A retirement withdrawal strategy can help you establish the appropriate amount of money to take out of your investment accounts each year. The amount you decide to make available to yourself will affect your quality of life in retirement, and you want to make sure your withdrawal strategy will protect against your savings accounts running dry. Below we discuss retirement withdrawal strategies that should ideally work together for an optimal distribution plan.
The 4% Rule
If you follow the 4% rule, you will withdraw 4% of your investment account balance in your first year of retirement. Theoretically, by increasing that amount each year in order to keep up with inflation and the rising costs of goods and services, you should have enough money available to maintain a 30-year retirement. The benefit of this approach is that it’s simple and keeps up with inflation. However, the best percentage for each retiree will vary person to person. This method also doesn’t support flexibility to adjust based on the performance of your investments.
Fixed Dollar Withdrawals
With fixed-dollar withdrawals you take the same amount of money out of your retirement account every month, quarter, or year for a set period. For example, you may decide to withdraw $2,000 monthly for the first three years of retirement and then reassess after that time to determine if this is still the best amount for your circumstances. The benefit of this distribution strategy is the predictable income, but it doesn’t account for inflation or a fund’s performance. Withdrawing a fixed dollar amount each month or year could cut into your account’s principal.
Systematic Withdrawals
Using this approach, you withdraw only the income your investments produce from interest or dividends, so your account’s principle remains intact. The benefit of this strategy is that you can be assured your account won’t run dry since the principle isn’t touched. However, your principal needs to be quite sizable to provide income for you to live on. Keep in mind that your income will vary from year to year, depending on market performance, which makes it challenging to create a financial plan.
Create a Floor
The simplified explanation of income flooring is to determine how much income you need to live comfortably for the rest of your life if you didn’t make another penny, and when that lifetime income should begin. First, you need to create your income floor, typically by building up accounts that provide guaranteed income on a regular schedule—Social Security, pensions, and annuities. By creating a strong financial floor, you can rest assured that you will be able to pay at least the necessary expenses in retirement, no matter the volatility of the markets.
Buckets
Implementing a bucket strategy means creating three separate sources of retirement income:
- A savings account that holds approximately three to five years’ worth of living expenses in cash
- Fixed-income securities, including government and corporate bonds or certificates of deposit
- Equity investments and growth funds
To use this approach, you draw from your savings account to cover your expenses and refill that “bucket” with funds from the other two sources of income. This allows you to refrain from selling assets at a loss. You can refill your savings account by selling stocks (as long as the market is up) or by selling your fixed income securities (as long as they’ve performed well). If both of these are down, continue drawing from your savings.
This approach allows you to potentially grow your investment account balance over time, but it can be time-consuming, and you need to use an additional method to figure out the amount you can afford to spend each year.
Account Sequencing
The goals with an account sequence strategy are to:
- Maximize the amount of money you can spend in retirement
- Receive a higher lifetime after-tax income
- Enhance the longevity of your portfolio
- Reduce taxes paid over the course of your retirement
- Eliminate or reduce Social Security benefits from being taxed
- Reduce Medicare premiums
Your tax bracket can heavily influence when to withdraw money from tax-advantaged funds, and the best approach may be to withdraw cash from a combination of savings and investment accounts. This is where the expertise of advisory firms can help you determine the best course of action.
