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Retirement Income and Systematic Withdrawals

There’s no shortage of articles about the process of accumulating wealth. We spend our working years deferring part of our incomes into retirement plans and establishing various investment strategies to grow and protect our assets. However, there’s less discussion about the process of distributing our money back out to ourselves in the most effective way possible.

The discussion about portfolio withdrawals, especially during retirement, has become more complicated lately. People are living longer and the typical retirement, which used to be 10-20 years, can now extend to 20-30 years. Also, prices are high and yields are generally low for the bond market, creating a need to rethink the strategy of slowly allocating away from stocks and into bonds as the distribution phase approaches.[1]

Portfolio Withdrawals

If you visit a financial planner, you may hear the general rule of thumb that your portfolio withdrawals should be at a level of roughly 4% (per year) of your portfolio, starting around age 65. If you withdraw at that rate, with a 50/50 mix of stocks and bonds, the general belief is that you’ll likely never run entirely through that portfolio. That essentially means that if you’ve saved $1,000,000 and begin withdrawals at age 65, you should be able to pull $40,000 per year out of that pool of money and still have funds available at age 95.

Now, there is increasing debate about whether it will remain an effective strategy going forward. Some of the concerns about the future solvency of the 4% rule hinge on the persistently low interest rate environment, which may cause people to spend their principal to meet the 4% withdrawal rate.[2] If rates are to rise, how will the bond side of a portfolio hold up?  Further, what if the bond market begins to struggle at a time when stocks decide to end their current bull run? That could spell trouble for a traditional 50/50 asset mix.

Asset Allocation

As with most financial planning issues, the right answer to an individual asset allocation strategy will be different for everyone. Some considerations will include the amount of money you’ve accumulated, the amount of money you’ll need each month in retirement, and your tolerance for risk. You’ll also want to be aware of the type of accounts you’re taking distributions from (taxable vs. after-tax), your average tax rate, and the overall economic climate.

With the most obvious concern being the low interest rate environment, some investors may consider shifting their asset mix more aggressively into equities, especially given the strong performance of stocks over the past few years. For some, particularly those with a somewhat higher tolerance for risk and perhaps a longer time horizon, the increase in allocation to stocks could be a wise move. For others who are truly not comfortable with a 60% or 70% stock allocation, the answer may be reducing the average rate of withdrawal, perhaps from 4% to 3.75% or even 3.50%. It may not sound ideal, but it may help to preserve your liquid assets for when they are needed down the road.

Keep Taxes in Mind

The tax status of the account you’re withdrawing funds from matters because ultimately, it’s what you keep after paying tax that counts. If you’re withdrawing from a traditional IRA, you need to adjust that withdrawal to account for any tax withholding. You can determine how much (if any) tax withholding to process once you get an estimate of what your total income will look like for the year. Many people enter a lower tax bracket once they retire, but some, particularly those with working spouses, may remain in a fairly high tax bracket.

If you do have retirement accounts, including traditional IRAs, it should be noted that distributions are required to start once you reach age 701/2, even if the money isn't needed and you'd prefer to pass more of that tax-deferred account to your beneficiaries. Required minimum distributions, commonly known as RMDs, do create a potentially effective distribution system of their own as the amount the account owner must withdraw increases every year. Many people need to withdraw more money than the RMD requires anyway, but for some investors with large account balances who don't need the funds, RMDs can act as more of an annoying task designed to repay some of the tax that Uncle Sam kindly let us defer during our earlier working years. RMD rules do not apply to Roth IRA accounts, something to keep in mind for those who are debating traditional vs. Roth retirement accounts.


Another interesting strategy is "bucketing" your funds for retirement. Bucketing is a strategy in which funds needed to meet short, medium, and long-term goals are earmarked in different buckets. Funds needed in the immediate future would generally be held in cash while long-term funds may be more aggressively invested in stocks. Funds needed a few years out can be allocated using a mix that presents some upside potential, but with some preservation of capital and income objective, as well. Bucketing can help investors formulate a correct asset allocation mix based on their future income needs. The cash bucket may also create some peace-of-mind that allows retirees to focus less on stock market volatility if their income isn't coming directly out of a single account that includes volatile stock investments.

When it comes time to start withdrawing from your investment portfolios, a holistic approach that includes all aspects of your financial life may be helpful. Planning out your income and distribution strategy should help to avoid more than a few headaches down the road.

[1] Ruth Davis Konigsberg, Why I Won't Own Bond Funds in my Retirement Portfolio, (October 20th, 2014)

[2] Reshma Kapadia, Retirement Rules: Rethinking a 4% Withdrawal Rate, (April 11th, 2015)

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