Have you heard that the past reliable retirement withdrawal strategies don’t work anymore? Well, there is good news, and bad news around that rumor.
The good news is that retirement withdrawal strategies can work for those seeking to withdraw 1 to 4% a year from their investment accounts as a passive source of funds.
The bad news is that retirement withdrawal strategies can burn through your hard earned retirement fund leaving you without enough money to live.
Success with any retirement withdrawal strategy is measured by having enough money to sustain your desired lifestyle for life. You cannot control all of the success factors, but you can control most of them, fortunately.
These success factors apply whether you plan to retire early or leave your career at the traditional age of 65.
Using one of the two retirement withdrawal strategies explained below, you can access funds to pay your bills during retirement. The money flows into your accounts passively, or without effort. This can be a beautiful thing, especially when you’re much older.
Right up front, I’ll say that this strategy works best for those with over a million dollars in their investment accounts unless you live very cheaply or you have additional income streams.
Before judging if retirement withdrawal strategies still work, let’s start with how you can succeed using a retirement withdrawal strategy.
Success Factors You Control for Retirement Withdrawal Strategies
Having money to sustain your standard of living can feel out of your control. That’s scary. This is especially true when your money is in stocks and bonds since their value can have huge swings.
Fortunately, there are factors you can control that determine the success of your money lasting throughout retirement. Just realizing this truth is empowering.
First, the obvious reality is the amount of money that you have in your investment account from which you’ll draw is under your control. With a few exceptions, this is a direct result of your income and your spending in pre-retirement.
Second, the percent you choose to withdraw is a factor you control, too. This factor is directly related to how much money you spend in retirement since the more you spend the more you’ll need to withdraw.
Success Factors You Don’t Control for Retirement Withdrawal Strategies
You simply cannot control the value of the economy. And the economy drives the value of your stock and bond accounts.
But what you can control is when and how you invest. You can choose to be a proactive investor. This requires staying abreast of the financial markets with minimal ongoing effort.
For example, you can choose to put less into overvalued stock markets. You can choose to scale back on longer term bonds when interest rates are headed up.
Or you can choose to hire a proactive financial advisor who is keenly aware of market values that tailors to your needs rather than a cookie cutter approach. Or you may choose several wealth managers or funds, leading the helm yourself.
Any of these solutions requires paying attention to market values. All of this can help you avoid one of the biggest threats to successful retirement withdrawal strategies: Bear markets just before and early during retirement.
Speaking of financial advisors and funds, you can also control the amount of fees that you pay for your retirement account.
Having clarified and hopefully inspired you by realizing that many of the factors determining the success of the retirement withdrawal you choose is doable, let’s look at the strategies.
Income Streams in Retirement
The idea of giving up a lifetime of income can be daunting but could also be painless if well handled with a reliable retirement income plan. My own retirement income preference is to supplement one of the popular retirement withdrawal strategies with alternative income streams.
This is the strategy we began late midlife. It ended up working so well that my husband retired from his career early.
Fortunately, the income streams from real estate and small business that we created late midlife have allowed us to delay relying on a monthly withdrawal strategy. Having said that, alternative income streams can beautifully complement either of these more traditional retirement withdrawal strategies below and will likely do so for us later in life.
The Most Popular Retirement Withdrawal Strategies
Spending your hard-earned savings can be scary. The rules below have been analysed and tested by traditional thinking financial professionals.
Fortunately, there is both the math and historical data to support the success of these retirement withdrawal strategies. There are, however, many unknown variables in both the lives and future spending needs of retirees plus the unknown future of stock and bond markets.
Retirement Withdrawal Strategy #1: The 4% Rule
This is one of the most popular retirement withdrawal strategies and is known to be a rule of thumb. Sources indicate that the rule came into existence in the early 1990’s. The creator, William Bengen, used historical data on stocks and bond returns over a period of 30 years to refine his research.
So, how does this popular retirement withdrawal strategy really work?
