How to draw down a portfolio using Variable Percentage Withdrawal (VPW)
Asset accumulation is easy. Sort of.
- Put money into lower-cost, diversified, equity solutions (stocks or funds).
- Keep contributing regularly to such solutions for 30+ years.
- Retire with some money in the bank.
Easy as 1-2-3, or thereabouts.
Asset decumulation is much more difficult.
- Do I even have enough to fund my retirement?
- When should I start drawing down my portfolio?
- How much should I even withdraw so I don’t outlive my money?
- In what order should I draw down my accounts or take my benefits?
- Should I work part-time to supplement my retirement income?
…and the list goes on.
Traditional retirement planning without VPW
With traditional retirement planning advice, some that I continue to follow myself, we are told to:
save early, save often, and keep saving.
Heck, our goal is to own a million-dollar portfolio (or close to it) for semi-retirement. It takes time and a massive dose of patience to build a portfolio like that…
So, while there is a wealth of information about asset accumulation, how to save within your registered and non-registered accounts to plan for retirement, there is far less information about asset decumulation including managing retirement income.
Thankfully there are a few great resources available to aspiring retirees including those I’ve written about below.
My retirement income articles:
- One of my favourite books about generating retirement income is one by Daryl Diamond, The Retirement Income Blueprint.
- An article about creating a cash wedge as you open up your retirement income investment taps.
- A review about The Real Retirement.
- These are six big mistakes in retirement to avoid.
- A review of how to generate Retirement Income for Life.
- Here is a bucket approach to earning income in retirement.
- Here are four (4) options to get more out of your retirement nest egg.
Canada Pension Plan (CPP) articles:
- Here’s when you should consider taking your Canada Pension Plan (CPP).
- Should you consider deferring your Canada Pension Plan?
Dividend income articles:
Under the banner of “did they save enough?” articles:
- This couple believes they have realized FIRE (Financial Independence, Retire Early) at age 52. Did they save enough?
- This couple wants to spend $50,000 per year in retirement. What order should they draw down their accounts?
Variable Percentage Withdrawal (VPW)
A great approach and tool to help answer some of the leading questions I posed above, is the use of Variable Percentage Withdrawal (VPW).
I previously wrote about VPW here, but this is the Coles Notes version. This approach works because:
- It combines the best ideas associated with constant-dollar withdrawal and constant-percentage withdrawal strategies (e.g., the 4% rule).
- It adapts your withdrawals to market/portfolio returns so effectively you don’t drawdown your portfolio too quickly.
- It uses a variable, and an increasing percentage to determine withdrawals so effectively you don’t hoard your money “until the end”. Spending is always variable and not linear.
- This is one of the best approaches I’ve seen that allow you to essentially:
- increase your spending in “good years” and,
- decrease your spending in “bad years” therefore giving investors psychological ease.
Retirement withdrawal assumptions – if we ever get to the $1 M dream?
Since I’m always very aspirational on this site…I figure I would use the VPW approach and tool for my own retirement dreams and see how VPW might be useful to manage our draw down plans.
In using this tool/spreadsheet – I clicked on the VPW tab and:
- Entered the Start Year and Start Age of my retirement. (For me, I used stopping full time work at age 55 – hopefully sooner!) I entered my Asset Allocation.
- Each year:
- I made up a fictitious balance. I was rather pessimistic with my assumptions given I used a 100% risky-equity portfolio that never grew in value over the first 10 years of retirement.
- I fictitiously entered some actual withdrawals and/or took the Suggested Withdrawal.
Here are the results for the first 15-years of retirement and how that might compare with actual results over the last 40+ years from data within the same tool.
Table 1 – My hypothetical, very pessimistic, VPW where my account never gains anything in value:
Table 2 – A far more realistic VPW. Compare my table above with a 4% constant dollar withdrawal sum AND against actual stock market returns from 1972 to 2005:
You’ll see in the table above…
- Over many years of investing, thanks to the VPW approach, while you should expect to die-broke you can also enjoy what you’ve worked so hard for – starting with a $1 M portfolio. (I’ve highlighted the almost insane amount of money you’re able to withdraw (>$300,000 per year) in the latter years of retirement using a VPW approach. While inflation-adjusted it’s an incredible amount of money.)
- Compared to a simplified 4% Constant Dollar Withdrawal (CDW) approach, you’ll see you can enjoy more of your capital during retirement using VPW without arriving at some ridiculous capital balance at age 100 or more.
First-person use / case study in practice by an actual retiree!
