How much should you be planning to withdraw when retiring as a physician

SAVING FOR RETIREMENT is relatively straightforward: Spend less than you make, and invest steadily. But as healthcare workers get closer to retirement, we often ask: How much is enough to retire and not run out of money?

To answer this question, we often utilize the 4% withdrawal rate as a guideline.

The magic number

The 4% withdrawal rate was first theorized by William Bengen in 1994 and then followed up by a Trinity study published in 1998. Bengen looked backward from 1925 to 1995 and tested which rate of withdrawal on a portfolio would allow someone to have enough money to spend for the rest of their life without running out. The result was 4%.
Someone close to retirement is likely to want more forward-looking data that models what might happen in the future, rather than the past. Financial planners often do this by running a Monte Carlo simulation (a type of multivariate analysis) to estimate our withdrawal rate based on our asset allocation and lifestyle goals.

Morningstar, a leading source of investment data for financial advisers, recently published their State of Retirement Income report that applies Monte Carlo simulations on a large scale to provide forward-looking guidance. Their answer: 4%.

If a retiree can adjust their spending based on market conditions, like most are, that approach can allow for higher withdrawal rates in conditions where the market is performing well, making room for giving and traveling.

A look at the strategy

The Morningstar analysis tested four commonly used flexible strategies. The base case assumes the retiree’s initial withdrawal is calculated as 4% of the total value of the portfolio and an upward inflation adjustment of 3% is added to that withdrawal every subsequent year. This strategy is quite inflexible and turns out to be inferior to the more flexible strategies that mimic real-life spending adjustments. The first flexible strategy forgoes the inflation adjustment in down markets to preserve capital during adverse conditions. This strategy cuts real spending but can allow for higher starting withdrawal rates (around 4.4% for a 40% equity portfolio) and results in a healthy portfolio value at the end of a 30-year retirement.

The second method ties the withdrawal to the Required Minimum Distributions (RMDS) required by the IRS. Because the remaining portfolio value can change significantly depending on the market conditions, there is substantial volatility to cash flows and ends up with lower portfolio values than other methods. This method may be good for people who can cover most of their living expenses from other sources of income such as social security or pensions.

The third method is the Guardrails system, developed by Jonathan Guyton and William Klinger. This method sets an initial withdrawal percentage and then adjusts subsequent withdrawals based on portfolio performance and the previous withdrawal percentage. When the portfolio is performing well and the market is trending upward, the withdrawal amount for that year increases by the inflation adjustment plus another 10%. In markets that are not performing well, the retiree cuts the withdrawal by 10%. This method supports the highest starting safe withdrawal rates across most asset allocations, from 4.9-5.2%, but results in lower portfolio values at the end of the 30 years. It could be good for retirees who prioritize maximizing lifetime spending over leaving an inheritance.

The fourth model incorporates the fact that spending usually declines in later ages, assuming real spending declines at 1.9% between the years of 65 and 75, 1.5% per year between 75 and 85, and 1.8% per year between 85 and 95. While it doesn’t maximize lifetime withdrawal rates, it delivers higher paychecks early in retirement and provides low cash flow volatility.

The Morningstar report introduces a fifth method of portfolio management for those seeking to generate guaranteed income: a tips (Treasury Inflation-Protected Securities) ladder. A tips ladder is a self-liquidating portfolio. A 30-year ladder buys tips of various maturities from one year to 30 years to generate guaranteed income for a specific period and then, literally, dying with zero. They provide a 100% success rate as they are immune from inflation. At current rates, a tips ladder would offer a 4.6% withdrawal rate with 100% success. But this strategy would liquidate the portfolio at the end of 30 years. For more flexibility, another strategy is to have a tips ladder with an equity kicker to keep some leftover value in the portfolio at the end of 30 years.

Though retirement spending waters can seem murky at first sight, we can be heartened that there are clear data and well-defined strategies that can help us preserve our portfolios and fund our lifestyles through retirement. •