In my previous article, I talked about why the 4% rule is not necessary for early retirement.
4% is the withdrawal rate that you would use if you want to your portfolio to last 30+ years.
That makes sense for our pensions, but what about ISAs: what withdrawal rate do we use?
The withdrawal rate to use for investments depends on how long you want them to last.
If you want your investments to last for 10 years, you could use a 8 – 9% withdrawal rate.
If you want your investments to last for 20 years, you could use a 4 – 5% withdrawal rate.
If you want your investments to last for 30+ years, you could use a 3 – 4% withdrawal rate.
In this article, I talk about why you need different withdrawal rates depending on your plans.
I also explain how we use these different withdrawal rates to calculate our portfolio amount.
Finally, I share where you can find out more information on where this research comes from.
Note: I will refer to GBP and UK retirement accounts but this also applies if outside of the UK.
So why can’t I just use the 4% Rule?
Legend says that in order to retire early, you’d need to save 25x your desired annual income.
For example, if you want an annual income of £40K, you would need 25 x £40K = £1 million.
4% of £1 million (£1 million x 0.04) = £40K. This is where the 4% withdrawal rate comes from.
However, 4% is the withdrawal rate to use if you want your investments to last 30+ years.
This makes sense for pensions, as we’d want them to last from age 55 to the rest of our lives.
But the problem with pensions is that we can’t access them until at least age 55 (for now).
Which is why in order to retire early (at say age 40), we would need to also invest in an ISA.
However, we only need our ISAs to last until we can access our pensions (more tax efficient).
Therefore in this example, we would just need our ISAs to last 15 years (from age 40 to 55).
So a 4% withdrawal rate would therefore be way too conservative for a 15 year time period.
So then the question is: what other withdrawal rates can we use for shorter time periods?
Introducing Alternative Withdrawal Rates
Above is a table of withdrawal rates that we can use for different durations from Monevator.
There is so much data behind these withdrawal rates that you can read about if interested.
As you can see in this table, they don’t use one withdrawal rate for each timespan but a few.
The reason for this is due to the different scenarios that they have considered for this table:
- If you want to choose a WR based on historical data, you would use the WRs in column 1.
- If you want to choose a WR based on hypothetical data, you’d use the WRs in column 2.
- If you want to choose a WR based on low interest years, you’d use the WRs in column 3.
- if you want to choose a WR based on a global portfolio, you would use the WRs in column 4.
In this table, the author highlights the green values as the WRs they’d use for each time frame.
I prefer to think of it as a range for each time frame based on your portfolio asset allocation.
Portfolio Asset Allocation and Success Rates
There are 2 things to note of in the withdrawal rates table: asset allocation and success rates.
SR refers to the % of scenarios that didn’t run out of money before the end of the time frame.
You may notice that the success rates in this table range from 82% to 99% – why is that?
That’s because no matter what WR you choose, there’s no such thing as 100% success rate.
And that’s ok, it’s just the reality; but the closer you are to 100%, they less you have to worry.
As for asset allocation, this refers to how your portfolio is made up: stocks, bonds, cash, etc.
The WRs presented in the previous table are made up of all sorts of asset allocations.
The table presented above shows just the asset allocation for a global portfolio vs time frame.
And honestly, there is no such thing as the optimal asset allocation or ideal withdrawal rate.
Just choose the best asset allocation corresponding to your time frames and success rates.
How do we use the Withdrawal Rates?
The way you use these withdrawal rates is similar to how you would the 4% rule/rule of 25.
To calculate how much you need in your portfolio: annual income x withdrawal rate inverse.
For example: £36K (annual income) x (1/8)*100 (inverse of 8%) = £450K for your portfolio.
This means you’d need £450K in your portfolio to withdraw 8% (36K) a year for 10 years.
This is equivalent to a 99% success rate if using a 30/30/40 stocks/bonds/cash allocation.
What if you need your early retirement period to last an awkward figure i.e. 12, 17, etc. years?
Then you’d simply use the withdrawal rate closest to that figure, or choose one in between.
What about less than 10 years for your early retirement, what withdrawal rate do you use?
In this case, the author suggests saving enough cash to cover those years (including inflation).
It wouldn’t be worth investing in case you hit a bear market and don’t have time to recover.
What Withdrawal Rates will I use?
For this section I thought I’d share my withdrawal rates, asset allocations, and target amount.
For early retirement, I plan this to last 15 years. However, instead of 6-8% WR, I will use 10%.
The reason for this is because my portfolio is made up of 100% equities i.e. stocks index funds.
My ideal annual income is £36K, therefore my target portfolio for early retirement is £360K.
Based on my calculations, I’m on track to have this invested over the next 10 years in my ISA.
For standard retirement, I expect this to last around 30 years. Instead of 3-4%, I will use 5%.
Again, the reason I am using this figure is because my portfolio is made up entirely of stocks.
My desired annual income is £36K, therefore my portfolio for standard retirement is £720K.
However, these are just my withdrawal rates; I don’t have tables and charts to back them up.
Therefore, you must choose your WRs based on data and whatever feels comfortable for you.
To find out more about early retirement, check out our articles on retirement and investing.
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