Is the 4% annual retirement corpus withdrawal limit reliable?

If you are asked to identify one of the most important financial goals of yours, than undoubtedly it has to be your retirement planning.  Any incorrect assumption or a bad planning can hurt your chances of a successful retirement. For example, with an assumption that stock market in India has historically returned an average of over 15 per cent every year and hence one could deduce to safely withdraw 10 per cent of the portfolio value annually without running out of money. The big assumption is return of 15 per cent. There will have their ups and downs with the returns being lesser than average on certain years. These will reduce the value of your portfolio. With the above- and below-average returns tending to run in different years makes it an unpredictable pattern.

Hence most of the studies shows that you can withdraw from 4 to 6 per cent of the portfolio value per year and stand a good chance of not exhausting the portfolio. Simply stated, for every year you’re retired, if you spend an amount no larger than 4 per cent of the savings you had in the first year of retirement, you should never run out of money. To check whether it works we did run different scenarios with 50000 simulations.

We have assumed that your portfolio consists of only stocks and will follow returns given by Sensex.  Since 1980, the BSE Sensex has given CAGR of 15.37% with standard deviation of 32.58%, which means the returns vary from 48% to negative 17%. We have also assumed that after your retirement you may live anywhere between 18-40 years. Hence, if you retired at 60, you will live in the range of 60-100 years. 

When you withdraw 4% of your initial amount there is ‘zero’ probability that you will outlive your retirement corpus.  For example if you have retirement corpus of Rs 1 crore and if you withdraw Rs 4 lakh every year, you need not worry.

The following graph shows the first 3000 simulated cases out of 50000 that we have run. In none of the case we see you are running out of money during your retirement year. The y-axis shows how much corpus you are left with at the end of your life.

In case you withdraw 10% of your initial portfolio every year, there is 42% probability that you will outlive your retirement corpus. Hence the assumption that if the market is growing by 15% historically and if you withdraw 10% you will be safe will give you false sense of satisfaction.

Even when you withdraw 6% of your retirement corpus, there is around 6% probabilities that you will run out of cash to sustain yourself during your retirement.

The above analysis is done purely based on your portfolio consisting of only stocks. In case you hold only debt funds, which is the ideal situation during your retirement, it will be a different situation. In that case the 4% of withdrawal may or may not hold true.