Question of the Month - How Much Should I Withdraw from My Retirement Assets
Withdrawal rates during retirement
At Pathlight, we are having more frequent conversations with clients regarding their retirement plans. In particular, the conversations focus on the amount of money they can spend from their assets during retirement. In financial planning parlance, this amount is known as the withdrawal rate. Although there is no hard and fast rule, years of empirical research suggest a good starting point is 4% ($1,000,000 X 4%= $40,000).
Although 4% may be a good starting point, the reality is that an appropriate withdrawal rate depends on several factors. They include the following: expected rate of return, spending habits, inflation, tax rate, other sources of income, and life expectancy. Due to the vast amount of unknowns, determining a safe amount to extract from one’s assets should be a tailored and dynamic process.
Factors to consider
Most financial planning programs assume static withdrawal rates, meaning a set percentage each year. However, we all know that life isn’t static. Spending needs are variable and certain expenditures unavoidable. For example, early in retirement, one is more likely to travel and spend on discretionary items. Later in life, medical costs can be a larger portion of spending. Recognizing the variability of costs and factoring in what-ifs are important to successful retirement planning.
A common error that we often see is the miscalculation of taxes. Withdrawals from retirement accounts, even 401Ks, are taxable as income. It is as if you received a paycheck, and for many, these taxes can substantially eat away at the net amount. Furthermore, future tax rates are uncertain and potentially will be higher, increasing the need for proper timing of withdrawals and planning from which account(s) to withdraw. The objective need not only be withdrawal amount, but tax efficiency of the distributions.
Often, there is a laser focus on managing investment risks. While we understand and agree that investment allocation must be appropriate to one’s risk tolerance, too there must be an understanding of the various kinds of risk. The largest, quite possibly, is the risk of outliving one’s money. Depending upon the assets and spending needs, conservative investors may require riskier assets in order to meet their long-term goals. This is very important, as we would argue that the greater risk is to outlive your money than to own riskier investments.
What to Do
There are many aspects of retirement planning, some of which can be controlled and some which cannot. Furthermore, given the vast amount of unknowns, planning is part art and part science. This requires focus on doing that which gives one the greatest likelihood of success. A few keys to success in planning for retirement include the following:
1. Focus on what you can control (spending, length of work, savings)
2. Pay down debt (#1 factor we see to a successful retirement is zero debt)
3. Don’t fund others’ obligations at your own expense (supporting adult children, college funding, housing down-payments for family members)
4. Start planning early (it’s never too early to start)
A successful retirement means different things to different people, but one universal aspect is the removal of financial worry. With proper understanding, education, and planning, a successful and fulfilling retirement can become a reality.
For more information or to schedule an appointment for a complementary retirement analysis, please contact M.J. Nodilo at (602) 795-7611 or email@example.com