I reached out to one reader of this site (RBull) who uses the VPW approach and tool to manage his draw down approach. Here is what he told me:
Just so your readers know… I’m celebrating five (5) years of full retirement this second week of May! (My wife retired a couple of years earlier.) I discovered VPW about 4 years ago. I entered the data for the beginning of my retirement (asset balance, 1st year withdrawal – like you instructed above) so it reflected our full 5 years of retirement including all withdrawals and balances to date.
OK, so, why do I like this? Who is it for? A number of reasons in no particular order:
- VPW is logical, intuitive and simple. Suggested withdrawals from assets will adjust annually based on market returns. An alternative method like the Safe Withdrawal Rate (SWR) isn’t safe nor logical nor intuitive. With SWR your spending is based on a set percentage (e.g., 4% rule) based on initial balance and adjusts only for inflation. With the 4% rule you’ll likely either run out of money or have a huge amount unspent when you die. Neither of those outcomes work for us and with VPW we can avoid it from happening!
- We’re planning to utilize a significant portion of our assets for retirement and desire a method to safely accomplish and monitor this to upgrade lifestyle.
- We have a sizeable steady income from work pension, reliable income from equity and fixed income assets to cover all basic needs (and more) without considering capital, or future OAS/CPP. It’s a great tool for that situation.
- It’s intuitive and logical as you say Mark – our overall asset withdrawals would adjust annually with the performance results and the size of our asset base, where the main effect of this for us would be on discretionary spending (like travel).
- All of my career I have worked with pay for performance variable income, so we are easily able to adjust accordingly.
- It’s incredibly simple to update the tool with an end of year asset balance to generate a suggested withdrawal amount. Assuming you have a steady income base, you can therefore choose to withdraw more or less than what is suggested or when it might be more favourable to utilize certain assets, and this will be reflected accordingly in future suggested withdrawals.
For anyone interested, our 5-year VPW suggested these withdrawals on my conservative assumptions followed by actual withdrawals. Funny enough, we have yet to walk-the-talk on upgrading our lifestyle – some habits are hard to change!
|VPW Suggested Withdrawals||Actual Withdrawals|
I would say in closing Mark to help fellow or aspiring retires – our conservative nature is winning out and keeping us well below suggested withdrawals but at the end of the day – it’s a great approach and tool for folks to consider as part of asset decumulation.
So, how might we draw down our portfolio? These are my plans!
Potentially the following order based on what I’ve learned:
- Start drawing down our RRSPs/RRIFs + spend non-registered dividends in our 50s
- In our 50s, while working part-time, we’ll withdraw assets from RRSPs (x2). We intend to stop full-time work as soon as our debt is gone.
- Part-time work in our 50s is also expected to cover some semi-retirement “fun stuff” like travel.
- Basic living expenses will be covered by our portfolio income.
- By withdrawing assets from our RRSPs earlier than necessary, it will reduce our deferred tax liability that is our RRSPs before any workplace pensions kick in.
- Deplete RRSPs in our 60s, start taking workplace pensions + spend non-registered dividends in our 60s
- In our 60s, we’ll continue to deplete our RRSP assets. We’ll continue to spend any non-registered dividend income or even start drawing down those non-registered assets.
- In our early or mid-60s, we’ll start taking our workplace pension plans. Mine is a defined benefit plan. My wife’s is a defined contribution plan. For hers, we’ll even consider taking her pension benefits earlier as provincial rules allow – potentially age 55.
- I figure around age 65, we’ll start taking our Canada Pension Plan (CPP) and/or also Old Age Security (OAS) government benefits. There is the real potential for us to delay our CPP until age 70. I think we’ll take OAS at age 65 regardless since the benefit to defer CPP vs. OAS is greater.
- In our 70s+ = enjoy pensions + spend non-registered dividends + spend TFSAs “until the end”
- With RRSP assets likely depleted, the non-registered account winding down; with workplace and government pensions now in full swing – we figure this is a rock-solid approach to increase fixed income while optimizing taxation in our golden years.
- In our 70s, we’ll consider drawing down our TFSA assets over time.
Takeaways on VPW
The more I read about how to manage our portfolio in semi-retirement or full-on retirement, I more I consider other options beyond simply trying to live off dividends or distributions – even though this remains a huge goal of mine.
When you consider taxation, inflation, longevity risk, portfolio risk, changing spending needs and much more – there is far from any one-size-fits-all approach to draw down a portfolio.
I hope this post about Variable Percentage Withdrawal (VPW) helped you with your draw down plan. I think it’s a solid one to consider.
Here are some key resources from various sites including some FREE calculators to dive deeper.
What’s your income plan for retirement? Do you have one? Are you already there and accomplishing your needs and wants?