While regulations specify the minimum required distribution (RMD) you must take from your tax-deferred employer plans and IRAs after turning 70½, they don’t address how much you can or should withdraw to maintain your desired lifestyle while ensuring your assets last throughout your retirement.
A common guideline suggests withdrawing no more than 3% to 4% of your total retirement assets in the first year of retirement, then adjusting that amount annually for inflation. For instance, if you choose to withdraw 3.5% from a $500,000 portfolio, that would amount to $17,500 in your first year. If inflation rises by 2%, your withdrawal for the second year would increase to $17,850, allowing your income to keep pace with rising costs.
Limiting withdrawals from your retirement plans means you’ll need to rely on other income sources to cover living expenses and unexpected costs. However, this approach also provides you with the flexibility to adjust your strategy as needed, allowing you to navigate financial challenges while maintaining your long-term financial health.
Keeping it up
The rate of return on your retirement assets during your contribution years is crucial in shaping the long-term value of your account. It’s clear that an average annual return of 6% can significantly elevate your account value compared to a 4% return. This emphasis on strong returns continues even as you enter retirement, making it vital to achieve solid growth on the funds you have remaining.
This is why many retirement advisers now advocate for maintaining a higher allocation of equities—such as stocks, ETFs, and stock mutual funds—later into retirement than was previously recommended. Traditionally, advisers would suggest that your portfolio’s fixed-income investments should match your age. For instance, if you were 65, the idea was to allocate 65% of your portfolio to bonds and similar investments.
However, the current trend encourages investors aged 65 to consider having 50% or more of their portfolios in equities. This shift aims to provide the potential for higher withdrawals while still ensuring your money lasts throughout retirement. The downside, of course, is the inherent risk of equity markets fluctuating, which can diminish your account’s value and affect how much you can withdraw without dipping into your principal.
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A hypothetical plan
While it’s impossible to completely shield yourself from volatility in equity markets without risking erosion from inflation, there are strategies to create a reliable income stream while still fostering long-term growth.
One approach to consider is viewing your retirement as a series of three ten-year phases. To generate the income you need for each of these phases, start by dividing your total account value into thirds. Allocate one-third to secure fixed-income investments, such as an annuity with a ten-year fixed payout period or a series of bonds structured as a ladder, with staggered maturity dates. This strategy ensures that a bond matures each year over the ten-year period, providing a consistent income stream that you can rely on. Keep in mind that if these assets are held within an IRA, you may need to withdraw some or all of the principal from the maturing bonds to meet your required minimum distribution (RMD) obligations.
For the remaining two-thirds of your portfolio, invest in equities and refrain from withdrawing any principal or earnings for ten years. If the market performs well during this timeframe, your investments have the potential for substantial growth. Additionally, in periods of slow growth or market downturns, not having to liquidate these assets can give your portfolio the necessary time to recover and continue on a growth trajectory.
Once the first ten-year period concludes, you can repeat this strategy, cycling through the phases again.
Here’s a hypothetical example to illustrate this approach: Imagine your account starts with a value of $300,000. You would invest $100,000 in $10,000 bonds, with one bond maturing each year for the next ten years. The remaining $200,000 would be allocated to equities, aiming for an annualized return of 7% or better over that decade.
As the ten-year period comes to a close, you can implement the same strategy once more, reallocating a third of your assets for spending while investing the remainder for continued growth.
However, it’s crucial to remember that there are no guarantees in investing. Collaborating with a financial adviser is a wise decision before making any investments. Additionally, you’ll need to carefully consider the risks of potential losses against the pursuit of higher returns.
Anticipating the inevitable
While your required minimum distribution (RMD) is calculated based on your life expectancy rather than presented as a specific percentage, the actual amount you withdraw represents a percentage of your account’s value. For instance, if you have a distribution period of 22.9 years—applicable at age 75—you’ll need to withdraw approximately 4.37% of your account value.
As you age and your life expectancy shortens, the percentage you are required to withdraw increases each year. If your account balance isn’t growing at least as fast as your withdrawals, you risk depleting your funds. This scenario is manageable if you don’t rely on that income. However, to mitigate the impact of these larger withdrawals, you may want to consider investing a portion of your portfolio in a manner that seeks higher returns while aligning with your risk tolerance.
Wishing you a great week!
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