Let’s assume, for instance, you’re just entering retirement. Assuming you have $1,000,000 worth of portfolio at the time you retire, you can calculate a withdrawal of $40,000 per year using the 4% rule. This is calculated simply as 4% of $1,000,000 the first year.
In the subsequent years, the 4% from year one will be the amount to withdraw, only that it will be adjusted for inflation. If, for example, the inflation rate is at 3%, the amount you’ll end up withdrawing in year 2 is calculated as ($40,000 × 1.03% equals $41,200).
Notice the $41,200 is bigger than the first year 4% withdrawal on a percentage basis. The percentage that the withdrawal is of your retirement savings will also vary according to how the value of your investments fluctuate from year to year.
In other words, in some years, the withdrawal of $40,000 could be 5% of your portfolio, and after inflation, it could be much higher.
Inflation is an important factor that affects the amount you withdraw with this strategy so you can maintain your standard of living. The guideline for the rule states that you withdraw 4% the first year and subsequently the figure will be adjusted for inflation year after year.
This allows you to keep the purchasing power of your withdrawals.
Dividends in Retirement
Important to note: Dividends and capital gains are withdrawn under this rule. In other words, the 4% includes dividends.
If you plan to have a withdrawal of $40,000, and you receive cash relating to dividends amounting to $15,000 that year, then you may only draw an amount of $25,000 from the capital in your investment account. The $25,000 would also include deposits, capital gains and compounding of dividends and capital gains.
Keep in mind that during the Accumulation phase of your investing, dividends and capital gains were all most likely lumped into your investment account to compound over time.
Many experts consider the 4% rate to be relatively safe since the regular withdrawals have an element of both interest, dividends and capital gains in them.
Pros for the 4% Retirement Withdrawal Strategy
• The retiree is guaranteed steady funds after retirement. This has been viewed as an assured living standard after retirement.
• The 4% rule also assists financial planners to evaluate a portfolio’s withdrawal rate. Additionally, the life expectancy is also important in determining whether the rate will be viable.
• The rule has been tested and used for over decades—making you less likely to run out of money during retirement.
Cons of the 4% Retirement Withdrawal Strategy
• The rule can be restricting if 4% isn’t enough to sustain your standard of living.
• Bear markets just prior to retirement or shortly after retirement can have a damaging effect on this strategy.
• The experiments relating to the rule were only conducted for a period of 30 years. You might live way longer than that even without an early retirement.
• While the withdrawal is adjusted for inflation, this means that you’re more likely to run out of money should inflation increase significantly.
Remember, too, the 30 year study period may not represent your retirement years as far as the performance of the financial markets, interest rates or inflation. Plus, taxes may be a variable for many investors that can sway the success of this model.
Early Retirement Withdrawal Strategy #2: 2% to 3% Rule
Just like the 4% thumb rule, a number of experts have in the recent past been championing for this early retirement withdrawal strategy. The rule basically has retirees withdraw funds at a lower rate of 2% to 3%.
Dividends and capital gains under this rule can also be withdrawn and treated as explained above under the 4% Rule.
A 2015 study published by Morningstar and written by three retirement specialists, David Blanchett, Michael Finke, and Wade D. Pfau compared the 4% and 2% rules. The team concluded that a 2% withdrawal rate was more realistic due to the following reasons:
1. They used a model that catered for mechanisms for market returns to revolve around historical averages over the retirement period. This is due to the fact their model is based on more current economic times i.e. 2015 onwards.
They also found the period to be one of unusually low interest rates coupled with high stock valuations.
2. They accounted for fees for fund management and financial advice.
3. They ran their simulations over a period of 40 years as compared to 30 for the 4% retirement withdrawal strategy. They believed that an individual might outlive thirty years after early or normal retirement.
4. It’s no doubt retirees face unusually high valuation returns risk near the end of bull markets. The study adequately accounted for the heightened sequence of returns risk.
The 3% Retirement Withdrawal Rule With Real Numbers
Enough technicalities—let’s break this down to numbers for easier digestion.
A lower rate of 3%, for instance, means that if your portfolio is at $1,000,000, then the math would be (1,000,000 x 3%) which results in an annual withdrawal of $30,000.
