Variable Percentage Withdrawal (VPW): A Flexible Retirement Strategy to Maximize Your Portfolio
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Disclaimer: I am not a financial adviser, and this content is for informational and educational purposes only. Please consult a qualified financial adviser for personalized advice tailored to your situation.
Understanding Retirement Withdrawal Strategies for Financial Independence
What Are Withdrawal Strategies?
When can I retire, how much do I need to have saved, and how much can I withdraw from my portfolio once retired? We’ve addressed these questions before in our blog, such as when we explored the widely-used 4% rule for retirement planning. In a follow-up blog post, we explained why early retirees might benefit from adopting a flexible spending strategy that adjusts to stock market trends. In this context, we suggested a very appealing Guardrail Withdrawal Strategy (GWS). Before continuing in this post, I recommend to start there in order to fully understand the pros and cons of each of these two approaches.
In a nutshell, the 4% rule can be incredibly powerful at the start of your wealth accumulation phase. At the start of your investing journey, it acts as a guide to determine how much money you need to achieve financial independence and retire comfortably. According to the rule, it amounts to 25 times your annual expenses. For example, if you envision needing $40,000 in retirement, you would aim to accumulate a $1M portfolio ($40,000 x 25). In your first year of retirement, you withdraw 4% of your portfolio (e.g., $40,000) and adjust annually in subsequent years for inflation to maintain your spending power. It is a “set and forget” strategy—once you retire, you withdraw fixed amounts annually, regardless of market fluctuations, portfolio growth, or life expectancy. There is substantial nuance related to this rule, and I recommend revising our coverage of its advantages and disadvantages in our previous post.
In contrast, the GWS operates under the assumption that you should align your annual portfolio withdrawals with the stock market’s performance. According to this approach, it is important to pay attention to what the market is doing and to adapt your spending accordingly. You don’t have to do this on a 1:1 ratio i.e., if the market goes down 20%, you don’t need to reduce your spending by 20%, or vice versa. But you do need a buffer for both cases. This flexible spending strategy, recommended by financial advisor Michael Kitces, suggests withdrawing within a “safety lane” defined by two guardrails, allowing you to adjust withdrawal rates based on market performance thresholds. According to the GWS, we would start out by spending 5% of our portfolio in the first year of retirement, and adjust by inflation in subsequent years. However, if you find the market has performed strongly over the initial years and you find yourself in the following year withdrawing 4% or less of your current portfolio, then you know you have “hit” the lower guardrail. You are spending too little and can therefore give yourself a 10% raise. If you were planning to withdraw $50,000 for that year, you could take $55,000 instead. Similarly, if you reach the upper guardrail–if your withdrawal represents 6% or more of your portfolio–you should adjust your planned withdrawals downward by 10%.
In this introduction, we’ve briefly reviewed two key withdrawal strategies that can be used by early retirees. Now, let’s jump right in to today’s withdrawal strategy, the Variable Percentage Withdrawal (VPW). This is also a variable spending strategy, and originated from the Bogleheads community, a group dedicated to low-cost index fund investing and inspired by the principles of the late Jack Bogle, the founder of Vanguard.
As an analogy, think of the Guardrail Withdrawal Strategy (GWS) as the bumper rails found in bowling alleys. Guardrails make it really hard to miss the mark! The guardrails are 4% and 6%–your withdrawal as a percentage of your portfolio should always stay in between these two limits. Photo from: murreybowling.com
Exploring the Variable Percentage Withdrawal (VPW) Strategy
What Is the VPW Strategy and How Does It Work?
The Variable Percentage Withdrawal (VPW) approach adjusts the withdrawal rate on an annual basis based on two key factors, the (early) retiree’s portfolio value and her life expectancy. The VPW strategy focuses on maximizing retirement income while preserving the portfolio for long-term sustainability. Unlike fixed-rate methods such as the 4% rule, The VPW strategy dynamically adapts to portfolio performance and life expectancy, ensuring a sustainable withdrawal rate. This means withdrawal amounts will be lower during market downturns and higher during more favorable market environments. The VPW approach not only changes withdrawals depending on the market but also over time–early on it requires lower withdrawal rates, and these increase over time as retirees age. This approach is generally appealing to those seeking to maximize income while safeguarding against portfolio depletion in retirement.
The VPW strategy originated from the Bogleheads community, an online forum dedicated to low-cost, index fund investing. It was collaboratively developed and refined by members of this community as a response to the rigid nature of static withdrawal approaches such as the famous 4% rule. The VPW method aims to provide a more flexible approach by adjusting withdrawals based on remaining life expectancy and portfolio performance. Prominent personal finance researchers and retirement experts such as Michael Kitces and Wade Pfau helped popularize VPW and similar dynamic strategies by discussing their advantages over static withdrawal methods in the broader financial planning community.
