“How do I access my retirement savings without running out of money? How can I make sure I’m using my funds wisely while enjoying the retirement I’ve worked hard for?”
These are some of the most common questions we hear from clients, especially those who are either nearing retirement or just a few years away from making the leap. You’ve worked hard your whole life to build up your savings, but now the real question is: How do you make sure that money lasts through retirement?
Retirement isn’t just about having enough money; it’s about managing it wisely so you can maintain a comfortable lifestyle and enjoy the freedom you’ve earned. While the 4% rule is often cited as a simple solution, it’s not a one-size-fits-all strategy. Let’s break down how to approach withdrawals to ensure you’re set up for success.
What Are the Basics of Retirement Withdrawals?
The goal in retirement is straightforward: withdraw enough to enjoy a comfortable lifestyle while ensuring your savings last. But finding the right way to do that can be daunting. This is where strategies like the 4% rule come into play—it's a widely known method for managing retirement withdrawals.
The 4% rule was developed by financial advisor William Bengen in 1994, and it offers a simple framework for sustainable withdrawals. Here’s how it works:
Withdraw 4% of your savings in the first year of retirement.
Adjust that amount each year to account for inflation.
Maintain a balanced mix of stocks and bonds (typically a 50/50 split).
For instance, if you’ve saved $1 million, you’d start with $40,000 in the first year and adjust that amount annually for inflation. If done right, this strategy is designed to make your funds last about 30 years.
On paper, the 4% rule sounds like a solid starting point, but let’s be real—retirement is unpredictable. There’s a lot more to consider when developing a strategy that’s tailored to your specific situation.
The 4% Rule Isn’t So Straightforward
While the 4% rule can provide a helpful starting point, it’s not without limitations. In reality, the following factors can significantly impact the effectiveness of the rule:
Longevity Risk: People are living longer than ever before. This means a 30-year withdrawal plan might not be enough to see you through retirement. If your family has a history of shorter lifespans, though, why stretch your funds for an extended period you might not need?
Market Volatility: A significant market downturn early in retirement can drastically impact your savings. This is where strategies like the bucket system can help protect against this risk, keeping your retirement plan on track even in volatile times.
Changing Expenses: Your spending habits will change throughout retirement. In the early years, you might be more active, traveling, and enjoying hobbies. But later on, healthcare costs may rise, and physical limitations could mean scaling back on activities. For example, you might withdraw 7% in the early years to check items off your bucket list, but once your expenses shift, that withdrawal rate may drop to 3%.
Taxes and Fees: It’s easy to overlook how much taxes and fees can eat into your savings. Remember, withdrawals from retirement accounts aren’t always made in after-tax amounts, and tax considerations can erode your nest egg faster than you expect.
Why Taxes Matter in Retirement
When planning your retirement withdrawals, you can’t ignore the tax implications of the different types of accounts in your portfolio. There are three main categories of retirement accounts, each with its own tax treatment:
Taxable Accounts (Brokerage Accounts): Withdrawals from taxable brokerage accounts may trigger taxes on capital gains (profits from selling investments), dividends, and interest. Short-term capital gains are taxed as ordinary income, while long-term capital gains are taxed at lower rates. Dividends can either be qualified (taxed at long-term capital gains rates) or ordinary (taxed as regular income). Interest income is taxed as ordinary income as well.
Tax-Deferred Accounts (401(k), IRA): Withdrawals from tax-deferred accounts are taxed as ordinary income. Timing matters here—taking out too much in one year could push you into a higher tax bracket. Required Minimum Distributions (RMDs) must begin at age 73 (or 75 for some, depending on birth year), and failing to meet the required withdrawals can result in hefty penalties.
Tax-Free Accounts (Roth IRA):Roth IRAs offer tax-free withdrawals of both contributions and earnings if you’re 59½ or older and the account has been open for at least five years. The benefit here is that you can strategically use Roth funds to keep yourself in a lower tax bracket. Additionally, Roth IRAs aren’t subject to RMDs during your lifetime, making them a great tool for long-term tax-efficient planning.
