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Every Monday, we address one of your most important personal finance concerns by consulting a panel of financial experts. If you have a general inquiry, money-related issue, or just want to chat about anything PeFi-related, drop a comment or email me at [email protected].
This week’s question comes from waterdragon:
This may be a bit more relevant for older readers than the average, but there seems to be a shortage of articles discussing retirement withdrawal strategies and how to avoid overspending early in retirement.
Here’s what financial experts generally have to say about an issue that affects everyone differently—if you’re looking for personalized advice, it’s best to consult with a financial planner.
Target a Lower Withdrawal Rate
Retirement strategies are as varied as the individuals planning for them. While it's impossible to pinpoint a specific plan without understanding your unique situation, Drew Parker, a financial planner and creator of The Complete Retirement Planner, suggests that as you near retirement, the first thing you should do is list all of your current monthly expenses. These should include essentials like your mortgage or rent and your cell phone bill, along with estimated costs for things like dining out and gifts for your grandchildren. This will help establish a baseline for your likely monthly spending.
“Seeing exactly where your money goes, in black and white, is eye-opening, and helps set priorities,” says Parker. As you approach retirement, aim to limit your overspending to just five to ten percent beyond what you've listed in the coming months. “This serves as a reminder to prevent spending without considering the consequences. If you consistently exceed your plan, you’ll need to make larger withdrawals, which could leave you running low on funds during a vulnerable period in your life.”
Parker then recommends a “needs-based approach” to withdrawals. In this model, the amount you withdraw each year should be your total annual expenses (which can be roughly calculated from your itemized list) minus your annual net income (after taxes, including Social Security). Then,
Take that total withdrawal amount and divide it by the total of your savings. In theory, if the percentage is less than five percent, you may be in good shape. However, if it falls between five to ten percent or more, especially in the early years of retirement, it is likely unsustainable unless your expenses decrease significantly over time.
You can try this on your own or, preferably, consult a retirement planner who can assist you with the calculations.
“You should plan your expenses, income, and withdrawals annually, so you can easily see the impact of any changes you make during each year,” says Parker. “Your goal should be to ensure your funds last at least until you turn 90.”
Here’s an example provided by Parker: $1 million in savings at age 65, a 4 percent return on investment (which is quite conservative), $45,000 in net annual expenses, and 2.25 percent inflation applied to those expenses.
“This is a very simplified example, but it shows that a steady increase in the withdrawal rate over 25 years can still prevent your savings from running out,” he explains.
Stick to the Four Percent Rule
Michael Brodsky, a financial advisor at Ameriprise, recommends that his clients follow the 'four percent rule,' a straightforward withdrawal strategy that can be adjusted up or down depending on your personal financial objectives.
“If the portfolio is properly diversified, the rate of return over time should ideally allow for some growth, even after withdrawing four percent annually,” says Brodsky. “A diverse range of investments gives you more flexibility in choosing what to sell when, and may help avoid the need to sell a particular asset when its value is down.”
However, your spending isn't the only factor at play. Your age, marital status, and other income sources (such as Social Security or a defined benefit plan) also come into play. For instance, if you retire later, you might be able to take larger withdrawals.
Here’s some additional information on when to withdraw from different accounts:
You can explore other options (and the rules for withdrawing from your various accounts) here.
Safeguard Your Principal
Above all, safeguarding your principal is key. Rebecca Walser, a tax attorney and certified financial planner, advises that if you're approaching retirement age, relying solely on Social Security and a retirement account isn’t enough—you need other sources to protect your principal. You don’t want to make the mistake of putting all your (nest) eggs in one basket, as many near-retirees did in 2008-2009.
“What we need to consider now is whether we should begin protecting our portfolios from loss,” says Walser, author of the newly released book Wealth Unbroken: Growing Wealth Uninterrupted by Market Crashes, Taxes, or Even Death. “Many people choose to roll over their funds into long-term CDs, market-indexed CDs, or growth-based annuities,” which preserve your principal while still offering the potential for growth.
“There’s nothing worse than taking distributions from a portfolio that has just experienced significant losses,” she adds.
And if you’re aware in advance that you’ll have a big trip or other major expense during retirement, Brodsky recommends setting up a separate savings account for that, rather than tapping into your principal. “This approach allows you to save for the goal without straining your [retirement] budget.”
Learn more about this idea here:
It can also serve as additional security if you happen to overspend during the early years of retirement.
A more significant change, requiring extensive planning and thought, is relocating to a state with lower or no income taxes. It’s a major decision that you might not want to make, but it remains an option. You can check this calculator to gauge potential savings.
For younger individuals, Walser recommends focusing on Roth IRAs and Roth 401(k)s. By paying taxes now, you avoid the issue during retirement (unless you withdraw early). If your employer doesn’t offer a Roth option, “contribute to the [employer] match and then seek other options,” she advises. And make it a habit to regularly have retirement check-ins with yourself.