How to Apply the VPW Strategy in Your Retirement Plan
How would prospective retirees apply this method in practice? We are going to answer this question using the handy spreadsheet developed by the Bogleheads community. This spreadsheet contains a lot of information and assumptions, but, for the purpose of this blog post let’s focus, as a starting point, on the “Tables” tab (screenshot below).
Table 1. Screenshot of the VPW table–Variable Percentage Withdrawal rates based on age and asset allocation.
In a nutshell, the table above provides you with the maximum percentage withdrawal you can use from your portfolio in retirement. Say you are 45 years old, have $1M invested in a 80/20 stocks-to-bonds portfolio, and want to know exactly how much you can safely withdraw in your first year of retirement without fear of depleting your portfolio. According to this method, you would withdraw up to 4.6%. So, if you have $1M dollars in your portfolio, in your first year of retirement you could withdraw up to $46,000 to cover your lifestyle expenses. If your asset allocation remains unchanged, the next year’s withdrawal rate could increase to 4.7% as life expectancy gradually declines. The table goes all the way to age 100.
The spreadsheet allows you to actually calculate a more nuanced withdrawal amount that also takes into account additional benefits in the future. In the “Retirement” tab (see Figure below), you can edit the following cells in yellow: age, portfolio balance, portfolio allocation, portfolio withdrawal frequency, and information related to pension plans. For instance, building on the above example (45 y/o, $1M portfolio, 80/20 asset allocation), we can add an additional $2,000 per month from Social Security kicking in at age 65. Instead of $46,000, we can now withdraw a higher amount: $55,000. If the $46,000 that we obtained in the previous paragraph was enough to fully cover our expenses, well, then we could have retired even sooner…
Figure 1. “Retirement” tab of Variable Percentage Withdrawal (VPW) tool from Bogleheads.
As mentioned earlier, you must apply the same calculation on an annual basis. Notice that, if there is a significant market downturn (e.g., 20%), you will have to enter a reduced portfolio amount in the tool. Even if the percentage withdrawal increases slightly (from 4.6% to 4.7%), your overall withdrawal amount will be substantially reduced in relation to the previous year due to the market performance. You are essentially protecting your portfolio to ensure it lasts your entire life.
Remember to factor in taxes when planning your withdrawals. Depending on which country you live in and the type of account you plan to withdraw from, such as taxable investment accounts or tax-advantaged retirement accounts, your actual net withdrawal amount may be reduced by capital gains taxes, income taxes, or other levies.
Although the tool doesn’t explicitly calculate your financial independence (FI) number, you can easily determine it using its withdrawal tables. The “Accumulation” tab provides you with how much you need to invest on a monthly basis to be able to retire at a target age, accounting for current age, salary, portfolio value, and asset allocation, but doesn’t explicitly show you the portfolio target value. Nevermind. Go to the “Tables” tab (screenshot above) and decide on a retirement age and an asset allocation. Let’s assume I want to retire by age 55 with a 80/20 asset allocation, the table show us a 4.9% withdrawal rate. Next, we need to understand what are our monthly expenses in retirement will be: if we need, say, $4,500 per month ($54,000 per year), then we obtain $54,000/0.049= $1.1M. This could be the financial independence number we can aim towards.
Alright, now let’s break down the pros and cons of using the VPW strategy.
Benefits of the VPW Strategy for Retirement Success
As a withdrawal strategy, the VPW approach offers the following advantages related to sustainability, customization, and maximization of portfolio usage:
Long term sustainability of portfolio: This strategy minimizes the risk of over-withdrawing during market downturns, helping retirees safeguard their portfolio against depletion. In other words, it aligns spending with remaining assets, similar to other variable spending strategies. This is a clear advantage over fixed withdrawals such as the 4% rule, which struggles addressing sequence of return risk—when poor market performance early in retirement depletes a portfolio faster, leaving less to recover during later market upswings.
Customizable to age and asset allocation: This is my personal favourite. The VPW strategy can be applied equally to a traditional retiree (e.g., 65 years old) or to a very early retiree (e.g., someone in their early thirties). The VPW provides detailed tables that guide retirees in choosing the optimal withdrawal percentage based on their age and asset allocation. Further, these tables also adjust the percentage of withdrawal depending on asset allocation (e.g., 80/20, 60/40, etc.). Early retirees will use a lower withdrawal percentage than their older counterparts, while investors with more aggressive asset allocations can use a higher withdrawal percentage than those with more conservative portfolios.
