What is a Suitable Withdrawal Rate for a Special Needs Trust?

by Patrick Collins, CFP®, EA- Principal

Within the financial planning community there has been a groundswell of information published in the past ten years regarding withdrawal rates from portfolios.  This body of knowledge is driven by our aging population and the curiosity of this demographic segment to know the answer to the question “How much can I safely withdrawal from my portfolio in retirement without running out of money?”  While this question has drawn increased attention as baby boomers move into retirement, it has profound implications for the trustees of special needs trusts. 

Determining how much a trustee can safely withdrawal from the trust can mean greater visibility into long-term asset projections and more meaningful planning for spending needs such as therapy, travel, entertainment, job training or other services.  The father of withdrawal rate research is William Bengen.  His first publication in this area came in the Journal of Financial Planning in October of 1994.  The paper’s premise was fairly simple:  determining the amount an investor could withdraw from a portfolio over a specified time period, using actual historical sequences of returns.

Since that initial paper there has been countless research done on this important topic.  There are two major areas that influence the withdrawal rate from a special needs trust:  time horizon and asset allocation.  First, the longer the period the trust will need to distribute funds, the smaller the safe initial withdrawal rate can be.  This is fairly obvious.  If the beneficiary of a trust will only need distributions for 3 years, they can take out much more each year than someone who needs annual distributions to last for 30 years.  Second, because the allocation of the portfolio (how it is split up amongst stocks, bonds, real estate, cash, etc) has a direct impact on the returns and volatility of the portfolio, there is a delicate balance between long-term growth and sustainability of the portfolio withdrawals.  As inflation will effect your purchasing power over time, a “safe” withdrawal rate should increase each year (in dollar terms), in order to maintain the beneficiary’s standard of living.

Since withdrawal rates are so dependent on what the future holds, it is impossible to determine the optimal spending plan solely by looking backwards.  With that being said, the chart (1) below should give trustees a starting point on determining whether their initial withdrawal rate is sustainable.

Stock/Bond Allocation

Minimum Years Portfolio will last

To use an example, if the trust held $1 million (allocated 75% in stocks and 25% in bonds), drawing $40,000 from the portfolio in the first year (and increasing each year for inflation) would likely give the beneficiary at least 32 years of withdrawals before the depletion of assets in the trust became a real risk.  As you can see from the data above, going above a 4 percent withdrawal rate adds additional risk to a traditional 30 year withdrawal scenario.  Of course, like I said before, this data is presented using historical information.  It is possible (even probable) that the next 30 years may be completely different than the past periods that are analyzed. 

Using the vast body of research on this topic, our recommendations to trustees are two-fold.  First, determine a reasonable withdrawal period for the beneficiary of the trust.  How long do you foresee this beneficiary needing to withdrawal funds from the portfolio?  Using that information, the trustee can then determine an appropriate allocation amongst various asset classes.  This will help ensure a portfolio that is closely aligned to a beneficiary’s spending needs.

(1) Bengen, William “Determining Withdrawal Rates Using Historical Data,” Journal of Financial Planning, March 2004