Being Tax-Efficient: A Strategic Approach
Rather than just following the 4% rule and taking 4% from the total portfolio, it’s smarter to structure your withdrawals based on tax efficiency.
Instead of withdrawing from all accounts evenly, you might:
Take withdrawals from taxable accounts first to allow tax-deferred accounts to continue growing.
Draw from tax-deferred accounts (like IRAs or 401(k)s) after taxable accounts are exhausted.
Use Roth IRAs as a tax-free buffer when needed, especially in years when you’ve already taken income from taxable accounts and want to avoid a higher tax bracket.
By focusing on reducing taxes, you can preserve more of your wealth and make your savings last longer. A well-thought-out strategy allows you to continue enjoying your retirement without constantly worrying about taxes or depleting your funds prematurely.
Know Which “Buckets” to Pull From
Market downturns can make retirees nervous, especially when relying on investments for income. Instead of cutting spending or selling assets at a loss, you can adopt a bucket strategy to safeguard your retirement savings and ensure long-term financial stability.
The Bucket Strategy:
Bucket 1: Short-Term (1–3 Years) This bucket is your financial safety net. It holds enough cash and low-risk, liquid assets (like Treasury bills, money market funds, or CDs) to cover essential living expenses and any major anticipated costs. For example, if you’re planning a big trip or a car purchase soon, this is where you’ll set aside those funds. With this cushion in place, you don’t have to sell investments during a market downturn, ensuring you “have a dollar when you need a dollar.”
Bucket 2: Mid-Term Income (3–10 Years) This bucket is all about generating income to replenish your short-term bucket while still offering moderate growth. Assets like dividend-paying stocks, rental properties, or bond funds fit here. These assets provide steady cash flow, helping maintain liquidity in Bucket 1 and offering some protection against inflation. This bucket bridges the gap between your short-term needs and long-term growth goals.
Bucket 3: Long-Term Growth (10+ Years) Designed for growth, this bucket includes stocks and other growth-oriented investments. These assets are aimed at outpacing inflation and building wealth for your later years or even leaving a legacy. Since this bucket isn’t tapped for many years, it has time to recover from market volatility and take full advantage of compound growth.
Why It Works
The bucket strategy ensures you have liquidity during tough market years, while your longer-term investments are allowed to recover and grow. By segmenting your portfolio based on time horizons and risk tolerance, you can confidently ride out volatility, maintain your lifestyle, and stick to your financial plan. It provides peace of mind and a clear framework for managing retirement income.
Retirement is about balancing your need for income with the longevity of your savings. While the 4% rule offers a helpful starting point, it’s not a one-size-fits-all solution. Life expectancy, market conditions, taxes, and changing expenses all play a role in shaping a withdrawal strategy that works for you.
By being mindful of taxes, structuring withdrawals strategically, and adopting approaches like the bucket strategy, you can create a plan that provides steady income, minimizes unnecessary losses, and protects your financial future. With a thoughtful approach, you can enjoy the retirement you’ve worked so hard for while ensuring your savings last.
Have any questions? Feel free to reach out to us using the Ask the Experts feature on the site's Home page or email me directly.
Alec Kelso-Capili
Wealth Management Advisor
January 27, 2025
Sources:
https://www.schwab.com/learn/story/beyond-4-rule-how-much-can-you-spend-retirement#:~:text=One%20frequently%20used%20rule%20of,withdraw%20to%20account%20for%20inflation.
https://finance.yahoo.com/news/does-4-retirement-rule-still-210210098.html
https://www.schwab.com/public/file/P-13005058#:~:text=Personalized%20withdrawal%20strategy.&text=This%20strategy%20withdraws%20from%20tax,and%20then%20from%20Roth%20accounts.
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