Once you retire, it’s likely that you’ll need to rely on retirement accounts to boost your finances. For this reason, you need a solid retirement plan in place. A retirement strategy consists of six steps: determining time horizons, estimating expenses, calculating after-tax expenses, assessing risk tolerance and estate planning. As part of this, you’ll also need a strategy to help
you figure out how much money you need to withdraw from an investment account annually.
There are five ways to go about this. The one you choose will depend on the amount you have set aside and any concerns surrounding shortages. You must also factor in the Financial Independence Retire Early strategy and determine how much investment income you are earning. It also affects how much income becomes available to you, which can then affect quality of life. The right strategy can help to prevent accounts running dry as you use your savings.
Buckets
This strategy involves using three separate buckets: an account that covers three to five years of living expenses, equity investments and fixed income security including corporate and government securities.
You can withdraw from your savings account and refill it with funds from the other buckets. With this strategy, you can avoid selling at a loss. If you want to replenish your savings account, you can do so by selling securities (if they perform well), or selling stocks in case the market is performing better. In case both of them fail, you can still access funds from your savings account.
The biggest advantage of this is the amount of control you have over selling these investments. This strategy also gives you the advantage of growing your fund balance over time. This can take time and you may be forced to use a different method to determine how much you can spend.
Systematic Withdrawals
This approach involves withdrawing only the income your investments produce from dividends or interest. The main benefit to this is that you cannot run out of money in your retirement account; however, to do this, you will need a sizable nest egg in place, and your income may also vary yearly depending on market performance, which can make financial planning difficult.
Fixed-Dollar
This method involves withdrawing a fixed amount from your retirement fund each year across a specific period which is followed by a reassessment. This is a relatively simple and predictable way to budget, and it can help to determine how much to withdraw in the first year.
One disadvantage of this is the fact that your finances can take a hit from inflation since you can withdraw a fixed amount only. On the other hand, setting a higher fixed-dollar amount puts you at risk of losing more money.
The 4% Rule
By withdrawing 4% of your investment account balance in the first year of retirement, you can then increase the amount in accordance with inflation (the rising cost of services and goods).
For example, if you had a nest egg of $500,000, you need to withdraw $20,000 in your first year of retirement. If there was then 2% inflation (the Federal Reserve’s target rate of inflation), you would need to withdraw $20,400 the following year.
Fixed-Percentage
A fixed-percentage withdrawal allows you to take out a fixed percentage each year. This amount can actually be adjusted according to market fluctuations. Unlike the 4% rule, you can opt for a different annual percentage. You don’t have to start with a 4% withdrawal and make adjustments based on inflation trends.
One downside is that if your percentage is too large, your funds may be significantly depleted, and if your income changes each year, it can make it difficult to plan ahead.
Whichever option you choose, in order to meet the IRS rules for required minimum distributions (RMDs), you’ll need to withdraw enough from tax-advantaged investment accounts, such as SIMPLE, SEP, a traditional IRA or your 401(k).
According to RMD rules, you need to withdraw a certain amount of your investment account balance annually after the age of 72. If you don’t, then you’re subject to a 50% tax penalty on the amount you did not withdraw.
In order to enjoy your retirement, it matters to know how you can secure the funds you need to accomplish your goals. Whether you are planning to travel the world or leave a lasting legacy, the secret lies in getting valuable advice from a retirement income planner to help set up your financial future. Work with one today and make the most out of your days as a retiree.
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