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Self-control is a personal trait that can make someone a great saver, but paradoxically, it can lead them to struggle when it's time to benefit from those savings.

Multiple studies including our own research* have shown that well-off retired investors often don’t spend much of their retirement savings, meaning their accounts can actually continue to grow. It's not a terrible problem to have, of course—but it could indicate that they don’t know how much is "safe" to spend and thus are overly frugal, sacrificing their enjoyment of retirement.

See other behavioral factors that can affect retirement spending Open page in a new window

As you plan how to use your retirement money, you want a strategy that accomplishes 2 often-competing goals: 1) giving you enough money to support your desired lifestyle, and 2) ensuring there's plenty left for the future (including any money you plan to leave to heirs). We've got a withdrawal strategy that can help you with both. But first let's review the traditional approaches.

Traditional withdrawal strategies: Pros and cons

The "dollar plus inflation" strategy calls for you to spend a percentage of your portfolio the first year and then make adjustments to that dollar amount based on inflation in future years. Here are a few things to note about this strategy:

  • The "4% rule" is a popular example of dollar plus inflation. If your expenses won't change much throughout retirement, it ensures you'll be able to cover your yearly costs for as long as the portfolio lasts (goal 1).
  • It ignores market conditions, so it could result in either running out of money (in down markets) or spending much less than you could actually afford (in up markets).
  • It could be best for someone whose main priority is maintaining a steady level of spending from year to year.

The "percentage of portfolio" strategy calls for you to spend a fixed percentage of your portfolio every year. Here are some things to know about this strategy:

  • It gives you complete confidence of achieving goal 2—not running out of money.
  • It results in yearly spending amounts that are completely market-driven and could fall below what you actually need to live.
  • It could be best for someone whose main concern is ensuring they don't deplete their portfolio and who can adapt their budget to a wide variety of spending levels.

"You want a strategy that accomplishes 2 often-competing goals: 1) giving you enough money to support your desired lifestyle, and 2) ensuring there’s plenty left for the future. We've got a strategy that can help you with both."

How to choose an initial withdrawal amount

No matter which strategy you choose, you'll start by selecting a withdrawal amount for the first year. (If you're still in the planning phase, many retirement calculators also rely on this as a critical component to tell you how much you need to save.)

Although 4% is a popular guideline, research has established it as "safe" only for specific time frames and allocations. And safe means different things to different people. For you, 4% could be too much—or too little. Here are the factors we consider when choosing a withdrawal rate for an individual client:

4 levers affecting withdrawal rates

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Dynamic spending strategy

Understanding that many people aren't able to prioritize either level spending or portfolio preservation, we identified a need for a retirement strategy that achieves both important goals—covering current spending while aiming to preserve enough money for the future.

Dynamic spending, which is a hybrid of the dollar plus inflation and percentage of portfolio rules, does just that. It builds on people's natural tendency to spend more when markets are up and less when markets are down—but moderates the wild swings you get when giving market performance free rein over your spending.

In other words, it achieves a happy medium. Your spending is more flexible than with a dollar plus inflation approach but also more stable than with the percentage of portfolio approach. It's also completely customizable, so in addition to deciding how much to withdraw the first year, you decide how much you're willing (and able) to raise or lower your spending in response to market movements.

To use dynamic spending, you calculate the upcoming year's spending by adjusting the amount of this year’s spending based on your portfolio return for the year. But you don’t go any higher than the “ceiling” or any lower than the “floor” you set as part of your strategy (more below).

Spectrum of spending rules

This framework allows you to decide how much you want to benefit from good markets by spending a portion of those gains. And it enables you to weather bad markets without substantially reducing your spending.

Best of all, dynamic spending can mean greater spending levels throughout retirement. For example, our historical research† showed that a retiree with a portfolio that was 50% stocks/50% bonds could withdraw 4.3% a year with 85% confidence that the portfolio would last through 35 years of retirement. But by incorporating dynamic spending, with a 1.5% floor/5% ceiling, that retiree could withdraw 5% a year and have the same level of confidence.

Dynamic spending on FIRE

Careful spending is even more important for early retirees. We looked at sustainable withdrawal rates for the "financial independence retire early" (F.I.R.E.) community and found a safe withdrawal rate of 3.3% for someone with a 50-year time frame using the dollar-plus-inflation strategy. But by using dynamic spending instead, the safe rate increased to 4%.‡

Setting your floor and ceiling as well as deciding on the right initial withdrawal rate means you'll need to make several decisions and maintain an additional level of oversight to use dynamic spending. And since all of these factors depend on your personal time horizon, allocation, retirement income sources, and priorities, there's no "right answer" for everyone.

If you're interested in incorporating dynamic spending into your withdrawal strategy, you can learn more in our research paper. Or set up a consultation with an advisor from Vanguard Personal Advisor Services®.

Learn more about dynamic spending Open PDF document in a new window

*Source: Vanguard, "Drawdown from Financial Accounts in Retirement" (Thomas J. De Luca and Anna Madamba, July 2021).

**This is an example of a possible ceiling/floor combination. When you use dynamic spending, you set your ceiling and floor based on your individual situation. An advisor can help you choose the combination that makes sense for you.

†Source: Vanguard, From Assets to Income: A Goals-Based Approach to Retirement Spending (Colleen M. Jaconetti, CPA, CFP®, et al., April 2020).

‡Source: Vanguard, Fuel for the F.I.R.E.: Updating the 4% Rule for Early Retirees (Paulo Costa, Ph.D., et al., June 2021).

Senior Financial Advisor Vernell Peter-Koyi

Vernell Peter-Koyi

Vernell Peter-Koyi is a Certified Financial Planner™ (CFP®) professional with Vanguard Personal Advisor Services®. She also has Chartered Financial Consultant (ChFC) and Retirement Income Certified Professional (RICP) designations. She's provided Vanguard clients with financial planning and advice since 2018.

Vernell earned a BA in accounting from Shippensburg University and an MBA in economics and finance from West Chester University.

When she isn't helping clients plan their retirement, Vernell spends time with her husband and 3 teenage children. She also enjoys reading as many books as she can and watching spy movies.

Ready to build your withdrawal strategy?

Working with Vanguard Personal Advisor Services gives you anytime access to advisors who are fiduciaries—always acting in your best interests. We'll work with you to build a flexible retirement withdrawal strategy to help you maintain a stable income while also preserving your portfolio.

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When taking withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.

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