7 Guidelines for a Retirement Withdrawal Strategy

“How much can we spend in retirement without dangerously depleting our portfolio or jeopardizing long-term financial goals?”  That question, in one form or another, is one of the most frequently asked by our clients. While there is no shortcut to the answer, a careful review of your situation will help produce the most appropriate withdrawal strategy and safe rate of spending.

Even people with considerable wealth must be alert to the risk of spending getting out of control. But how can you determine a withdrawal rate that provides a steady income flow without worry that it will go too far? The following guidelines are points to keep in mind as you devise a retirement plan aimed at keeping your finances in optimal shape.

1.  Recognize what can and cannot be controlled, and create a minimum five-year budget.

Spending is largely within your control. What is not is the rate at which your money will grow – since growth depends heavily on the ebb and flow of the economy, stock market and changes in tax laws. With that in mind, we advise and help our clients to create a minimum five-year cash flow that identifies and includes their month-to-month lifestyle spending, short- and long-term spending goals and future cash inflows with the goal of creating a budget  for a sustainable long-term financial path.

Budget planning can help you absorb big-ticket items without significantly altering your lifestyle. Identify the likely life events in your near future and prepare for their economic impact: children attending college, weddings, trips, purchase of a second home, a move into a retirement community, even philanthropic donations. In addition, keep an adequate liquidity reserve in cash and short-term fixed income investments to help you weather market volatility and provide for emergency spending.

The coronavirus pandemic has demonstrated how your outlook can change overnight due to circumstances beyond your control. Having a budget and plan in place will put you in better position to deal with unexpected events.

2.  Plan ahead for the most tax-smart withdrawal timetable involving multiple accounts.

Having a variety of accounts with different tax characteristics – pre-tax IRAs and 401(k)s, post-tax Roths and taxable brokerage accounts – can give you more choices in making tax-efficient withdrawals that also keep future financial goals in mind. But determining how best to orchestrate the process can be tricky and will depend on your mix of assets, income, distributions, tax rate and other factors, including the likelihood of changes in tax laws. We recommend you consult with your adviser for help in devising this strategy.

If you are not yet retired, consider increasing your tax diversification by building up the desired balance among your taxable, tax-deferred and Roth assets. This will improve your flexibility in retirement. A Roth conversion may or may not make sense depending on your circumstances; check with your adviser.

Remember that required minimum distributions will significantly reduce your ability to manage taxes after age 72. Try to develop your withdrawal plan before then.

3.  Do not rely on a rule to determine withdrawal amounts.

 No reliable rule of thumb exists that can tell you how much to safely take out of your portfolio for retirement each year. The so-called 4% rule suggests you can withdraw that percentage of your investments in the first year of retirement, then adjust the amount annually for inflation without incurring a substantial risk of running out of money. But it makes a lot of assumptions about time horizon, expected returns and spending predictability that do not fit every investor’s situation and may have become obsolete. Life expectancy, bond yields and future market assumptions are among the many things to have changed since a financial planner created this guideline in 1994.

Rather than a rule of thumb, we believe investors need a personalized withdrawal plan. We work with our clients to create one, taking into consideration a budget and financial plan. Living off a portfolio’s interest and dividends, if feasible in this era of ultra-low yields, may be a worthy objective, though we do not recommend reallocating your entire portfolio to provide enough yield to live off.

4.  Your time horizon, allocation and how confident you want to be that your money will last will determine an optimal withdrawal rate.

Health and life expectancy should be considered in deciding how long to plan for, factoring in family history and data from the Social Security Administration’s life expectancy calculator. Planning to outlive your life expectancy is prudent, bearing in mind that there is a 50% probability you will live longer than actuarial tables say is average for your age. And remember, your life expectancy is not fixed – it is dynamic and will change as you get older. You should revisit and update your financial plan as your time horizon changes.

Everyone wants to be confident their money will last, but you will need to choose a specific level of confidence. After consulting with our clients on their time horizon, risk level and allocation preferences, our financial planning department runs Monte Carlo simulations to estimate the likelihood client portfolios will have money remaining at the end of the designated time period. We think aiming for a minimum Monte Carlo success rate of 75% provides a good balance between a comfortable withdrawal level and not running out of money. A somewhat higher number is more appropriate for older retirees, entailing the trade-off of less spending for a higher chance of success for the portfolio.

5. Choose an allocation you are comfortable with, not just one with the greatest chance to increase.

Asset allocation is generally the biggest driver of a portfolio’s long-term performance; how you invest your portfolio will have a big influence in determining the ending balance. But there are other things to consider: How well it is built to endure in the next bear market, your comfort level with and ability to endure a possible big decline, and other ups and downs in the market and your spending in the decades ahead.

A well-diversified retirement portfolio will include not only stocks with future capital gains in mind but also a safety reserve with lower-risk assets such as cash or fixed income. At Altair, we are mindful of taxes, cash-flow analyses and the need to keep an adequate cash reserve on hand in a portfolio. Consider a “total return” approach to investing, where you withdraw not only from income generated within a portfolio but also from capital appreciation.

6. Review your plan regularly and be prepared to make changes.

A mentality to “set it and forget it” is ill-advised for any retirement strategy. You should review your withdrawal rate at least annually and adjust it as needed based on changes in personal wealth, time horizon, market conditions and portfolio performance.

Some retirees choose to make fixed-dollar withdrawals, taking out a pre-determined amount over a certain number of years. While this can make budgeting easier in the short term, it can put a portfolio’s principal at risk if not revised when needed. Inflation, while currently near a historically low level, is one of the biggest longer-term risks to any portfolio. Your expenses will fluctuate from year to year over retirement, so it is important to stay flexible and on top of your plan.

7. Work with an investment professional.

Your Altair adviser can devise a strategy that takes potential future variants into consideration along with your risk tolerance, investment preferences and future taxes. He or she can help you build and regularly review a well-diversified and tax-efficient portfolio, to maximize the probability of achieving your long-term financial goals.

Ultimately, there is no “right” withdrawal rate that will ensure the longevity of a portfolio or the ability to meet long-term goals. A wise approach is to work with an investment professional who can help determine the most prudent withdrawal rate and keep you on course for a financially secure and gratifying retirement.

The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice.  Altair Advisers LLC is a registered investment adviser with the Securities and Exchange Commission; registration does not imply a certain level of skill or training.  While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented.