Busted: The 5% Myth

When you retire, you’ll likely have a nice amount of money saved up — possibly even more than you thought you’d have. So withdrawing a small amount, such as five percent or even a little more, each year to help cover your expenses during retirement won’t add up to much, right?

Wrong.

One of your biggest retirement risks is outliving your savings. In fact, most retirees should plan on living 20 or 30 years (or even longer) in retirement. That’s why you have to be very careful not to draw too much money from your savings each year.

In the past, most experts have generally recommended annual withdrawal rates in the neighborhood of four or even five percent. However, in light of low savings rates and reduced investment returns, an increasing number of financial planners are recommending even lower withdrawal rates in the 3 to 3.5 percent range.

If this is news to you, you’re not alone. In fact, more than half of retirees surveyed in the Principal Financial Well-Being Index don’t understand the impact of spending rates on their savings. As a result, they would likely spend their money too quickly.*

Your best bet? Work with a financial professional each year during retirement to calculate an appropriate withdrawal rate. He or she can look at your unique situation — including your savings level, expenses, retirement goals, and so on — to help you determine the withdrawal rate that’s right for you.

Joe Moklebust will tackle the next myth-busting post. He’ll discuss expenses during retirement and why they may be higher than you think.

See our previous Mythbusters posts on:

* Principal Financial Well-Being Index, First Quarter 2011

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

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  • Drew

    Kevin, interesting article. While I agree with the need to potentially reduce the withdrawal percent due to “reduced (I’m assuming future) investment returns”, I’m a bit perplexed on how a “low savings rate” has any correlation. Withdrawing 5% from $500,000 has no more/less risk than withdrawing 5% from 100,000. Would be interested in your thoughts and insights on this. Thanks, Drew

    • Kevin Hansen, Director Business Development – Retirement Solutions, Principal Financial Group, Principal Funds Distributor, Inc.

      Thanks for your comment Drew. There’s no question that 5% is 5%. However, in the real world, additional risk can be present for the retiree who has failed to save enough. In your example, we would be talking about $5,000 vs. $25,000. If a retiree has expenses of $4,000, all is well – whether they saved $100,000 or $500,000 for retirement – until they encounter the unexpected financial road bump (like a protracted market downturn or a significant health-related expense). Those who have not saved enough for retirement are typically less likely to have adequate emergency funds and have lower capacity to deal with the unforeseen.