As you retire, there are variables you can’t control; investment performance and fate are certainly toward the top of the list. Your approach to withdrawing and preserving your retirement savings, however, may give you more control over your financial life.
Drawing retirement income without draining your savings is a challenge, and the response to it varies per individual. Today’s retirees will likely need to be more flexible and look at different withdrawal methods and tax and lifestyle factors.
Should you go by the 4% rule? For decades, retirees were cautioned to withdraw no more than 4% of their retirement balances annually (adjusted north for inflation as the years went by). This “rule” still has merit (although sometimes the percentage must be increased out of necessity). T. Rowe Price has estimated that someone retiring with a typical 60 percent/40 percent stock/bond ratio in their portfolio has just a 13 percent chance of depleting retirement assets across 30 years if he or she abides by the 4 percent rule. A 7 percent initial withdrawal rate invites an 81 percent chance of outliving your retirement assets in 30 years (individual.troweprice.com/staticFiles/Retail/Shared/PDFs/retPlanGuide.pdf).
That sounds like a pretty good argument for the 4 percent rule in itself. However, while the 4 percent rule regulates your withdrawals, it doesn’t regulate portfolio performance. If the markets don’t do well, your portfolio may earn less than 4 percent, and if your investments repeatedly can’t make back the equivalent of what you withdraw, you will risk depleting your nest egg over time.
Or perhaps the portfolio percentage method? Some retirees elect to withdraw X percent of their portfolio in a year, adjusting the percentage based on how well or poorly their investments perform. As this can produce greatly varying annual income even with responsive adjustments, some retirees take a second step and set upper and lower limits on the dollar amount they withdraw annually. This approach is more flexible than the 4 percent rule, and in theory you will never outlive your money.
Or maybe the spending floor approach? That’s another approach that has its fans. You estimate the amount of money you will need to spend in a year and then arrange your portfolio to generate it. This implies a laddered income strategy, with the portfolio heavily weighted towards bonds and away from stocks. This is a more conservative approach than the two methods above: with a low equity allocation in your portfolio, only a minority of those assets are exposed to stock market volatility, and yet they can still capture some upside with a foot in the market.
Attention has to be paid to tax efficiency. Many people have amassed sizable retirement savings, yet give little thought as to the order of their withdrawals. Generally speaking, there is wisdom in taking money out of taxable accounts first, then tax-deferred accounts and lastly tax-exempt accounts. This withdrawal order gives the assets in the tax-deferred and tax-exempt accounts some additional time to grow. A smartly conceived withdrawal sequence may help your retirement savings to last several years longer than they would in its absence(online.wsj.com, March 7, 2011).
Keeping healthy might help you save more in two ways. Increasingly, people want to work until age 70, or longer. Many assume they can, but their assumption may be flawed. The 2012 Retirement Confidence Survey from the Employee Benefit Research Institute found that 50 percent of current retirees had left the workforce earlier than they planned, with personal or spousal health concerns a major factor (www.dailyfinance.com, Sept. 3, 2012).
When you eat right, exercise consistently and see a doctor regularly, you may be bolstering your earning potential as well as your constitution. Health problems can hurt your income stream and reduce your chances to get a job, and medical treatments can eat up time that you could use in other ways. Good health can mean fewer ER visits, fewer treatments and fewer hospital stays, all saving you money that might otherwise come out of your retirement fund.
Fidelity figures that a couple retiring now at age 65 will spend $240,000 (in 2012 dollars) on retirement health expenses across their remaining years. That $240,000 doesn’t even include dental, over-the-counter drug and long term care costs (and as a reminder, many eye, ear and dental care costs are not even covered under Medicare or by Medigap policies). Every year you work may mean another year of health insurance coverage as well as income (www.marketwatch.com, Dec. 6, 2012).