Retirement Withdrawal Optimization

October 9, 2022

Topics: Saving for retirement | Early Retirement | Retirement | Retirement Income

Media type: Article, Video, Podcast

Retirement Withdrawal Optimization

4.6 minute read • 

October 9, 2022

How to know how much you can spend

Self-control is a personal trait that can make a person an excellent saver, but paradoxically, it can put them in difficulty when it comes time to dip into those savings.

Numerous studies, including ours*, show that wealthy retirement investors typically don’t spend much of their retirement savings and their accounts may continue to grow. Sure, that’s not a terrible problem – but it could mean they don’t know how much money it’s “safe” to spend, so they get too frugal and forgo the fun of retirement.

Learn about other behavioral factors that can affect your retirement spending

When planning how to spend your retirement savings, you need a strategy that achieves 2 often competing goals:

1) have enough money to support the lifestyle you want, and 2) be sure to leave enough money for the future, including any money you plan to leave to your heirs. We have an exit strategy that can help you solve both of these problems. But let’s review the traditional approach first.

Traditional withdrawal strategy:

advantages and disadvantages

A dollar plus inflation strategy requires you to spend a certain percentage of your portfolio in the first year and adjust that amount for inflation in subsequent years. Here are some notes on this strategy:

The “4% rule” is a popular example of dollar plus inflation. If your expenses don’t change much in retirement, you can be confident that you can cover your annual expenses for as long as your wallet lasts (Goal 1).

It ignores market conditions, so you may end up spending money (in a bear market) or spending much less than you can afford (in a bull market). This may be better for you if your top priority is to maintain a consistent level of spending each year.

Portfolio percentage strategies require you to spend a fixed percentage of your portfolio each year. This strategy:

Have confidence in achieving Goal 2 – not running out of money.

This results in annual spending amounts that are entirely market driven and may not meet your basic needs.

If your primary concern is ensuring you don’t exhaust your wallet and being able to adjust your budget to a wide range of spending levels, this may be right for you. You want a strategy that allows you to achieve 2 often competing objectives:

1) Have enough money to support the lifestyle you want, and 2) Make sure you have enough money set aside for the future. We have a strategy to help you with both.

-Vernell Peter-Koyi, CFP®, Senior Financial Advisor

How to choose the initial withdrawal amount

Whichever strategy you choose, you will start by choosing your withdrawal amount for the first year. During the planning phase, many retirement calculators use this as the key to determining how much you need to save.

Although 4% is a popular recommendation, research has only identified it as “safe” for certain time periods and allowances. Security means different things to different people. 4% may or may not be too much for you. Here are the factors we consider when selecting withdrawal rates for individual clients:

4 Leverage Effects Affecting Withdrawal Rates

A chart showing how time horizons, asset allocation, spending flexibility, and the degree of certainty required lead to lower or higher withdrawal rates.

Read the chart description

Do you need a retirement withdrawal strategy?

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Dynamic spending strategy

Since spending levels and portfolio preservation are top priorities for many people, we’ve developed a retirement strategy to achieve these two important goals: paying for living expenses while trying to keep enough money for life. ‘coming.

Dynamic payouts – a mix of dollars plus inflation and portfolio percentage rules – do just that. It builds on people’s natural tendency to spend more when the market is up and less when the market is down – but it smooths out the wild swings you experience when market performance gives free rein to your spending.

In other words, it implements the golden mean. Your payouts are more flexible than the dollar plus inflation approach, but also more stable than the percentage of portfolio approach. It’s also fully customizable, so in addition to deciding how much to withdraw for the first year, you can also decide how much you’re willing (and able) to increase or decrease your payout in response to market movements.

To use dynamic payouts, you calculate your payouts for the coming year by adjusting the amount you spend this year based on your portfolio returns for that year. But you cannot exceed the “upper limit” and you cannot go below the “lower limit” that you have defined in your strategy.

Scope of spending rules

The chart ranks the 3 spending rules based on market performance and how they affect short-term spending stability, spending flexibility, and portfolio viability. Read the chart description

Dynamic spending on FIRE

For those retiring early, spending wisely is even more important. We looked at sustainable withdrawal rates for the Financial Independence Early Retiree (FIRE) community and found that the safe withdrawal rate for those using the dollar plus inflation strategy over a 50-year period was 3. 3%. But using dynamic payments, the security rate rises to 4.0%. ‡

Determining your floor and cap, as well as deciding the correct initial withdrawal rate, means that you will need to make several decisions and maintain an additional level of oversight to use Dynamic Payouts. Since all of these factors depend on your personal schedule, allowances, sources of retirement income, and priorities, there is no right answer for everyone.