The fear of outliving their savings is one of the biggest fears of retired individuals.1 Consequently, it should come as no surprise that withdrawal strategies are very important to anyone thinking about retirement. How much can you withdraw from your portfolio annually without spending down your assets? What are the best ways of withdrawing from your accounts? We will discuss several possible strategies below.
The 4% Rule
This rule was first proposed by financial advisor William Bengen in 1994. Bengen wanted to determine what an initial safe withdrawal rate would be based on historical market conditions and inflation rates. He studied retirement portfolio withdrawals beginning in each year from 1926 to 1976. Based upon the results of his study, he concluded that an initial withdrawal rate of 4% of a portfolio, with distributions adjusted for inflation each year thereafter, provided at least 30 years of income. The 4% rule worked even for individuals who retired just before significant bear markets including the market crash of 1929 and the stagflation of the 1970s.2
In recent years, some advisors have advocated reducing the initial withdrawal percentage from 4% to 3.3% or even as low as 2.4%.3 Their analysis is based upon today’s historically low interest rates for bonds and historically high prices for equities and presumes that future returns may not match past returns.4 To be sure, Morningstar recently published an article indicating that the 4% rule may be appropriate once again because of lower stock and bond valuations within the last year.5
Fixed-Dollar Withdrawals
Fixed-dollar withdrawals entail taking the same amount of money out of your retirement account every year for a specified period. For example, you may decide to withdraw $30,000 annually for the first five years of retirement and then reassess thereafter.
The major benefit of fixed-dollar withdrawals is that you have a predictable annual income, and you may determine the amount to withdraw based on your budget in your first year as a retiree. However, there are downsides. If you don’t increase your withdrawal amount, you’ll lose buying power over time as a result of inflation. And if you establish your fixed-dollar amount too high, you risk running out of money in retirement.
Fixed-Percentage Withdrawals
Fixed-percentage withdrawals involve withdrawing a fixed percentage of your account balance every year -- for example, taking out 3.5% or 4% of your total invested funds every single year. With this approach, the amount you withdraw will vary as your investment account balance rises and falls.
This differs from the 4% rule both because you might choose a different percentage of your account balance to withdraw and because you keep the percentage the same every year instead of starting with a 4% withdrawal and adjusting upward based on inflation. One variation on this strategy might be to make adjustments upward based upon aging and not so much due to inflation.
The major benefit of this approach is that this system naturally adjusts your withdrawals to respond to market fluctuations. Unfortunately, if you choose too large a percentage, you risk being left with too little money. Also, your income changes from year to year, so it can be difficult to make financial plans.
Dynamic Withdrawals
Dynamic withdrawals allow you to change how much you take out of your accounts each year, with an annual spending floor and ceiling to help you stay within an appropriate range. This allows you to adjust for market fluctuations, withdrawing more in years when your investment returns are higher.
Dynamic spending withdrawal strategies aren’t quite as simple as those outlined above and there are many variations of these strategies. Under dynamic spending strategies, you may have the freedom to spend a bit more liberally during their first year of retirement. However, you may need to adjust spending based on market conditions and inflation. High inflation combined with a down market may lead to some belt-tightening during some retirement years.
One dynamic spending strategy is the Guyton-Klinger Dynamic strategy. Retirees may withdraw as much as 5.8% to 6.2% of their portfolio in the first year of retirement. The actual amount of withdrawal depends on the retiree’s strategy. If the market goes up, the retiree adjusts their withdrawal for inflation. However, if the market drops, the withdrawal amount freezes.6
As alluded to above, a downside to this strategy is that you may need to adjust your standard of living according to market performance, not an easy thing for some retirees to do.
Bucket Strategy
The bucket strategy is a retirement income plan that breaks your assets into three buckets: short-term needs, mid-term needs and long-term needs. Each one is filled with different assets with varying levels of risk. Higher-risk assets often go in the long-term bucket, while safer assets may go in the short-term one.
For example, you might keep a few months’ worth of emergency savings in a savings account along with living expenses for a year. You could keep another couple years’ worth of living expenses stored in fixed-income investments, such as certificates of deposit, treasury notes and municipal bonds. From there, you could retain the rest of your long-term savings in your retirement or investment accounts. You may need to make periodic adjustments to retain adequate funding for short and mid-term needs.
This strategy may diminish risk because you’ll have cash on hand and won’t need to sell off stocks or tap into another account in the event of an emergency.
Conclusions
We have provided a very brief overview of some of the more common withdrawal strategies in retirement. Depending upon individual circumstances, one or more of these strategies may be preferable to others. One size may not fill all. If you would like to know more about retirement withdrawal strategies, please feel free to contact us.
Doug Lemons, CFP®
CRN-5449535-020323
6https://www.retirementbudgetcalculator.com/post/before-thinking-about-withdrawal-strategies