Financial independence is a dream for many people, where one can retire comfortably without worrying about the need to earn a steady income. But achieving financial independence requires careful planning and disciplined saving strategies.
One key aspect of retirement planning is determining a safe withdrawal rate that will ensure your savings last a lifetime.
There are many discussions about Safe Withdrawal Rate if one retires earlier. What exactly is safe withdrawal rate?
Defining Financial Independence
Financial independence is the state of having enough savings and investment portfolio to sustain your lifestyle through your retirement years without having to work for an income.
Achieving financial independence requires a clear understanding of your expenses, savings, and goals.
It’s also essential to have a well-diversified investment portfolio that can generate a steady income stream in retirement.
What is a Safe Withdrawal Rate?
A safe withdrawal rate is a percentage of your investment portfolio that you withdraw annually during retirement to meet your expenses.
The safe withdrawal rate is calculated based on a variety of factors, such as life expectancy, inflation, investment returns, and expenses, to ensure you don’t outlive your retirement funds.
Many “Experts” online suggest using a safe withdrawal rate of 4%, which means withdrawing 4% of your portfolio’s value yearly.
How does it work?
A safe withdrawal rate of 4% means that you can withdraw 4% of your portfolio’s value each year in retirement to meet your expenses without significantly reducing your savings.
For a $1 million portfolio, a safe withdrawal rate of 4% would allow you to withdraw $40,000 annually ($1,000,000 * 0.04 = $40,000).
Safer option? 4% really safe?
There may be many uncertainties such as increased longevity, higher than expected expenses, and lower-than-expected investment returns.
Is 4% really safe?
Many has seen through many bears, 2008 financial crisis, covid drawn down etc. This will make people not feeling safe.
Personally, I think 2.5% safe withdrawal rate would be considered a more conservative approach to retirement income planning than using a 4% safe withdrawal rate.
A 2.5% safe withdrawal rate can provide an added degree of insulation against a retirement plan’s failure.
A calculated example
Let’s calculate the safe withdrawal rate of 2.5% for a $2 million portfolio:
Annual Withdrawal = Portfolio Value * Safe Withdrawal Rate
Using a 2.5% safe withdrawal rate for a $2 million portfolio:
Annual Withdrawal = $2,000,000 * 0.025
Annual Withdrawal = $50,000
With a 2.5% safe withdrawal rate, you would be able to withdraw $50,000 annually from a $2 million portfolio to support your retirement expenses while aiming to sustain the portfolio over a longer period of time.
$50,000 annually mean $4167 per month. Is this enough for you?
Don’t forget that this is based on 2.5% return per annum which is not difficult to attain if one is conversative ETF investor instead of those trade in/out investors. Hence, the actual income is likely more than $4167.
For a family of four with mortgaged fully paid and don’t anyhow spend + CPF or other social security as backup, this should be a sufficient amount with good buffer.
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