How can you make the most of your income in retirement? People are living longer, and that adds up to more years of spending that they need to plan for. To ensure your money lasts as long as you need it, you might explore these different retirement withdrawal strategies to see if any might be right for you.
These retirement withdrawal strategies vary in their approach and flexibility. Sometimes a withdrawal strategy may work well in certain economic and market conditions than in others. For example, one withdrawal strategy uses a percentage-based rule, which works well when investment markets are posting gains and retirement investments rising in value.
Over your career, you may have built up funds in your 401(k) (or another workplace retirement plan). In retirement, the matter of deciding how to manage savings largely falls on our shoulders. What makes this even trickier is that investing for retirement is completely different from retirement income planning. In that case, you have to figure out how to turn your nest egg into reliable income that lasts for the rest of your lifetime.
Use these retirement withdrawal strategies as a starting point in your income planning. By seeing each one’s upsides and downsides, you can see how you can make the most of your money for as long as you need it.
How Can a Withdrawal Strategy Help Me in Retirement?
Who wants to leave their financial peace of mind to chance? No one does, and failing to plan for how you will have income in retirement is basically just that: relying on guesswork and hoping for the best.
In retirement, your lifestyle can be undermined by many financial risks: inflation, market swings, taxes, costly healthcare, and more. As you live longer, those risks take on more weight and your chances of running out of money multiply. Ignoring them can prove to be costly in later years.
A withdrawal strategy puts you in the driver’s seat. It gives you more choices and flexibility. You can figure out the baseline income that you need to pay for your lifestyle. Your plan can also be tailored to your ability to stomach risk and losses.
If you worry about a market downturn hitting your investments, your withdrawal strategy can be structured so that you have monthly payments pouring in no matter what. Should you want your money to keep growing and are okay with some risk in exchange for that, your withdrawal strategy can be set up accordingly. If something unexpected happens or your needs change later on, your withdrawal strategy can be a lifeline for adapting to your new situation.
The 4% Withdrawal Rule
The 4% withdrawal rule is a widely known strategy in income planning. According to this rule, in your first year of retirement, you can safely withdraw 4% of your total retirement savings. As the years pass, you adjust the amount each year to account for inflation. The primary goal of the 4% withdrawal rule is to provide a steady stream of income while maintaining the principal balance of your retirement nest egg.
Pros: The 4% rule is simple and easy to put into practice. It can be used for a wide variety of financial needs and situations for retirees. The 4% rule is predictable and comes with structure, so you have a pretty good idea of knowing what you have in place to support your retired lifestyle.
Cons: One big drawback to the 4% withdrawal rule is the lack of flexibility. When he created the rule, William Bengen was working in times of different conditions for the stock market and interest rates. Today, market and economic conditions haven’t been as stable, and interest rates lingered at near zero for over a decade (the effects of which are being felt now).
The 4% withdrawal rule may not work as well in such circumstances. If your investments perform poorly, you might have to cut your spending for a year so that you don’t run out of money early. This withdrawal strategy also doesn’t account for your personal expenses changing over time. That could be an issue for retirees with evolving financial needs.
The Bucket Withdrawal Strategy
The bucket withdrawal strategy is a more complex approach. It divides your retirement savings into distinct “buckets,” with each bucket earmarked for different goals and timelines. You typically have a short-term bucket for immediate expenses, a medium-term bucket for upcoming years, and a long-term bucket for the distant future.
You might break down the timeline for each bucket into five-year increments. For example, the first bucket might be for years 0-5, the second bucket for years 6-10, and the third bucket for years 10+. The assets inside each bucket are based on the bucket’s timespan and what asset holdings might be appropriate for how long that timespan is.
To fill your first bucket, you would need a budget of your annual expenses. Throw in some funds for emergency situations, just in case something unexpected happens. From there, it’s a matter of creating estimates for spending over many years. Don’t forget inflation, and include less-frequent expenses, such as taking a trip abroad.
Bucket 1 might have cash and short-term assets. Bucket 2 might hold investments that have a longer time horizon than Bucket 1, but these investments would have some risk potential. That depends on your risk tolerance. In Bucket 3, the holdings would be focused on growth and have the most risk of all three buckets. Since it has the longest timeline, those bucket holdings would presumably have more time to grow and recover from any losses.
Pros: This strategy offers flexibility and control over your finances. You have more wiggle room to weather short-term market volatility while your long-term investments can grow in value. Dividing your retirement savings into different buckets can help you plan more effectively.
Cons: Sequence of returns risk is a major threat for a bucket withdrawal strategy. This risk is when your portfolio takes a hit just before or in early retirement. And if you are taking withdrawals? Not only are you depleting your savings faster than you counted on, but you also have fewer assets to grow in value later on.
On top of that, a bucket withdrawal strategy is intricate. It may require ongoing attention to refill your buckets over time. If this strategy isn’t carefully monitored, you may see imbalances that may require fixes.
The Dynamic Withdrawal Strategy
The dynamic withdrawal strategy aims to be flexible. With this approach, you begin with an annual withdrawal rate – say 4%. Then you set an annual spending floor and ceiling, which helps you stay within a sustainable range for your withdrawals.
If your investments perform well in a given year, then you can take out more (within the ceiling) and have more income. On the other hand, if your investment return is negative for the year, you still have your spending floor to rely on. Overall, the dynamic withdrawal strategy gives you room to adjust based on what the market does.