Maximizes portfolio usage: this approach allow the retiree to enjoy the fruits of his labor. The VPW approach enables retirees to use more of their portfolio during favorable market conditions, avoiding the overly conservative spending of static withdrawal strategies. For instance, it is well documented that, in the vast majority of cases, applying the 4% rule will leave retirees with a larger balance than that which they started with. While their descendants may appreciate this aspect of the 4% rule, the retiree has left potential enjoyment on the table.
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Caveats and Limitations of the VPW Strategy
In contrast, we should also be aware of the following disadvantages of using the VPW strategy and how we can mitigate them:
Income fluctuations and uncertainty: Applying the VPW strategy requires to adjust withdrawals on an annual basis, which can lead to significant income fluctuations. You may be happy making the adjustment when the market went up by 20%, but how would you feel when the opposite occurs? Not everyone has the ability (or wish) to react so strongly to market changes, e.g., some retirees will have more fixed expenses and limited flexibility in their spending. If this is a major concern to you, then the GWS strategy–also a variable spending approach–could be a better alternative to consider.
Complexity in implementation: Calculating and applying this withdrawal method is straightforward for determining your annual retirement withdrawal rate: are you retiring when you are 48 and would prefer an asset allocation of 60/40? Then…(checking table), you should use a 4.2% withdrawal rate. Is it at age 55 with a 80/20 asset allocation? Then you should use a 4.9%. This process took me less than a minute to figure out. The complexity, rather, lies in adjusting your budget to fluctuating withdrawal amounts. For example, during a significant market downturn, the same 4.2% withdrawal rate you used last year might result in a lower dollar amount this year, potentially making it harder to fund your lifestyle. The psychological aspect of adjusting spending downward during market downturns can be challenging for many retirees. It may feel difficult to scale back their lifestyle, even temporarily, after becoming accustomed to a certain level of spending. Behavioral discipline is crucial here to ensure the long-term sustainability of applying this strategy.
No guaranteed income floor: This point is related to the previous one, but worth stating explicitly. Unlike other approaches that incorporate guaranteed income sources, this method provides no minimum withdrawal level to cover essential expenses. This may affect retirees differently. If you own your house and have low fixed expenses, perhaps this is less of a concern. For those of us who–given the property prices in big cities and their ratio to salary–prefer to rent, this may be an important drawback to consider. In a nutshell, you need to have some built-in flexibility.
Risk of longevity uncertainty: The VPW approach ramps up with withdrawal percentages as retirees age, allowing for higher spending in their later years. However, this method’s assumption considers only a life expectancy of 100. Go beyond this and you risk depleting your portfolio entirely. A simple mitigation strategy could be to just leave your withdrawal percentage constant after a certain age, e.g., 85 or 90. In other words, after a certain age, you no longer follow this method. Retirees frequently pair VPW with guaranteed income sources like annuities or pensions to create a safety net for extended longevity.
Allocation of funds per age: Of course, part of the focus of the VPW approach is to not run out of money, but the consequence in practice is that you may have a much larger amount of money to spend when you are 87 than you had when you are 57 or 67. If you are familiar with Bill Perkin’s book “Die with Zero” (interview here), you may reach the conclusion that this money allocation is illogical, since, in all likeliness, your spending in your eighties–even after accounting for health care–will still be substantially reduced compared to earlier years. Again, if this point is a major concern to you, then the GWS strategy–also a variable spending approach–may be a better alternative.
Is VPW the Right Retirement Strategy for You?
The Variable Percentage Withdrawal (VPW) strategy provides a flexible approach to retirement withdrawals, aligning spending with market performance and life expectancy. While it provides important advantages in relation to fixed withdrawal strategies (e.g., the 4% rule), it has potential drawbacks related to income fluctuation and longevity risk that need to be considered and mitigated. The VPW strategy excels in adaptability and maximizing portfolio usage, but it requires retirees to manage complexities and potential risks carefully, particularly regarding longevity and income stability. Generally, if paired with other strategies like guaranteed income sources (e.g., pension, Social Security, other), this is a very solid approach to follow. If you are a bit unnerved by some of its drawbacks, however, I think the Guardrail Withdrawal Strategy (GWS) circumvents many of them: there is less annual income fluctuation over time, the longevity risk does not apply, and the disproportionate allocation of funds to later years is not an issue.
Enjoyed this post? Don’t miss our insights on reaching the crossover point for financial independence or the importance of geographic arbitrage for accelerating your timeline to financial independence.
