Develop Your Withdrawal Plan

Building a fiscal foundation during your 20s and 30s; and accumulating wealth as you enter into your forties are the first two stages respectively of a multi-stage effort for securing a financially sound retirement.

The third stage is pre-retirement, the five-year period prior to your desired retirement age. During this period, there are two elements to consider:

  • The complete elimination of debt
  • Developing a plan to draw-down the retirement nest egg

Millennial Work

Up to this point, eliminating debt was a goal. However, now that you are close to leaving the workforce, it is absolutely essential to be debt-free as debt, along with taxes, is an impediment to maintaining fiscal fitness in retirement. As debt is reduced, attention should be turned to developing a plan for drawing down the nest-egg. Too many retirees jeopardize their retirement by drawing down their nest-egg too fast and in an inefficient order.

Regarding the withdrawal rate, a popular method is the 4% rule …

In general, the rule – developed by William Bengen –  says that if a retiree takes out 4% of their nest-egg the first year in retirement, and then adjusts that rate to account for inflation in each subsequent year (e.g. if inflation rises 1% during the first year of retirement, 5% would be taken out during the second year in retirement), they will not run out of money for at least three decades.

Sequence of Returns Risk [RetirementSavvy]

The number is based on a portfolio with a 60/40 split between large-cap stocks and intermediate-term government bonds. After continued research Mr. Bengen added small-cap stocks to the mix and revised the ‘rule’ to 4.5 percent. However, the 4% name has stuck over the years. While some believe it is simply too arbitrary, some believe it is too high, and some believe too low, it provides a good starting point for most people. Determining the withdrawal rate, whether it be the popular 4% rule, or others such as the interest only strategy, must be accomplished prior to retirement.

From Savings to Income: Retirement Drawdown Strategies [AIER]

Determining the order of withdrawal from the various retirement accounts is also critical prior to retirement. For example, if the retiree is 70½ years of age, the general rule of thumb is to first withdraw from accounts where Required Minimum Distributions (RMDs) are mandated. However, for most retirees, the order of withdrawal, before they reach 70½ years of age and are subjected to RMDs, will be from taxable accounts (e.g. brokerage cash account), then tax-deferred accounts (e.g. 401[k]), and finally tax exempt accounts (e.g. Roth IRA).

Taxable accounts are withdrawn first as they are generally taxed at favorable dividend and capital gains rates, and only on the capital appreciation. If the expectation is that future tax rates will be higher than current rates, it makes sense to withdraw from tax-deferred accounts next. However, if the expectation is that the future tax rate will be lower than the current, retirees should spend from tax exempt accounts prior to tax-deferred accounts.

The last thing you want, with regards to finances, is to come up short halfway through retirement. Eliminate debt before retiring and develop a savvy withdrawal plan that considers the rate and order of withdrawal from your various retirement accounts.

How about your withdrawal plan, SavvyReader? Does it consider your debt load at the time of retirement, taxes, the different types of accounts, the withdrawal rate, your retirement age and the number of years spent in retirement?

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

13 Comments

  1. While 4% sounds safe, and is likely a good plan for most people, I don’t think I will want to withdraw that much, and if I do, I likely would not adjust the withdrawal for inflation. I’m still 30 years from age 60, so I’ve got some time to craft my plan, but my real hope is that I have enough saved up to live off of the dividends flowing into my account without touching the principle. Thats the dream!

    • There is a lot of debate with respect to utilizing 4% as a withdrawal rate. However, I believe for most people it is a reasonable place to start when developing a withdrawal plan. I currently use 4% with respect to drawing down my investment portfolio primarily because we – the wife and I – will have income from at least five defined benefit (pension) sources, outside of our investment portfolio, and 4% strikes me as reasonably safe. However, for a household that might only have one or two defined benefit sources, a more conservative (e.g. 2 of 3%) rate might be more appropriate. The most important thing is for people to start saving early, hone their financial literacy, and to develop a plan, any plan. Over time, as their own situation, the economic environment, and own their literacy improves, adjustments to the plan can be made.

      Thanks for stopping by, Ryan and adding to the conversation.

  2. Going forward, I’m not convinced 4% will be a Safe withdrawal rate. Mainly because equities are priced so much higher than the historical averages. No idea where we’ll land…

    But historically, you’re spot on. Nice work here.

    • Jake, Agreed that 4% may be too high. However, I do believe it still serves as a good starting point. As individuals get more savvy and have a better understanding of their retirement plan and the investment environment at the time they are solidifying their withdrawal plan, they can always adjust accordingly. While I do not go into great detail in the post, I touch on this in my book and note that there are other methods (e.g. interest only and RMD based) that have gained attention lately. A good friend of mine, a very savvy investor, plans on utilizing a 2% rate. Some might argue that is too low…and he will end up leaving a lot of money on the table so to speak and never get to enjoy it. As you note, no one really has any idea of what the future holds and where we’ll land. I also touch on that idea in the book when I note that retirement planning is one part science and one part art. Some things, such as compound interest, are known and can be accurately tracked and accounted for. Other things, such as the perfect withdrawal rate, simply cannot be known because no one knows what the market will do, how long they will live….

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