Pros: This strategy is adaptable and flexible. It lets you benefit in years of market gains and adjust your spending in years of market losses. You can pull out less money if need be, so you also have that flexibility to make your money last.
Cons: A dynamic withdrawal strategy is quite complex. It may not appeal to retirees who prefer a hands-off approach to their finances. Since your withdrawals are based on what the market does, they may change with your investment values. In other words, you will spend less in years of market losses, which can hurt in periods of high inflation. Others who want more consistency in their income may not like this withdrawal strategy.
Required Minimum Distribution (RMD) Withdrawals
Required minimum distributions (RMDs) are mandatory withdrawals imposed by the IRS for certain retirement accounts, such as traditional IRAs and 401(k) plans. Once you reach a certain age, typically 72, you must take out a set amount from your retirement account. That amount is based on your life expectancy and what your account balance is.
You can use RMDs as a straightforward withdrawal strategy, making it simple to determine how much you take out each year. Some economists and researchers have noted that an RMD withdrawal strategy, combined with a waiting strategy on delaying Social Security until age 70, can make a big difference in income for many retirees. As you progress more in retirement, it’s good to note that RMDs make your withdrawal percentage go up.
Pros: An RMD withdrawal strategy ensures that you are meeting your RMD requirement, which lets you avoid hefty penalties for missing it. It’s simple and easy to follow. Many people also like how predictable this withdrawal strategy is, as they don’t have to make discretionary decisions around their spending.
Cons: Using RMDs for withdrawals won’t appeal to those who want a fulfilling lifestyle in early retirement, when their health is typically better. They want to spend more in these years than in later times. By following an RMD schedule, you won’t be taking out large amounts of money until you are way into retirement.
The Safety-First Withdrawal Strategy
A safety-first retirement withdrawal strategy is a relatively new thought in the field of income planning. It’s focused on financial security and stability. With this approach, you establish a reliable income floor for your living expenses. The idea is that you aren’t relying on investment returns, guardrail withdrawal rules, or other variables that may change your income for your living expenses.
An annuity is typically used to cover the income floor. Its predictable income stream will cover your essential expenses, giving you a financial safety net. From there, your portfolio can hold investments with more growth potential (and market risk). That will enable your assets to keep growing and help you keep up with inflation. The attractiveness of this strategy is for those who want an assured income, no matter what the market does.
Pros: This strategy is effective for generating a steady income stream in retirement. People have an ongoing, dependable source of cash-flow with the established income floor. That can bring great peace of mind, especially in years when the market falls.
Cons: While the income floor covers living expenses, you tie your money up in the annuity and might not have the same liquidity with this withdrawal strategy as you would with others. You also give up growth potential for the money in the annuity that you might have otherwise had. It’s a question of whether the protected income from the annuity makes up for that possible downside.
Withdrawal of Earnings, a Preservation Strategy
The withdrawal of earnings, and not principal, is a long-vision strategy. It sets as a priority preserving your savings for the long haul. The idea is to live off the interest, dividends, and capital gains generated by your investments while leaving your principal balance untouched. If the portfolio grows in value, then the interest earnings and dividends would typically grow along with that. By peeling off your earnings in this way, it can help your retirement savings go the extra mile.
Pros: This strategy is focused on protecting your principal. That can make your initial nest egg last longer, and if you wish to leave a legacy to your heirs, that money can be used for that goal. Either way, your principal stays intact, and future cash-flow is more likely to be around.
Cons: Some retirees won’t be happy with only living off the earnings from their retirement assets. It means smaller withdrawals and therefore less spending, which may not be appealing to those wanting an active lifestyle in early retirement. What’s more, in times of poor returns, you may also wind up spending less than you would otherwise like. You aren’t assured good returns or even long-term dividend payments.
Know Your Retirement Income Sources
No matter which retirement withdrawal strategy you choose, it’s good to have a clear picture of your sources of retirement income. How will you generate the income that you need for your retirement lifestyle? How reliable will that income be in different market conditions and economic cycles?
If you want some more mathematical certainty and precision in your retirement income, consider adding protected income to your overall retirement plan. This protected income serves as a stable baseline that you can rely on. An annuity can be used to fuel that stable baseline.
Again, it all depends on what retirement goals you have, and what you want for your money to do for you.
Working with a Retirement-Focused Financial Professional
Retirement planning has many moving parts. Not all financial professionals can offer you the same level of knowledge and experience. To create a well-thought-out financial plan, you might think about working with someone who is a “retirement specialist.” Or in other words, someone who understands the nuances of different withdrawal strategies, retirement issues in general, and has helped other clients with these challenges.
Income is a crucial part of retirement planning, but it isn’t the only thing that matters. Your financial professional should be well-versed in healthcare planning, asset protection, end-of-life care, and legacy planning so that they can help you address your complete picture in retirement.
You may also want to work with someone who is independent and not captive. By that, we mean someone that isn’t beholden to one parent financial company for their business. An independent financial professional will have the ability to work with multiple insurance and financial companies, so they may be able to offer more customized solutions for your situation.
If you are looking for someone who fits these criteria, many experienced and independent financial professionals are available here at SafeMoney.com. You can get started by visiting our “Find a Financial Professional” section, where you can connect with someone directly to discuss your needs, goals, and situation. If you would like a personal referral, please feel free to call us at 877.476.9723.