By Oscar Casas, CFP®, CRPC®, MPAS®, ABFP℠
One of the most common and valid worries for retirees and those nearing retirement is the possibility of outliving their savings. After spending years building a solid financial foundation, the focus naturally shifts to the next phase: decumulation. This stage is all about drawing down your assets in a way that supports your lifestyle while preserving your long-term financial health.
Successfully navigating this transition calls for thoughtful planning and a deep understanding of various withdrawal approaches. Relying on a fixed annual percentage may seem simple, but it can leave you vulnerable to market volatility and unforeseen expenses.
In this article, I explore sustainable withdrawal strategies designed to help you maintain reliable income throughout retirement so you can enjoy the years ahead with greater ease and confidence.
The 4% Rule: A Starting Point, Not a Silver Bullet
The 4% rule has been a widely accepted guideline for retirement withdrawals for a long time. According to this guideline, retirees can take out 4% of their initial retirement portfolio balance in the first year. In later years, they can alter that amount for inflation.
The 4% rule provides a straightforward foundation, but it’s important to understand that it has limitations and isn’t a panacea. Its appropriateness for certain retirees can be influenced by a number of factors, including:
- Longevity: Since people are living longer, their savings may need to survive for more than 30 years.
- Market volatility: Even with a moderate withdrawal rate, a portfolio can be severely depleted by sequence of returns risk, which involves experiencing large market downturns early in retirement.
- Inflation: Unexpectedly high inflation can reduce fixed withdrawals’ purchasing power.
- Personal circumstances: Spending requirements, medical expenses, and other financial commitments might differ significantly from person to person.
Therefore, even though it can be a useful starting point for discussions, depending solely on the 4% rule without taking specific circumstances and market dynamics into account can be a problematic strategy.
Beyond the 4% Rule: Exploring Sustainable Alternatives
Retirees should investigate more flexible and dynamic withdrawal strategies to manage the challenges of retirement income planning:
- Guardrails method: The 4% rule is expanded upon in this strategy by adding “guardrails,” or thresholds, that cause the withdrawal rate to change in response to portfolio performance. For example, a somewhat bigger withdrawal is allowed if the portfolio balance is substantially above a particular threshold. Conversely, withdrawals are curtailed to safeguard capital if the balance falls below a preset threshold.
- Variable percentage withdrawal (VPW): VPW entails determining the annual maximum sustainable withdrawal based on the retiree’s remaining life expectancy and the present balance of their portfolio. This method allows for larger withdrawals in years with robust market performance and requires smaller withdrawals during downturns.
- Time segmentation (bucket strategy): This strategy involves splitting retirement funds into several “buckets” according to risk tolerance and time horizon. Liquid assets for short-term income demands are kept in a short-term bucket; more cautious investments for the following 5 to 10 years are kept in a mid-term bucket; and growth-oriented assets are kept in a long-term bucket. To provide the longer-term assets the chance to grow and replace the shorter-term money, withdrawals are mostly made from the short-term bucket.
- Actuarial-based withdrawal strategies: By using mortality tables and actuarial science, these more advanced techniques calculate a withdrawal rate that is likely to endure throughout the retiree’s anticipated lifespan. These tactics can be customized by a financial professional to fit each person’s risk tolerance and life expectancy.
Integrating Tax Planning and Healthcare Costs
Now let’s take a look at the effects of taxes and medical costs on sustainable withdrawal strategies.
Proactive tax planning is crucial since taxes have the potential to drastically erode retirement income. Tax liabilities can be reduced with the use of strategies like Roth conversions, tax-efficient asset allocation, and careful management of required minimum distributions (RMDs).
Similarly, medical costs represent a significant and often unpredictable expense in retirement. Incorporating potential healthcare expenses into your withdrawal plan and exploring strategies like health savings accounts (HSAs) and long-term care insurance can help you feel confident that your retirement income can remain sustainable even despite health-related costs.
Expanding Your Retirement Income Strategy
While having a clear strategy for withdrawals is important, it’s essential to recognize that other income streams play an important role in supporting your lifestyle. A sustainable withdrawal strategy is just one piece of a successful financial plan in retirement. Ideally, your retirement income would come from multiple sources, which could include your investments, Social Security, and even guaranteed options that provide lifetime income. For more on how to balance various sources of retirement income, take a look at our article on comprehensive retirement income planning.
Implement Sustainable Withdrawal Strategies With Confidence
Running out of money in retirement is a real worry for many, but with careful planning and sustainable withdrawal strategies, it’s a risk you can confidently navigate.
At Tranquility Path Investment Advisors, we’re committed to delivering honest guidance and personalized service. Your goals come first, always. Schedule a no-obligation conversation or reach us at (732) 856-4324.
About Oscar
Oscar Casas is the chief executive officer at Tranquility Path Investment Advisors, an independent Registered Investment Advisor firm dedicated to putting their clients first, always. Oscar has over a decade of experience helping clients plan for a confident retirement. He is known for being an empathetic and compassionate listener and for prioritizing his clients’ needs and goals above all else. He acts as a coach, advising his pre-retiree and retiree clients through all the ups and downs on their financial journey. He loves that he has the opportunity to make a difference in people’s lives and take some of the stress off their shoulders.
Oscar has a bachelor’s degree in finance, a master’s degree in personal financial planning, and is a CERTIFIED FINANCIAL PLANNER®, Chartered Retirement Planning Counselor℠, Master Planner Advanced Studies℠ and Accredited Behavioral Finance Professional℠ professional. When he’s not working, you can find him enjoying the outdoors with his three children. He is an avid tennis player who also loves golf, the beach, snowboarding, traveling, and volunteering with the Scouts.
