When it comes to saving for retirement, you want to make sure you enjoy your “someday.” That means a strategy built for the long haul—these days, retirement often last 25 years or more.
That’s why we came up with four key guidelines: a yearly savings rate, a savings factor, an income replacement rate, and a sustainable withdrawal rate, to help you create your retirement road map. (See chart.) They are all interconnected, so it is important to keep each in mind on your journey to retirement, and to understand how they work together.
We'll dive into each guideline in separately. (To read about all our guidelines see Viewpoints special report: "Retirement rules of the road.") Here we focus on the potential sustainable withdrawal rate.
A target withdrawal rate
We did the math—looking at history and simulating many potential outcomes—and landed on this: Aim to withdraw no more than 4% to 5% of your savings in the first year of retirement, and then adjust the amount every year for inflation. Let’s look at a hypothetical example. John Lee retires at age 65 with $500,000 in retirement accounts. He decides to withdraw 4% or $20,000, each year for expenses. That amount is his baseline for the years ahead. Each year, he increases that amount by inflation—regardless of what happens to the market and the value of his investments.
“The sustainable withdrawal rate is a useful rule of thumb for retirees looking to withdraw steady income from their retirement savings,” says Adheesh Sharma, vice president of financial solutions for Fidelity Strategic Advisers, Inc. “However, it is important to understand how the rule works. The rate just gives you a starting point for your withdrawal amount and then has to be adjusted annually for inflation.”
A look back at history
Of course, your actual sustainable withdrawal rate will vary based on many things, including some you can’t control—like how long you live, inflation, and the long-term risk and return of the markets. When you retire is particularly important, as a bear market early in retirement can significantly diminish your nest egg, especially if you don’t dial down your withdrawals with the declining markets. On the other hand, a strong stock market early in retirement can put the wind at your back—financially speaking—for decades.
Consider the graph below, which illustrates a historical look at how much an investor could have withdrawn from savings without running out of money over a 28-year retirement, depending on the date of retirement. As you can see, sustainable withdrawal rates varied widely,1 from 10% if you retired in 1980, at the beginning of a roaring bull market, versus less than 4% if you retired in 1936, during the Great Depression.
A good starting point: the 4%–5% rule
You don’t know what the future will hold for you, and past market performance is no guarantee of what will come next. Nevertheless, our historical research suggests that limiting the first withdrawal to 4% to 5% is a good place to start.
We went back and looked at what would have happened with a hypothetical person’s 28-year retirement, basing our calculations on the first day of each month, beginning with January 1, 1926. In 90% of those retirement periods, a balanced portfolio (50% stocks, 40% bonds, and 10% cash) with a 4% withdrawal rate would have lasted for at least 32 years, and a 5% withdrawal rate would have lasted for at least 22 years. This means that even with market ups and downs, these withdrawal amounts worked most of the time—assuming that investors stuck to this balanced investment plan. (See footnote 4 for more details on how these results were calculated.)
Of course, 4%–5% is just a starting point. Our research and the interactive tool below show how things you can control—your retirement date, investment mix, savings at retirement, and spending plans—all play a role in figuring out the right number for you.
Take your timeline into account
One of the biggest factors that affect how much you can withdraw is how many years of retirement you plan to fund from your retirement savings. Say you plan on a retirement of 30 years and you invest in a balanced portfolio. Our research shows that a 4.2% withdrawal rate would have been sustainable 90% of the time.2
But if you work longer—say you expect to retire at age 70—or if you have health issues that compromise your life expectancy, you may want to plan on a shorter retirement period—say, 25 years. The historical analysis shows that, over a 25-year retirement period, a 4.6% withdrawal rate has worked 90% of the time.
On the other hand, if you are retiring at age 60 or have a family history of longevity, you may want to plan for a 35-year retirement. In that case, 3.8% was the most you could withdraw for a plan that worked in 90% of the historical periods. These may sound like small differences, but they could equate to thousands of dollars in annual retirement income.
How you invest is important, too
The mix of investments you choose is another key to how much you can likely withdraw without running out of money. Portfolios with more stocks have historically provided more growth—but have also experienced bigger price swings.
Should you add more stocks to your portfolio to try to maximize the amount you can withdraw, or play it safer with a more conservative mix? It depends. We believe that you should aim to cover food, housing, and other essential expenses in retirement with guaranteed income from Social Security, pensions, and annuities. If this is your situation, you may want to then try to maximize the income that comes from your other invested savings by investing more in stocks in this part of your retirement portfolio.
Our research suggests that in about half the hypothetical scenarios we tested, a growth portfolio with 70% stocks, 25% bonds, and 5% cash would have allowed you to withdraw more than 6% each year—nearly 20% more than a conservative portfolio (20% stocks, 50% bonds, and 30% cash) for a 25-year time period. Your invested savings could be used for discretionary expenses like entertainment or gifts to charity, so if you were to begin to run out of money, the impact would not be as critical.
But what if you don’t have your essential expenses covered by guaranteed sources and don’t feel comfortable with a plan that works only in about half the scenarios we tested? A plan with a higher success rate can come with a cost. As the chart right shows, for a plan that worked more often in our hypothetical scenarios, you would need to accept a lower withdrawal rate—which means taking less money out of your savings each year.
If you feel you need high confidence that your savings will last throughout retirement—and in particular if you find volatility unnerving—history suggests that a high allocation to stocks may be less attractive to you than it might be to others. For a 99% chance of success over a 25-year period, you would need to reduce your withdrawals to 4.2% for a conservative portfolio, 3.6% for a balanced portfolio, and 3.1% for growth portfolio.3
Choosing the right withdrawal rate can improve your odds of success, but it won't guarantee that you won't run out of money. Some products do offer that guarantee.5 While investing always involves risk, some insurance products guarantee a stream of income until death, thus all but eliminating the risk of outliving that portion of your savings. Of course, there are trade-offs: Annuities restrict or even eliminate your access to your assets, and they also are subject to the claims-paying ability of their issuers. Still, this is one way to deal with the lifetime income challenge, particularly when it comes to essential expenses.
For many people, planning for withdrawals in retirement can be challenging. And no wonder, given the range of uncertainties, from how long you will live, to market performance, inflation, taxes, and more. Our 4%–5% sustainable withdrawal rate takes those uncertainties into account and gives you a starting point for laying out your retirement income plan.
- Estimate how long you think you will live based on your health and family history. You may want to be conservative, since many people underestimate their lifespan.
- Evaluate how much investment risk you can live with.
- Choose an appropriate mix of investments.
- Make sure your money is likely to last, by choosing a withdrawal rate you believe has a good chance of success.
Use our interactive tool to familiarize yourself with the potential trade-offs involved in retirement income planning. But don’t stop there. As you approach retirement, consider generating a more complete plan with the help of Fidelity’s Planning & Guidance Center, or working with a financial consultant.
You may find that a little planning can help to give you more confidence so that even if you can’t know the future, you will be more prepared for what comes your way.