There are a number of withdrawal approaches you can take, and all have essentially the same goal: Provide you with the income you need during retirement, without running out of money.
With inflation rearing its ugly head, you may be one of many who have asked whether your retirement withdrawal strategy should change, so that your hard-earned retirement funds can go as far as possible. While every retiree’s strategy will be different, here’s a look at five common strategies, along with some of the advantages and disadvantages of each.
#1 The 4% Rule
For decades, the 4% rule has been the rule of thumb when it comes to taking money out of your retirement accounts to pay for expenses. But recently, some in the financial industry have questioned whether that percentage is too high, and could drain your savings too quickly.
What is the 4% rule? It’s a guideline that suggests the total amount that a retiree should withdraw from their retirement savings account each year, providing a steady income stream that also doesn’t drain the money too fast, so it leaves enough for the future. It was calculated by a financial advisor in the mid-1990s based on historical stock and bond return data.
Even though the rule seems simple and straightforward, it’s come into question recently. Some financial professionals (including its founder) believe it’s too conservative, while others think it should be much less. The recent thinking has been spurred by inflation, market volatility, and longer life spans.
If you do decide to withdraw a certain percentage of your retirement accounts each year, only you and your wealth advisor can determine which percentage will be right for you based on your financial plan and goals.
#2 The Fixed-Dollar Strategy
This strategy has less to do with a percentage, and more to do with the hard number you would need to withdraw each year for living expenses. This way, you would know the exact amount you’ll be working with every year, rather than having to calculate a percentage of your portfolio.
As your portfolio value changes in either direction, or as income needs change, you could reassess this dollar amount. Retirees using this strategy should understand that it doesn’t account for inflation, and if your portfolio takes a dive due to poor market performance, that set withdrawal amount could eat up a larger portion of your portfolio year over year.
#3 The Total Return Strategy
This option can be a good one for those who can tolerate more risk and potential volatility of the markets. With the total return strategy, you would only withdraw what you need for a set period (from three months up to a year’s worth of expenses), then leave the rest of your money fully invested for as many years of retirement as you can in long-term growth assets, like stocks.
Where this strategy can be risky is if you need to withdraw money right after the market has dropped, when your portfolio may be at a lower value. At the same time, this strategy could provide the potential for greater gains as more assets remain invested.
#4 The Investment Income Strategy
With this strategy, you would only use income generated from dividends and interest each year, and leave the principal in your retirement accounts untouched.
This can work best for those with sizable principal generating enough income via interest and dividends to cover living expenses. It can be somewhat tricky. This could make your annual retirement income unpredictable. As well, it’s best for those with sizable principal generating enough interest- and dividend-income to cover all your living expenses.
#5 The Bucket Strategy
This final strategy is something of a compromise between the others, and some favor it during particularly turbulent times. Using this strategy would entail leaving much of your money invested long-term in growth assets, while withdrawing funds to cover needs in the short term.
There are three so-called buckets: The immediate, intermediate, and long-term buckets. The immediate bucket holds funds that needs to be liquid in the short-term — or roughly two years. This bucket will be held in an account like a money-market account or high-yield savings account, since access — not interest or return — is the goal.
In the intermediate budget, you would place the funds you’ll require for the next eight years (taking you to year 10) of retirement. You could invest the funds in this budget in something that is low-to-moderate risk, such as bonds, CDs or even real estate.
The last bucket, or long-term bucket, must be positioned for as much growth as possible. According to this strategy, you won’t be dipping into this bucket for 10 years, so you can invest more aggressively in vehicles like stocks or real estate investment trusts.
Which Retirement Withdrawal Strategy is Best for You?
It depends entirely on your financial plan. Remember, no withdrawal strategy is a guarantee that your funds will outlast you. This is why it’s so critical to have a comprehensive financial plan in place, and to work closely with your wealth advisor to determine the best course for you.
Ironwood Wealth Management is here to help you make your money last. Contact us to learn more about our personalized approach to wealth management.