As featured in WORTHWHILE, a quarterly periodical dedicated to serving the clients of Raymond James advisors and affiliated advisory firms.
It’s official. You’re retired. As in, your days are yours alone. No early morning meetings. No deadlines. No paycheck.
Without a job, you’ll no longer receive a salary. Something you’ve likely relied on every couple of weeks for the past 40 to 50 years. It’s unlikely that Social Security alone will be enough to replace that flow of income and fully support your standard of living in retirement, which means it’s time to start drawing down the retirement income you’ve saved so diligently over the years.
And that’s easier said than done.
There’s a highly emotional component to drawing down your savings without knowing exactly how long you’ll need it to last. For many, tapping into their retirement principal causes some anxiety. They view their savings as a safety net of sorts, when in reality it can help fund their vision of retirement. So it’s important to start planning for this early. Work with your advisor in the months and years leading up to retirement to develop a withdrawal strategy that works with your other streams of income (e.g., Social Security, annuities, incomeproducing investments, pensions and distributions). You’re looking to create a sustainable plan that gives you confidence that your money will last at least as long as your retirement does. Hopefully even longer.
Something for Everyone
Fortunately, there are flexible strategies that can be used alone or in combination to get to the ideal income you desire at each stage of your life. There are many variables to consider – unknowns like longevity, inflation, market performance and long-term care costs – which is where your advisor can come in handy when designing an income plan to cover the next 20 to 30 years of life.
Let’s take a look at the two main approaches designed to provide reliable income to cover different retirement spending needs and preferences. In both cases, it’s a good idea to start with a conservative withdrawal rate; then increase it incrementally if your portfolio grows.
The constant withdrawal method advocates estimating your expenses and withdrawing a set dollar amount from your portfolio every year to cover initial spending expectations. Like Social Security, you would adjust the amount for inflation and withdraw the new dollar figure. Because you set the rate at the beginning of retirement, it doesn’t factor in some of the “what ifs” that might come along as a customized plan would (see nearby chart on how income needs can change over time). Should your wants and needs deviate from your budget or the market become unpredictable, your measured withdrawal plan may not keep up.
So, that brings us to flexibility. As mentioned earlier, it may be best to start with a relatively conservative withdrawal amount to account for an unknown sequence of returns early in retirement. If your portfolio experiences a market boost early on, adjustments can be made upward to allow for higher withdrawals. And vice versa.
Strength: A predictable and consistent amount of yearly income
Consideration: Relies heavily on portfolio value at the beginning of retirement to determine future withdrawals
Percentage-based withdrawals are based on the current value of your portfolio. You can withdraw a constant percentage, say the 4% often espoused as a rule of thumb, or take a more variable approach. With each passing year, it may make sense to gradually increase your withdrawal percentage to match your changing life expectancy. This is similar to how traditional IRAs calculate required minimum distributions. A percentage-based withdrawal may make more sense for those who rely on their retirement savings mostly for discretionary spending or are comfortable with their income fluctuating from year to year.
Strength: Flexibility to allow for larger withdrawals following positive portfolio performance and lower withdrawals during periods of volatility
Consideration: Annual income varies with the markets and the size of your portfolio
There are variations on the main strategies, each with its own benefits and considerations.
Flooring relies on guaranteed income from Social Security and annuities to cover your retirement living expenses – the essentials. You then tap into your investment portfolio for discretionary spending. Relying less on your portfolio gives your assets a better chance to grow and fund long-term goals.
Good for: Those with long life expectancies; risk-averse investors who prefer a steady “paycheck” with less risk
Bucketing provides a twist on asset allocation. The idea is to invest a certain portion of your portfolio in relatively safe and liquid investments (think cash and cash alternatives) so that you feel confident that your needs will be met over the short term. While the cash provides a safety net of sorts, it may limit overall returns as it sits idle. The rest of your portfolio would be dedicated to growth investments that can help give you a better chance of funding long-term goals.
Good for: Those who prefer a safety net when drawing down the value of their portfolio
Adjust as Needed
With all of these models, there are a few things to keep in mind. Even with a carefully planned withdrawal strategy, you can’t account for everything. You may be excited about a new grandchild and spend more than you had planned or find your preferred lifestyle requires more than you had anticipated. What we’re saying is your spending strategy must align with your withdrawal strategy to keep your plan on track. Set up systematic withdrawals, say monthly or biweekly, to help you stick to your budget, and be sure to monitor your budget every month.
And during periods of rocky market performance, be prepared to cut discretionary spending or tap into existing lines of credit to improve the long-term sustainability of your retirement investments. Most of all, work with your financial advisor to set realistic expectations for what you can comfortably spend during what should be the best years of your life.
There is no assurance any investment strategy will be successful. Investing involves risk including the possible loss of capital. Withdrawals which exceed earnings will reduce the principal value of your retirement savings. Asset allocation does not guarantee a profit nor protect against a loss.
This article is provided by
Bill Martin, CFP®
1845 Capital of Raymond James
7001 N 10th St, Ste 205
McAllen, TX 78504