The options, pitfalls of retirement distributions

I have always said that asset accumulation is easy but the true difficulty is in asset distribution. There is no single plan that is right for everyone.

Perhaps the best-known distribution plan is the “4% rule,” which makes room for cost-of-living adjustments. The best plan is based on a retiree’s personal circumstances, including their health, financial needs and risk tolerance.

Fixed percentage withdrawal: The fixed percentage strategy involves withdrawing the same percentage of the remaining portfolio every year. This creates a variable annual income. During a bull market, spending increases. During a bear market, spending decreases, which naturally extends the portfolio’s longevity. This is not for retirees who need a consistent income stream for fixed expenses. The base rate for a fixed percentage withdrawal method is typically 3% to 5% of the portfolio’s value, although what is “safe” depends heavily on individual factors.

Performance-based rules: This is also known as the guardrails approach. This approach is a dynamic retirement strategy that adjusts annual withdrawals based on portfolio performance. It was introduced by financial planners Jonathan Guyton and William Klinger in 2006. The method allows for higher initial spending than a static rule but protects against market downturns through a set of rules. It’s often tested in the 5% to 6% range. It is also one of the more complex plans.

Under this strategy, withdrawals are adjusted annually for inflation. You set guardrails 20% above and below your withdrawal rate. For example, using a target withdrawal rate of 5%, the lower guardrail is 4% and the upper guardrail is 6%. If your withdrawal amount after adjusting for inflation falls outside your guardrails, you would take a 10% increase or reduction in your withdrawal amount.

After making the 10% adjustment, your withdrawal rate should be between the upper and lower guardrails. For example, if your retirement withdrawal rate is above 6% next year, you take the inflation-adjusted withdrawal amount and reduce it by 10% so your withdrawal rate is below 6%.

Front-loaded spending: A front-loaded spending formula for retirement plans allows for spending more in the early years of retirement than in later years. Research has determined that retirement spending follows a “retirement spending smile” phenomenon. Retirement is generally composed of the go-go years (first 10 to 15 years), the slow-go years (mid-70s to 80s), and the no-go years. This method allows for higher spending on travel and hobbies during early retirement when you are young and healthy. Spending decreases in the middle years as expenses decline before increasing again for later-life health care needs. Success is predicated on creating a detailed budget that anticipates spending at different phases of retirement.

Annuities: An annuities approach to retirement distribution involves converting a portion of your savings into a guaranteed stream of income, often for life. This method shifts the risk of outliving your money from you to an insurance company, which can offer stability that other retirement strategies, like systematic withdrawals, do not.

There is no single rule that is right for everyone. Your personal circumstances— including your health, financial needs, risk tolerance and portfolio value—should influence your chosen plan. Key factors to consider include:

Investment timing: The market conditions at the start of retirement, especially in the first few years, can significantly impact a portfolio’s longevity.

Inflation: High, sustained inflation is a major threat to a retirement portfolio. While a market downturn may recover, persistent inflation erodes purchasing power and can deplete a portfolio over time.

Asset allocation: Different allocation strategies, such as using a rising equity glide path or adding small-cap stocks, can allow for different withdrawal rates.

Withdrawal timing: Taking withdrawals as a lump sum versus spreading them out monthly throughout the year also impacts the overall sustainable withdrawal rate.

Whatever plan you select, the key is to monitor your spending, economic conditions and portfolio value, be flexible and adjust as needed.

~Jalene