Now, don’t panic if you’re approaching retirement time and your savings fall far from the million-dollar example I keep using. This is solely for demonstration purposes since other factors can turn your calculations around. Retirement income could include social security, pension, and or even small business or rental property income.
Plus, your expenses might be reduced time on retiring, as well as your tax rate.
In addition, most retirees target retirements after their dependents are self-sustainable. And if you’re one person, you’ll have lesser expenses.
Pros of the 3% Retirement Withdrawal Strategy
• The rule is more realistic in terms of life expectancy after retirement. At 40 years, it’s a better bargain as compared to the 30 years by the 4% rule.
• Being a more recent rule, there’s likely to be some better level of accuracy since the parameters used reflect more current economic times.
• The supporters of the rule considered the fact that you may need the services of a professional to make more informed decisions. Of course, they are in the financial services business. Investors can learn to invest themselves with low cost index funds, stock selections, or hire a financial advisor depending on their skills and desires.
Cons of the 3% Retirement Withdrawal Strategy
• It can be quite tough to live off 3% of your portfolio unless you have a great deal of money stashed in your retirement account. Sadly, most people don’t. For instance, if you only managed to save $250,000, that leaves you with $7,500 per year to live on. It’s even worse if you split the withdrawals into months —that’s $625 a month.
• The cons with the 4% retirement withdrawal strategy also apply here.
The Rule of 25 Vs Retirement Withdrawal Strategies
Please, don’t confuse the 25X Rule with any of the two retirement withdrawal strategies above.
In a nutshell, the “multiply by 25 rule” estimates how much money you need to retire by multiplying the amount of retirement income you desire by 25.
Many people confuse the multiply by 25 rule with the 4% rule. The two have a critical difference. While the multiply by 25 rule guides you on how much to save, the 4% rule shows how much you can withdraw from your retirement. See? Quite different!
To paint a better picture of the multiply by 25 Rule, consider this example:
If you would like to live off a $40,000 annual income after retirement, you would need $1,000,000 in your portfolio. This would be calculated under the multiply by 25 rule as ($40,000 x 25 equals to $1,000,000). This, therefore, means you would work towards saving that much by the time you retire.
Are These Retirement Withdrawal Strategies Risky To Count On?
Many experts term these retirement withdrawal strategies as simply “too risky” for retirees while some advocate for these strategies. Whether the 4%, 2% or 3% is the better one is a matter of understanding the strategy that works best for you. Never can one strategy work for all, right?
Other Factors That Affect Retirement Withdrawal Strategies
It is essential to take the time to research, consult, and understand the various parameters involved with any retirement withdrawal strategies. These may include tax implications, expected inflation rates, market cycles and portfolio investment returns.
The most important thing is to have a plan to manage withdrawals from your retirement account unless you have alternative income streams to cover your living expenses. As much as making informed decisions is paramount towards choosing a suitable retirement withdrawal strategy, the process shouldn’t make life harder for you.
The whole idea for saving for retirement is to make your golden years plentiful. Yet with longer lives and greater market fluctuations in more recent times, the challenge to have funds for life is greater.
Steps Toward Plenty of Income Sources in Retirement
While it pays to be conservative when it comes to your finances, humans lean toward expecting the worse. It’s our “negativity bias”.
Don’t let financial fear get the best of you! Instead, use this information to motivate and inspired you to:
-Update or review your retirement savings goals.
-Spend in alignment with your financial goals.
-Do the quick math for these retirement withdrawal strategies. What is 2%, 3% or 4% of your retirement investment savings? Is this close to the amount you want to live during retirement? Capitalize on the power of this information to take actions that will get you where you want to be.
If you don’t see any way to make your numbers work while sustaining your desired lifestyle in retirement, consider creating alternative income streams. They often have opportunities for a triple win to build wealth, lower taxes and provide monthly income in retirement. If this appeals to you, Click here to grab my free Income Streams eBook Here with our favorite 9 income streams strategies that also build wealth.
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