Retirement Withdrawal Strategies

If you're like many professionals, you spend a significant part of your career saving for retirement. When the time comes, you're faced with a big decision: how and when should you withdraw money to ensure your expenses are covered and your funds last? That's where retirement withdrawal strategies come in — these systematic approaches can help you achieve financial stability once you stop working.

Popular Retirement Withdrawal Strategies

The right retirement withdrawal strategy can help your investments last longer, particularly in the face of market fluctuations. Before you select a strategy, it's important to meet with a financial planner who can assess your portfolio, see how and where your assets are invested, consider your financial goals and recommend the most efficient withdrawal option.

The 4% Rule

One of the most common retirement withdrawal strategies is called the 4% rule. This strategy is based on the idea that you can usually withdraw 4% of your investments each year in retirement without running out of money.

There are a few parts to the 4% rule:

1. During the first year of retirement, withdraw 4% of your total investments. If you've saved $1 million, you'd take out $40,000.
2. The next year, increase your withdrawal amount to account for inflation. If the inflation rate is 2%, you'd take out $40,800.
3. Continue increasing your withdrawal rate each year to keep pace with the current inflation rate.

The 4% rule is convenient and straightforward; you don't need to worry about a complicated withdrawal strategy. It's also a handy tool for retirement planning — if you're following this rule, you might build a portfolio that's 25 times the amount of money you need each year. 

For example, say you need an additional $20,000 per year to supplement your pension, retirement accounts and Social Security income. That means during your career, you'd need to invest $20,000 x 25, or $500,000. When you retire, you'd withdraw 4% of the $500,000, or $20,000.

This strategy isn't without fault. If the market is volatile, your investments might earn less than expected. The 4% rule doesn't allow much flexibility, which can be an issue in years when you need to spend more on healthcare or other items. Your tax rate in retirement can also affect how long your investments last.

Fixed Withdrawals

If you like the idea of predictable income, you might choose a fixed withdrawal strategy. Instead of withdrawing a percentage, you take out the same amount of money each year. This process helps you plan for a fixed income and also gives you the freedom to change the dollar amount down the road.

However, it doesn't account for a loss in purchasing power due to inflation and fluctuations in the market. If your portfolio loses value, your fixed dollar amount may be too high; when this happens repeatedly over time, you could end up outliving your investments.

Bucket Withdrawal Strategy

The retirement bucket withdrawal strategy separates your assets into different groups, or "buckets."

• One bucket contains cash and cash equivalents — assets that can be converted into cash quickly, such as treasury bonds, money market mutual funds and commercial paper. This bucket should have enough money to cover 3-5 years of living expenses.
• The second bucket contains investments that come with some degree of risk, such as equities.
• The third bucket usually includes lower-risk investments that provide a fixed income. This might include derivatives and securities. In some cases, you group investments that mature around the same time.

Once your assets are clustered in buckets, you withdraw money from the cash bucket. Then, you refill it from the other buckets.

Typically, you don't wait until the cash bucket is empty to refill it — instead, your financial advisor will help you find the best opportunities. For example, if the price of a stock in another bucket rises, you could sell at a profit. Because your cash reserves can cover you for a few years, you're free to jump on good opportunities. More importantly, you can avoid selling at a loss to fund your living expenses.

As you might guess, the bucket method requires a considerable amount of attention and effort. A financial adviser can help; they can also assess your assets to determine a safe withdrawal rate.

Dynamic Withdrawals

Do you expect your expenses to vary from year to year? A dynamic withdrawal strategy might help you cover costs without taking too much from your investments. There are many different types of dynamic strategies; each one uses rules that govern how to adjust withdrawals based on the performance of the market.

Some dynamic withdrawal methods use tools called "guardrails" — upper and lower limits that help you track the performance of your investments. When poor market performance reduces the value of your account, it might fall below the lower guardrail. At this point, you need to reduce your withdrawals to prevent the value from dropping into a danger zone. Typically, you can resume normal withdrawals when the market bounces back.

When the market is strong, your account might hit the upper guardrail. At this point, you can usually increase your monthly withdrawals. It's not necessary to withdraw the maximum, of course, but it's nice to know the flexibility is there if you need it.

Other types of dynamic withdrawal strategies use different rules to track and respond to market performance. The goal of each strategy is to avoid a sequence of returns risk — the risk that the lifetime of your account will drop due to an early decline in returns combined with regular withdrawals. In other words, if you don't adjust withdrawals when the market declines, particularly at the beginning of retirement, you risk running out of money earlier than expected.

To use dynamic retirement withdrawal strategies, you must be willing to cut back when necessary. This can put a squeeze on your finances if your investments perform poorly over a long period of time.

Keep in mind that many dynamic withdrawal strategies require ongoing monitoring and management. To make your money last longer, make sure to work with an experienced financial professional.

Things To Consider When Selecting a Retirement Withdrawal Strategy

Retirement withdrawal strategies can be complicated to choose and manage. As you're considering your options, consider the following factors:

• Taxes: You may owe income taxes in retirement, so it's important to factor them into your estimated living expenses. For example, you'll need to pay taxes when you withdraw money from a traditional IRA funded with tax-deductible contributions. The same grows for distributions from annuities.
  
  
• Minimum age for benefits: Are you planning to get benefits from a pension, retirement account or Social Security? Keep in mind that these accounts usually have age limits; if you withdraw earlier, you could pay a penalty.
  
  
• Required minimum distributions: Some retirement accounts require you to take out money when you're 72. You'll need to factor these distributions into your withdrawal strategy.

Don't wait until you retire to start thinking about retirement withdrawal strategies. By starting early, you can prepare your portfolio to meet your financial goals.