If you're still working and tucking money into a retirement plan, you're in the "accumulation" phase. Once retired, you've officially entered the "decumulation" phase, the period of life during which you spend the money you spent years saving and investing. The decumulation phase can be challenging for one primary reason: You want assurance that you won't outlive your money.
That's where a smart withdrawal strategy comes into play. With the right withdrawal plan, you can be confident that your money will be there when needed. Whether you're still on the job or retired, it's never too late to choose a strategy that works for you. Here are four examples of withdrawal strategies, along with their strengths and weaknesses.
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1. The 4% (or 4.7%) withdrawal rule
The 4% rule has been around since the 1990s and has become the gold standard for those seeking a high probability that they won't run out of money over a 30-year retirement. William Bengen, who invented the 4% rule, recently researched and wrote a new book, A Richer Retirement. In it, Bengen states that retirees may be able to withdraw 4.7% rather than 4% of their retirement portfolio in the first year of retirement and adjust for inflation each subsequent year.
Whichever version you choose to implement, the 4% (or 4.7% rule) offers both pros and cons.
Pros
- Easy to understand and utilize without advanced financial knowledge.
- Based on a foundation of historical U.S. market data.
- Can help control overspending, particularly in the early years of retirement.
- Can help those still in the workforce determine how much money they need to save and invest before they retire.
Cons
- The historical data on which the rule is based may not reflect future market performance.
- Adjusting for inflation may not be realistic during periods of exceptionally high inflation.
- The rule doesn't adjust for portfolio performance. If you're entering retirement just as the market declines, you risk depleting more of your savings than expected.
2. Fixed-dollar withdrawals
A fixed-dollar withdrawal allows you to withdraw a set amount from your portfolio yearly, regardless of market performance, balance, or inflation. You could take a fixed-dollar amount over a specific time period. Let's say you want to withdraw $40,000 annually. You might do that for the first five years of retirement, then reassess how your portfolio is doing at that time.
Pros
- Simple and easy to understand.
- Provides a stable income stream.
- You can set the initial amount to cover your lifestyle, potentially pairing it with other income sources, such as Social Security benefits.
- Can be customized to fit your retirement plans. For example, you may withdraw more in the early years of retirement to cover the cost of travel or hobbies.
Cons
- Doesn't do much to protect against inflation, and depending on how much you choose to withdraw, it could erode your principal.
- Unlike some other withdrawal strategies, it doesn't adjust to portfolio size.
- You could withdraw too much early in retirement, leaving too little for later years. Or, you could be too conservative, leading to unnecessary penny pinching.
3. Fixed-percentage withdrawals
A fixed-percentage withdrawal involves withdrawing a set percentage of your portfolio's value annually. However, the amount you withdraw varies yearly, depending on your portfolio's performance.
Pros
- Simple to calculate.
- Adjusts to market performance.
- Reduces the risk of outliving your savings.
Cons
- Income could fluctuate annually.
- May not cover fixed expenses.
- May not align with your needs as you age. For example, you may have more money than you need at one point and too little at another.
4. Withdrawal buckets strategy
With the bucket strategy, you divide your portfolio into different "buckets," each based on a time horizon and risk tolerance. Each bucket is intended to fund a different stage of retirement. Here's how the bucket strategy breaks down:
- Bucket 1: Cash or short-term investments. This bucket is designed to meet immediate needs (three to five years).
- Bucket 2: Holds mostly fixed-income securities for medium-term needs (five to 10 years).
- Bucket 3: Stocks or growth assets for long-term needs (10+ years).
As you use the cash from the first bucket, you replenish it periodically with earnings from the second and third buckets.
Pros
- Since you have cash and stable assets to cover near-term needs, you're less likely to have to sell stocks during a market downturn.
- You know you have a few years of safe income, even during market volatility.
- Flexible and customizable since you can adjust the number of buckets, time frames, and asset allocations.
- Balances growth and safety, a factor that may help you rest easier at night.
Cons
- More moving parts to manage compared to other withdrawal strategies.
- Keeping three to five years of expenses in cash or very low-yield investments may reduce your overall return potential.
- Can be challenging to determine how and when to refill the short-term bucket.
- Requires ongoing oversight. There's no "set it and forget it."
Determining your retirement income strategy requires careful consideration, including how and when to make withdrawals. Fortunately, it's not a question with a one-size-fits-all answer. You can choose the strategy that best fits your situation, or mix and match different plans until you come up with one that provides income and a sense of security.
