You’ve spent most of your adult life planning and saving for retirement. Then, when the day comes, and you make the call to finally retire, your entire thought process needs to change. Instead of thinking about what you need to do to save as much as possible, you need to figure out how to strategically withdraw your money so it lasts.
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In this article, we’ll discuss creating a sustainable withdrawal strategy for your retirement fund. The goal is that you’ll be able to live comfortably throughout your entire retirement without feeling pressure about whether or not you’re spending too much money.
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Popular Withdrawal Strategies for Your Retirement Fund
Even though there are several popular withdrawal strategies that many people follow, don’t feel like you need to stick to one. Financial advisors often recommend using a combination of strategies if that will align with your goals and needs. Here’s a look at a few of the more common withdrawal strategies you can choose from.
The 4% Rule
One of the older strategies that’s still commonly used to ensure you don’t run out of money during retirement is the 4% rule. With the 4% rule, you’ll withdraw 4% of your account balance in the first year and adjust your future yearly withdrawals for inflation.
For example, assume you have a retirement account balance of $1 million. Withdrawing 4% during year one of retirement would mean $40,000. If inflation were 3%, you would increase your withdrawal by 3% in year two, giving you a withdrawal of $41,200. By adjusting your withdrawal amount for inflation, you’re helping to preserve your buying power.
The only downside of the 4% rule is that if you withdraw money when the stock market declines, you can no longer keep the money invested, allowing it to recoup losses after the market heads back up. Depending on the situation, this can affect how long your money will last. However, even with the risk, the 4% rule has been tried and true for decades.
“With the 4% rule, the later you retire the higher this ‘annual percentage’ could be to sustain you through your retirement,” said Stephen Kates CFP®, principal financial analyst for Annuity.org. “Those who are planning to draw down their investments over time and do not plan for a specific legacy to heirs can spend at a higher rate knowing that their growth and earnings will offset withdrawals even as they slowly deplete the assets over time. Large negative market moves may require reducing spending to avoid depleting the assets too fast.”
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Fixed Dollar Strategy
The next approach is a fixed-dollar strategy. This will look very similar to the 4% rule but without considering inflation. For example, assume you’re 70 and have a retirement account of $1 million. To ensure you’ll have enough money to last until you reach 100, you’d want to set a yearly withdrawal of $33,333.
This tends to be a popular approach because it simplifies the budgeting process in retirement. Unfortunately, this strategy can reduce buying power because inflation isn’t part of the calculation. What you can afford with $33,333 today may differ from what you can afford five or 10 years from now. Things can also get a little uneasy if the stock market has a prolonged down period. Continued withdrawals would impact your ability to ride the market back up again.
Dividend Withdrawals
For those with a sizeable retirement fund, you can structure your portfolio to withdraw dividends and interest, keeping the principal intact. This strategy is great because it will ensure you don’t run out of money in retirement and allow you to grow your account over time.
The two big downsides to relying on dividends and interest is that your annual withdrawal amounts could fluctuate, which makes budgeting a little more difficult. Additionally, depending on account performance, you might find that inflation starts becoming a concern.
“By taking out only the dividend yield, the principal investments can remain untouched and capitalize on price appreciation over time,” Kates said. “This would be a very safe strategy and leave plenty of room for increasing withdrawals through asset sales. However, it is a high bar to reach. Dividend-focused investment strategies can offer a higher rate of return that might approach 3%, requiring a portfolio balance of only $1.66 million. Unfortunately, this is still higher than most retirees expect to have.”
The Bucket Strategy
The bucket strategy involves dividing your retirement fund into three separate buckets, each used for a specific period of time. The first bucket would be a portfolio of mostly cash and cash equivalents. You’d use this money for living expenses over the next few years.
The second bucket would consist of a percentage of your remaining funds, which would be allocated toward fixed-income securities like bond funds or higher-yield CDs. The third bucket would consist of your remaining retirement funds, which would be placed into growth-oriented securities.
As you take money from bucket one to pay for living expenses, you would replenish it with funds from bucket two, which would be replenished by bucket three. Using this strategy will give you more growth and control of your portfolio. However, it will require quite a bit more maintenance and oversight.
“One of the best strategies divides investments into different ‘buckets’ based on their time horizon,” said Michael Collins, CFA, founder and CEO of WinCap Financial. “Short-term buckets are used for immediate expenses while long-term buckets are invested in growth assets. As each bucket is emptied, funds are replenished through rebalancing. The last approach involves individuals setting up regular withdrawals from their investment accounts based on a predetermined percentage or fixed dollar amount, which allows for consistency in income stream and can be adjusted for inflation as needed.”
Things To Consider Before You Start Withdrawing Funds
Before you start withdrawing your funds based on the strategy or strategies you choose to use, there are a few other things you need to be aware of.
Start With Your Required Minimum Distributions (RMD)
If you’re turning 73 between 2024 and 2032, you must start taking the RMD from your 401(k), traditional IRA and other tax-deferred retirement accounts. If you don’t, you’ll face penalties of up to 25% on the amount not withdrawn. However, starting in 2033, the age for RMD will increase to 75.
As you’re getting ready to withdraw your RMD each year, be aware that the amount will change from year to year. Instead of being a constant amount, it will be based on your age, life expectancy and balance in your account.
You can use the Uniform Life Table on IRS Publication 590-B to help you determine your RMD.
Understand Which Account To Withdraw From
As you begin tapping into your retirement accounts, it’s important to plan how you use your funds based on the account types.
Most people will have both taxable and tax-deferred accounts. The best strategy will be to use funds from taxable accounts like a traditional IRA, 401(k) or taxable investment account first. Taking withdrawals from these accounts means you’ll need to pay taxes on the gains, but you’ll be able to continue growing the funds in your tax-deferred accounts.
Once you’ve used the funds from taxable accounts, you can move on to tax-deferred accounts like a Roth IRA or Roth 401(k). Leaving these funds alone until you need them is smart because they’re growing tax-free. That means you won’t pay any taxes on the gains once the funds are withdrawn.
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This article originally appeared on GOBankingRates.com: How To Create a Sustainable Withdrawal Strategy for Your Retirement Fund
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