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Spending flexibility and safe withdrawal rates

Author

Listed:
  • Finke, Michael
  • Pfau, Wade Donald
  • Williams, Duncan

Abstract

Shortfall risk retirement income analyses offer little insight into how much risk is optimal, and how risk tolerance affects retirement income decisions. This study models retirement income risk in a manner consistent with risk tolerance in portfolio selection in order to estimate optimal asset allocations and withdrawal rates for retirees with different risk attitudes. We find that the 4 percent retirement withdrawal rate strategy may only be appropriate for risk averse clients with moderate guaranteed income sources. The ability to accept greater shortfall probabilities means that risk tolerant investors will prefer a higher withdrawal rate and a riskier retirement portfolio. A risk tolerant client may prefer a withdrawal rate of between 5 and 7 percent with a guaranteed income of $20,000. The optimal retirement portfolio allocation to stock increases by between 10 and 30 percentage points and the optimal withdrawal rate increases by between 1 and 2 percentage points for clients with a guaranteed income of $60,000 instead of $20,000.

Suggested Citation

  • Finke, Michael & Pfau, Wade Donald & Williams, Duncan, 2011. "Spending flexibility and safe withdrawal rates," MPRA Paper 34536, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:34536
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    References listed on IDEAS

    as
    1. David A. Wise, 2005. "Introduction to "Analyses in the Economics of Aging"," NBER Chapters, in: Analyses in the Economics of Aging, pages 1-12, National Bureau of Economic Research, Inc.
    2. Pfau, Wade Donald, 2011. "Can We Predict the Sustainable Withdrawal Rate for New Retirees?," MPRA Paper 30877, University Library of Munich, Germany.
    3. Wade D. Pfau, 2010. "An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule?," GRIPS Discussion Papers 10-12, National Graduate Institute for Policy Studies, revised Oct 2010.
    4. Pfau, Wade Donald, 2011. "Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle," MPRA Paper 28796, University Library of Munich, Germany.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    retirement planning; utility maximization; retirement spending goals; safe withdrawal rates;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance

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