Deciding how much to withdraw from retirement investment accounts can be really confusing. You neither want to withdraw too much too soon -- leaving you broke in your later years -- nor do you want to withdraw too little and struggle financially because of it.
The good news is, there are proven approaches to deciding how much money to take out of your accounts. The bad news is, some of the "rules" people use to calculate withdrawals could actually put them at serious risk of running out of cash.
You can find out here what the experts suggest -- and which common rule you might not want to follow, lest you jeopardize your financial security toward the end of your life.
Here's what experts say you should withdraw
The Center for Retirement Research (CRR) analyzed different approaches for calculating withdrawals and determined the best approach for most seniors is to base your strategy off of Required Minimum Distribution (RMD) tables the Internal Revenue Service makes available for retirees.
RMD tables are actually prepared by the IRS to dictate how much money people with certain tax-advantaged retirement accounts, such as 401(k)s and IRAs, are mandated to withdraw each year to avoid being hit with a tax penalty.
However, the Center for Retirement Research recommends retirees of all ages use RMD tables to determine the percentage of their retirement account balance to withdraw each year because:
- It's simple for retirees, unlike certain other processes for determining withdrawal rates that require complex math.
- It allows you to withdraw more money each year as your life expectancy decreases and you have fewer remaining years to rely on your investments to produce income.
- You're more likely to build a balanced portfolio since the strategy doesn't rely on withdrawing only the income that investments produce -- which could lead you to invest too heavily in dividends.
- Your withdrawal rates respond to changes in the stock market since the amount you withdraw is based on your portfolio's current value, contrary to other approaches that calculate withdrawals based on the value of your portfolio when you began drawing down your account.
Because you're required to begin making minimum withdrawals at age 70.5, the IRS RMD tables begin at this age. However, CRR recommends following the same basic rules from the start of your retirement and provided a table with recommended withdrawal rates based on RMD calculation methods.
Here's the recommended percentage of your retirement account balance you should withdrawal annually from age 65 to 100, according to CRR.
To use this recommended approach, find your current age on the chart and withdraw that percentage of your retirement account balance to use as your income for the year.
If you were 80 and had $500,000 saved, you'd withdraw $26,750 ($500,000 multiplied by 5.35%) whereas if you were 95 with that same $500,000 balance, you'd withdraw $58,150 ($500,000 multiplied by 11.63%).
A modified RMD rule is also an option
The Center for Retirement Research also reported that while this RMD rule tends to produce good outcomes for many seniors, it's subject to criticism because it results in retirees withdrawing less of their money during their early years of retirement.
For those who'd prefer higher initial withdrawal rates, the RMD rule could be modified so retirees withdraw the percentage of their portfolio recommended by the RMD rules plus income from interest and dividends.
This would allow more consumption while still young and healthy enough to travel -- but the downside is that it could leave you less prepared if expenses rise dramatically in your later years when health issues develop.
Why the RMD rule is recommended
The RMD rule is presented as an alternative to other common approaches of calculating withdrawals from retirement savings including the oft-repeated 4% rule, which involves withdrawing 4% of a portfolio's value during the first year of retirement and adjusting upward each year only for inflation.
The 4% rule has a number of detractors despite it being one of the most common approaches to establishing a baseline for retirement savings.
The Center for Retirement Research lists disadvantages of this rule, the biggest downside being the fact that the 4% rule isn't responsive when investments don't perform as expected. Retirees with better-than-expected returns, for example, might not increase consumption when they should, while those with lower-than-anticipated gains might not adjust consumption downward, even when it's imperative to do so.
The Center for Retirement Research indicates one advantage of the 4% rule is that retirees who follow it have a low probability of running out of funds. Unfortunately, other research suggests this may not be the case in low-yield environments. In fact, a 2013 study found retirees who follow the 4% rule faced an almost 60% chance of running short of funds in retirement based on interest rates at the time of the study.
How much should you withdraw from retirement accounts?
Ultimately, retirees all need to make their own assessments of how much they feel it is safe to withdraw. It's important to find a balance between being so conservative you struggle financially and risking running out of money too early.
Using RMD tables could be a strong approach that allows you to respond to changing market conditions so you ensure you have the money you need now and in the future.