Income Planning in Retirement: Which Withdrawal Strategy Should You Use?June 2, 2016 10:09 am
You’ve worked hard and saved for a long time, and it’s finally time to retire. In planning for retirement, you will need to evaluate your retirement income sources. For most, a Social Security benefit will be one of the fixed sources of monthly income. Others may also receive a monthly pension or perhaps a monthly annuity payment. If those funding sources are not enough to meet your needs, you will need to supplement your income with withdrawals from your portfolio. Clearly, the goal will be to attempt to make your portfolio last as long as possible, so you will want to choose the withdrawal strategy most suitable for your personal situation. Below are three strategies that I will detail.
Systematic Withdrawal Approach
The systematic withdrawal approach is one in which you will determine either the amount or percentage that you plan to withdraw from your portfolio each year. The annual withdrawal will be comprised of income generated from the portfolio and perhaps some of the principal. Care should be taken to choose a safe withdrawal amount or rate that will allow the portfolio to last for your and your spouse’s lifetime, if married. A diversified investment strategy should be implemented to reach the yearly safe withdrawal goals. While the systematic withdrawal approach can seem like the most straightforward because you determine a set amount or percentage to withdraw from your portfolio each year, there are still variations of the approach to consider. Issues that will need to be considered are withdrawal amounts being adjusted for inflation and dealing with less than expected investment returns. A perfect example of a current issue is dealing with today’s low interest rate environment for the fixed income portion of your portfolio.
Bucket Approach (aka Age Banded Approach)
The bucket strategy is one that sets up three different bands of investments. Each band is invested for a particular time period in your life. The first band, which would be utilized in the first segment of retirement, (say from ages 65 to 75, as an example), would be invested more conservatively than the other bands, because it will need to be accessed sooner. The second band could be used to fund needs from ages 75 to 85 and would be more moderately invested. Finally, the third band would be to fund needs from age 85 to 95, and this segment would be invested using more aggressive investments. Short term buckets will typically utilize lower risk investments like money markets, CDs and bonds, so that the cash availability dates are readily determined. The more distant buckets will likely utilize equities in their investment allocation.
Essential Versus Discretionary Approach (aka Flooring)
The flooring approach will require you to determine which retirement expenses are essential and which are discretionary. The income streams and portfolio will again be segmented or assigned to the two categories. The essential expenses will usually be funded by low risk investments or guaranteed income streams, like Social Security, which create a “floor”. The discretionary expenses will be funded with more moderate or higher risk investments such as a portfolio of stocks and mutual funds. As an example, you may have Social Security benefits and a monthly pension which will cover your essential monthly expenses (your “floor”) for housing, food, utilities and health coverage while your travel expenses and gifts will be withdrawn from your discretionary assets.
In addition to using any of these approaches, you must also consider risk tolerance and tax strategies in forming your retirement income plan. The sooner you can start planning for retirement the better. Even if you are five or six years away from retirement, now is the time to begin trying to figure out what your lifestyle needs will be and which approach will suit you best.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Chrissy’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.