A reliable stream of funds to live on is a necessity for retirees. When a retirement fund is depleted, the retiree must rely on other sources of income to survive or return to work if possible. However, a properly calculated safe withdrawal rate can keep you from spending down your retirement savings too quickly.

A safe withdrawal rate:

What Is the Safe Withdrawal Rate Method?

A safe withdrawal rate represents the maximum percentage of retirement funds a retiree may take from an investment portfolio on an annual basis without depleting the investment account too soon. Once you have determined a safe withdrawal rate, a retiree can then go ahead and plan a reliable household budget for retirement that may stretch 30 years or more.

How to Calculate a Safe Withdrawal Rate

Like the 4% retirement withdrawal rule, the safe withdrawal rate model usually leads to a retiree using no more than 3% or 4% of their total available retirement investment funds on an annual basis. For example, a 60% stocks and 40% bonds retirement portfolio allows for a 4% withdrawal rate with a high degree of confidence that the retiree will have sufficient funds for a 30-year retirement. “You could put 60% of your money in the S&P 500 and the 40% balance in an A+ corporate bond fund,” says Lyle Solomon, principal attorney of Oak View Law Group in Rocklin, California. “That scenario is simple, as there’s nothing more to think about other than collecting the money.”

To follow this withdrawal protocol, you would withdraw 4% in the first year of retirement, and that amount gets increased by the amount of inflation in subsequent years.

If your nest egg is $100,000:

However, a retiree doesn’t have to withdraw exactly 4% of his or her nest egg annually and could make adjustments based on stock market performance. You could choose to reset your withdrawal rate if the value of your retirement nest egg drops from year to year. “In that scenario, you could reset that year and restart at a 4% withdrawal rate of what’s left,” Solomon says. “In contrast, if your nest egg is growing by leaps and bounds, you could choose to increase the withdrawal rate.”

Pros and Cons of the Safe Withdrawal Rate Strategy

Like any investment management strategy, the safe withdrawal rate has its upsides and downsides. “The primary benefit of the safe withdrawal rate method is that it’s simple to understand and can encourage people to control their expenses,” says Paul Tyler, chief marketing officer at Nassau Financial Group in Hartford, Connecticut. “Controlling expenses is perhaps the biggest lever retirees can realistically control.”

The biggest risk with using the safe withdrawal rate strategy is that everyone has their own definition of a safe withdrawal rate. “Let’s say you decided 4% was the right amount for you to withdraw,” Tyler says, “Do you keep withdrawing this amount for the rest of time? What if the stock market drops and your account value dips, too? These are the questions a retiree should ask their trusted investment advisor.”

What Retirement Withdrawal Rate Is Right For You?

Determining your safe withdrawal rate starts with getting help from a retirement planner. A good money manager can look at your expenses and other sources of retirement income to develop a plan that works for your unique financial needs. “Any retiree, working with his or her advisor, must carefully establish a safe retirement withdrawal rate based on factors including predicted lifespan, the size of your portfolio, your outgoing costs and the amount of retirement income you already receive,” Solomon says.

The first step is to determine your financial needs. Then calculate how much of your expenses will be covered by Social Security, a pension or other sources of retirement income. Remember to factor in your life expectancy, perhaps by using a life expectancy calculator, and take into account any health concerns. You will also want to consider tax efficiency when timing withdrawals from your retirement accounts. “Make sure to review that plan every year,” Tyler says.