live off our portfolio without considering OAS. We figure that is “gravy” for retirement 🙂

  4. Byron on February 19, 2016 at 1:19 pm

    I have an issue that has always concerned me about RRSP withdrawals discussions. Just because you withdraw cash does not mean you have to spend it. There are many reasons to withdraw the most important should be to pay less tax now than when you contributed to the RRSP. Maximizing ones TFSA is a good idea.

  5. Kathy Your Net Worth Manager on February 19, 2016 at 1:26 pm

    Good article Marie, I think a lot of the problem for ordinary folk lies in the statement you make : “you should monitor the performance of your portfolio closely …..what you will have to do if your investments lag behind your expectations”

    They do not have a plan or IPS , Investment Policy Statement to start with so have no function or expectations set for their portfolio. This suits most advisors as they are not being measured against anything. If its down and the media is howling end of the world they can just say to clients , “ well what do you expect” not was it down by more than it should be , did we capture the upside in the good times?
    Even if they have a required rate of return in mind they probably couldn’t track how its actually performing because they have a collection of “stuff” their advisor was attending lunch seminars for that year . Dan Bortolotti calls it the advisor 6 pack. It doesn’t get rebalanced or sold, just added to. The asset allocation pie chart on the statement conveniently doesn’t work as its such a mix clients have no chance of knowing how this may react at different times or comparing it to the market to see if its done well.
    But of course our advisor loves us , takes us for lunch once a year , lends us his cabin so we must be doing OK
    Your blog is great at encouraging people to wise up
    Kathy Your Net Worth Manager http://www.yournwm.ca

    • boomer on February 21, 2016 at 12:04 pm

      Well said Kathy. I think most financial/investment advisors concentrate on the accumulation phase and don’t have the training/experience to formulate a sustainable and tax efficient withdrawal plan for their clients who are starting to need this advice.

      • Kathy Your Net Worth Manager on February 21, 2016 at 12:24 pm

        There is actually a huge conflict of interests here , if you are paid a % of some ones assets either through a trailer from a MER or as a fee based account then its not in your interests for the client to use their money. I am meeting numerous older clients whose advisors tell them they can’t afford to do things ( fix up cottage / travel ) or talk them out of using interest bearing investments. Boomers are becoming more savvy , asking more questions , depleting accounts equals more work for less pay. Not an advisors dream but this is exactly the moment people need more help.

  6. John Ryan on February 20, 2016 at 9:45 am

    Great topic and post! What do you think of people who argue that 4% is super conservative (http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/) versus those who say it’s too aggressive (http://www.cnbc.com/2014/11/03/the-4-retirement-rule-is-broken-and-heres-why.html)?

    • boomer on February 21, 2016 at 12:23 pm

      Thank you John Ryan. The 4% rule is just a starting point but people are looking for a one-size-fits all answer, and it’s just not realistic. There are too many individual variables – your age at retirement, your lifestyle spending needs, size of portfolio, amount of government benefits, company pension payments, whether you own your home, or a cottage, if you’ll receive (really) an inheritance, etc. etc.

      A too conservative rate will reduce your lifestyle and leave a lot for your beneficiaries. A too aggressive rate leaves you broke too soon. You can’t just take someone else’s opinions. It’s a very personal decision.

  7. FletcherLynd on February 20, 2016 at 9:33 pm

    I think people need to understand simulations and run some to produce a real number that is personalized for them. Moshe Milevsky does real work on this topic and anything he has written is worth reading but I especially recommend Pensionize Your Nest Egg.

    • kathy Your Net Worth Manager on February 21, 2016 at 12:28 pm

      FletcherLynd I love Milevskys work! Its compulsory reading for my clients. Even his white papers on things like sequence of returns are jargon free.

      Beware sales people who use it as an excuse to sell you seg funds or GMWB with high MERs and a mass of small print though. As always the sales brigade manage to hijack a good idea.

  8. Tom on February 28, 2016 at 10:50 am

    I think the withdrawl rate could be at times more complicated. If one enters ones retirement in early 60’s you have a choice to defer OAS and CPP , take out more from the rrsp’s early on and you ger a larger guarenteed income when you reach 70’s to compensate for a smaller rrsp.

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