Many many years ago when my dad retired I remember him receiving a gold watch for his years of service and a nice pension for his hard work.
Today, many people have to rely on their 401(k) or individual retirement account (IRA) to help fund their retirement.
Not only that, but they also have to make smart decisions about withdrawing that cash.
Here are four withdrawal strategies to help you with that choice.
Dollar plus inflation
This strategy allows you to spend a percentage of your portfolio the first year and then adjust that dollar amount based on inflation in future years.
It is best for someone whose main priority is maintaining a steady level of spending from year to year.
If you settle on taking 3% of your portfolio in the first year, and that amount comes to $22,500, multiply that number by the annual inflation rate to come up with a new dollar amount the next year.
If inflation runs 2%, then $22,500 x 1.02 = $22,950 for the next year.
Percentage of portfolio
This strategy allows you to spend a fixed percentage of your portfolio every year. It is best for someone whose main concern is ensuring they don’t deplete their portfolio and who can adapt their budget to a wide variety of spending levels.
Unlike the inflation model your dollar will go less far year by year. However, your portfolio is more likely to stay stable in terms of overall value if you are invested prudently to beat inflation over time.
If the portfolio does well your dollar amount taken will be higher since the percentage doesn’t change.
If the markets fall back you would take less but also leave more money invested to recover with a rebound.
This strategy allows you to focused on covering your basic need expenses, such as rent, electricity, and food that Social Security payments won’t cover. A
s a rule of thumb, many retirees use 4% as their safe withdrawal rate — called the 4% rule.
Four levers affecting withdrawal rates are time horizon, asset allocation, spending flexibility, and degree of certainty desired.
I would suggest you meet with a financial advisor to have them understand your current financial needs, wishes, and wants. Most people in this strategy take about 3% to 5%.
If you choose the lower end of that range, your retirement should be quite safe.
Dynamic spending strategy
This strategy builds on people’s natural tendency to spend more when markets are up and less when markets are down. However, the wild swings in the market might give you a false sense of spending. Here is how that works:
- Start with last year’s withdrawal amount.
- Look at your portfolio’s returns for the year, and adjust next year’s spending up or down as needed. If your rate of return was greater than your ceiling, increase your spending only by the amount of the ceiling. If it was lower than your floor, reduce your spending only by the amount of the floor.
- Repeat each year.
Again, the best thing you can do is to talk with a financial advisor and ask them to perform a custom financial plan based on your current assets, liabilities, as well as needs, wants, and wishes.
He or she will have you fill out a detailed questionnaire so that they can better understand how you live today and how you want to live in the future.
Most advisors today use financial planning software because it provides sophisticated solutions and smart assumptions to help advisors navigate the complex financial elements of their client’s lives.