Low Interest Rates Could Affect Your Retirement Account Withdrawls

February 19, 2015

There is a general notion in financial planning that, given a historically average rate of a return over time from a balanced, diversified investment portfolio, a retiree may draw approximately 4% each year from the portfolio for retirement expenses without completely depleting that account in their lifetime.

Recent academic research indicates even 4% may be too much today.  This is primarily due to the low-interest rate environment we’ve been experiencing over the past several years. In a normal, balanced portfolio of 60% stocks and 40% fixed income, if bonds are delivering sub-par returns (due to low interest rates on those bond holdings), then either the stock-portion of the portfolio has to work harder or the account owner may not be able to withdraw 4% and still maintain the same account longevity.    In other words, if your returns are less than expected, you could be taking too much from your account.

The research indicated that bond yields have a significant effect on what a retiree could withdraw from their account and not have it decline too soon.  This is because retirees often have much more conservative portfolio allocations with a large percentage allocated to bonds, especially US Treasuries.  If the bond investments are not yielding much above inflation, or perhaps even less than inflation, then withdrawals may be too much from principal, as there is less “profit” in the form of interest and appreciation and inflation increases the cost of maintaining one’s lifestyle.

Solving the problem may involve unpleasant choices.  Lowering the withdrawal to 3% or even 2.5% during low-interest rate years could help to preserve the longevity of the account, but may also require a lower-spending level for the retiree.  You could increase the portfolio allocation to stock investments, but that invites higher volatility and risk to a portfolio – something most retirees are uncomfortable assuming.  Deferring retirement or saving more during the working years are also possibilities, but many are adverse or unable to elect either of these options.

Knowing this effect on withdrawal rates, it is worthwhile to revisit your assumptions about retirement income.  No one (really) knows when or how much interest rates will rise in the coming years, but understanding their effect on your retirement could give you insight to perhaps adjust your income expectations or require a little more “cushion” in your plans for the future.