Floor plan

How to Choose a Safe Withdrawal Rate for Retirement – Forbes Advisor

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Talk to someone who is retired these days and the conversation invariably ends up discussing inflation and the stock market.

There are very good reasons for this. The S&P 500 is down 17% year-to-date, bonds are down more than 10% and prices are 9.1% higher than 12 months ago. Meanwhile, another recession looms as the Federal Reserve aggressively raises interest rates.

“We do a lot of education work with our clients, but the weather has a way of eroding it when the fires get hot,” says John Shrewsbury, co-owner of Arkansas-based GenWealth Financial Advisors. “They contact us and say, ‘Do we need to do anything?'”

It’s a natural impulse given the wild swings in the market and the outrageous price hikes we’re seeing, especially at the gas station. But planning for retirement isn’t about addressing the concerns of the moment, it’s about crafting a well-considered plan that anticipates those bumpy times and sticking to it.

Here are a few different ways to dip into your retirement nest egg during these uncertain times.

The 4% rule is dead

The 4% rule provides an easy-to-understand method for deciding on a safe retirement withdrawal rate.

It works like this: In the first year of retirement, people could withdraw 4% of their savings. In subsequent years, they would adjust this amount based on the annual rate of inflation. If people stuck to the framework throughout retirement, their nest egg could safely last for decades.

Financial planner William Bengen first formulated the rule in 1994. His research showed that a portfolio of equal parts of stocks and bonds could suffer withdrawals using the 4% rule for each continuous period 30 years dating back to 1926.

But the days of the 4% rule may no longer apply.

A recent article from investment research firm Morningstar says the new standard should be 3.3% because bond yields are low by historical standards and stock market valuations are high.

The 3.3% rule is not such a catchy name. Nor is it a rule that today’s retirees should follow blindly. That’s because the assumptions under the 3.3% rule — a 30-year time horizon, adjusting withdrawals for inflation — don’t match everyone’s experience.

Not everyone will spend 30 years in retirement, for example. The average length of retirement, according at the Boston College Center for Retirement Research, is about 20 years old.

Other strategies outlined in the Morningstar article support a higher withdrawal rate: don’t adjust for inflation, withdraw less money in years when the stock market is down, or base their drawdowns on minimum distributions. required (RMD) of their retirement savings.

Morningstar found that a plan that waives inflation adjustments years after your portfolio has lost money would allow a withdrawal rate of 3.45%. While a so-called guardrail approach – adjusting withdrawals from year to year according to market conditions but always within limits – allows for a withdrawal rate of 4.11%.

“With variable strategies, you have to be prepared to be aggressive about how much you withdraw each year,” said Christine Benz, director of personal finance and retirement planning at Morningstar.

Guarantee part of your income

Another strategy to consider for lightening your portfolio is guaranteed income.

Rob Stevens, financial planning strategist at TIAA, recommends retirees use a combination of Social Security and annuities — or pensions if you’re lucky enough to have one — to cover about two-thirds of your expenses. The rest comes from portfolio distributions.

To illustrate this approach, consider a 65-year-old woman who needs $50,000 in income a year and has $750,000 in her Individual Retirement Account (IRA).

Following Stevens’ recommendation, this would require approximately $33,500 in guaranteed income.

Assuming she would receive about $20,000 a year in Social Security payments if she retired today, she would need an additional $13,500 in pensions to meet the two-thirds threshold. Stevens advises people to use both a fixed and a variable annuity, with the latter acting as a hedge against inflation.

To provide an annual income equal to $13,500 from annuities, Stevens estimates that you will need to invest a total investment of around $210,000.

That leaves $540,000 in his IRA. To cover the other $16,500 of income she will need, she would initially draw 3% per year from her portfolio. If she were not using annuities, this amount would be 4%. (Future withdrawal rates would be influenced by inflation and market performance.)

“That’s the big advantage of a diversified income plan. Less stress on your portfolio and less likelihood that a bad run of returns will cause it to run out of money during a long retirement,” says Stevens.

Passing on 28% of your hard-earned retirement savings isn’t easy, even if it provides guaranteed long-term income.

“It can be tough,” Stevens said. “We strongly believe that people go from a mindset of hoarding during their working years to an ‘income for life’ mindset when they actually need the money.”

Floors and buckets

Shrewsbury takes a somewhat different approach: floors and buckets.

The floor part of the plan involves determining your basic income needs – food, clothing, and insurance – and covering those costs with a guaranteed income. If you finance this amount via social security and a pension, it is perfect. Otherwise, consider filling the gap with an annuity.

Without a solid foundation of guaranteed income, “the rest of the house will be shaky,” says Shrewsbury.

The rest of your portfolio should consist of three buckets: conservative, moderate, and aggressive.

The conservative tranche includes short-term investments such as treasury bills. It provides money for years with more expenses. Hello, inflation! The moderate slice is funded by securities such as real estate investment trusts (REITs) or dividend ETFs, which offer stable income plus appreciation. The aggressive bucket is filled with stocks.

All annual earnings from the Moderate and Aggressive buckets are diverted to replenish the Conservative bucket.

This approach could leave potential gains on the table, admits Shrewsbury, but it’s better than not knowing if you’ll have enough money to live out your golden years.

Choose a plan, then stick to it

Which plan is right for you depends not only on your financial situation, but also on your personality.

Do you like to know how much money you will have each month? Or are you willing to be flexible if that means more revenue down the line? Do market corrections scare you? Do you want to leave money to your family?

Speak to a financial advisor to help you plan and decide on the best course of action. Having a plan should help inoculate you against the scary headlines.

“There are two types of people who earn in retirement: people with a plan and people with a pension,” says Shrewsbury. “If you have both, you are in great shape. If you don’t have either, it’s a crap shoot.

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