One of the more difficult issues facing individuals close to retiring is deciding what type of retirement income withdrawal strategy will work best for them. After a lifetime of setting money aside and managing their retirement savings through all types of market conditions, many people have given little thought to how they intend to take money from their retirement accounts for day-to-day expenses.
There are several approaches to withdrawing money from retirement savings. What follows is a brief overview of two common strategies and an explanation of their relative pluses and minuses.
The Bucket Approach
With this approach, you think of your retirement portfolio as different buckets of money, each with a different investment time horizon, such as short-term (0 to 5 years), medium-term (6 to 14 years), and long-term (15 plus years). You then determine an appropriate asset allocation for each bucket based on your personal risk tolerance that you can plan to liquidate over time.
To protect against volatility, the amount you estimate you will need during the first five years of retirement — your short-term bucket — could be invested in conservative asset classes, such as money market instruments. Your medium-term bucket — holding the money you will need for years six through fourteen — might be invested in investments with moderate risk, such as investment grade bonds. This would offer you the potential to earn somewhat higher returns without going too far out on the risk scale. Your third bucket consists of your long-term funds. Typically, you will want to include investments with the potential to earn inflation-beating returns in this bucket, such as stocks and stock funds, since your 15-year-plus time horizon gives your portfolio time to potentially recover from downturns in the market.
The bucket strategy is not a “set and forget” approach. It requires you to periodically replenish your short-term bucket with funds from the other buckets. Additionally, you will need to determine how much you can withdraw each year without spending down your assets too quickly.
The Systematic Strategy
This approach involves withdrawing a set percentage of your initial retirement portfolio every year, increasing the dollar amount of your withdrawals only to adjust for inflation. If your portfolio earns at least as much as you withdraw, your principal would remain unchanged or grow over time. Of course, there are likely to be years when the stock and bond markets are down and your portfolio earns less than you withdraw, depleting your principal.
Although systematic withdrawals are relatively easy to implement, it’s critical to choose your withdrawal rate and investment mix carefully since both factors will impact how long your money will last. If you expect your spending needs to vary from year to year, you’ll want an approach that offers you more flexibility.
Your Decision to Make
These are just two withdrawal strategies that you can consider. Ultimately, the approach that works best for you will depend on your personal situation. You may benefit from consulting with a trusted financial professional to help you determine and implement a strategy that suits your needs. Contact us if you’d like to create a plan on how you can withdraw retirement funds in a way that works best for you.