Whether you're planning to travel, relocate abroad, or hang around home and spend time with friends and family, the best thing you can do for yourself before claiming Social Security benefits is to plan for "decumulation." All those years you spent saving and investing for retirement are considered your "accumulation" period. Once you begin to spend the money you've accumulated, you've entered the decumulation phase.
If there's one thing you should do before claiming your first benefit payment, ensure you have a decumulation plan in place. Planning for retirement is vital, but equally important is knowing how you will spend those funds so you don't outlive your money.
Image source: Getty Images.
It all begins with knowing how much you need
Have you created a post-retirement budget that shows you how much money you'll need to cover the basics and the things you want to do, like hobbies or travel? If not, now's the time. To create a retirement withdrawal strategy, you must first know how much you'll need from each available account.
If you haven't already, check my Social Security for the latest details on how much you can expect in monthly Social Security benefits. Next, add other sources of guaranteed income, like pensions, rental income, annuity income, royalties, or a part-time job. That gap between your income and how much you need to cover expenses tells you how much you'll need to draw from retirement accounts to make sure everything gets paid.
Depending on the year you were born, you'll need to begin taking required minimum distributions (RMDs) at age 73 or 75. RMDs are primarily required for pre-tax retirement accounts, like traditional IRAs and 401(k)s. Since you didn't pay taxes on the money when it was contributed, RMDs ensure the government can collect taxes on it.
Finding a method that works for you
Whether you wait until 73 or 75 to make withdrawals, or begin making them soon after retirement, planning for decumulation means figuring out the best withdrawal method for you and your personal situation. There isn't a one-size-fits-all solution. However, you have some solid options to choose from.
The 4% (or 4.7%) rule
One of the most popular withdrawal strategies since the 1990s is the 4% rule. It's a simple strategy that suggests withdrawing 4% of your total savings in the first year of retirement, then adjusting that amount to account for inflation in subsequent years. For example, if you have a $500,000 portfolio, you'd withdraw $20,000 (4%) the first year. If inflation the following year is 3%, you'd withdraw $20,600.
According to William Bengen, creator of the original 4% rule, now may be the time to raise it to the 4.7% rule. The rule's popularity may be due to its simplicity and the fact that historical data supports the proposition that sticking with the rule can sustain a diversified portfolio through 30 years.
The bucket strategy
This withdrawal method hinges on dividing your retirement assets into different "buckets," each dependent on when you believe you'll need the money. For example:
- Bucket 1 (cash flow): Made up of cash and cash equivalents, the funds in this bucket are intended for immediate needs and emergencies. One advantage of this bucket is that it allows you to avoid selling assets during market downturns.
- Bucket 2 (transfer): You expect to use these funds a little further down the road. They consist of more conservative investments, like bonds, to keep pace with inflation.
- Bucket 3 (longevity): This is money you don't expect to need until you're older, and it's invested in growth-oriented assets, like stocks. This bucket has a higher risk, but you also have more time to recover if your portfolio takes a hit.
Dynamic withdrawals
Sometimes referred to as the "Guardrails" strategy, dynamic withdrawal allows you to adjust withdrawals based on market conditions and your specific spending needs.
With dynamic withdrawals, you set a target withdrawal rate (the money you plan to withdraw each year). You then set "high" and "low" guardrails. These are the limits on the most and the least you'll withdraw annually. When it's time to withdraw, if you realize that you're planning to take too much or too little, you know to scale back or pick up the pace.
These three strategies represent the tip of the iceberg. There are many more. Some are straightforward, while others are a hybrid of two or three strategies -- and that's the point. Your retirement will be unique, and your decumulation strategy must be specific to you. Most of all, it needs to ensure two things: that you're comfortable, and that it will carry you through your entire retirement.
