Hoping to Generate More Income in Retirement? A Dynamic Retirement Withdrawal Strategy May be Worth Considering

A new report examines 5 strategies – which one’s best for you?

Saving and investing for retirement, or as I prefer, “work-optional,” is one of the top financial goals for most of us.

At least once we have fewer work years ahead of us than behind…

Unfortunately, that doesn’t necessarily mean we all manage it well enough. According to DQYDJ.com, the median net worth for Americans aged 65–69 is $272k.

That sounds like a good deal of money.

However, remove home equity, and it drops to just $75k!

How Much “Static” Retirement Income Can the Median Portfolio Provide?

None of us has a functioning crystal ball.

Financial planners try to forecast likely outcomes using history and/or Monte Carlo simulations.

According to the well-known “4% rule,” if you draw 4% of your portfolio’s value (if invested 50/50 in large-cap stocks and bonds) when you stop working and adjust annually by inflation, your money should last 30 years.

This sort of withdrawal strategy is called “static” because it stays constant in real (inflation-adjusted) dollars, no matter how well or poorly your portfolio does.

However, later research using Monte Carlo simulations found the likelihood this would still be true in the future is just 87%.

According to a recent Morningstar State of Retirement report, if you want to increase the likelihood of success to 90% with static withdrawals, start with 3.8%.

For the $75k median portfolio, that translates to just $239 a month.

Add the $1792 average monthly Social Security retirement benefit, and the median retirement income would be $2031/month — just $24.4k/year!

Dynamic Strategies to Consider

There are many strategies you can use instead of static ones.

The above-mentioned Morningstar report examined five such dynamic methods and what each offers for a 90% success rate (i.e., 900 out of 1000 simulated scenarios don’t run out of money for 30 years).

The 5 strategies are as follows:

1. Cut spending by 10% anytime your portfolio value drops and go back to your original schedule once it starts going up in value again.
2. Don’t cut spending, but skip inflation adjustment if your portfolio value drops.
3. Cut spending by 10% if your scheduled draw is 20% higher than your target percentage and boost spending by 10% if your scheduled draw is 20% lower than that target (a.k.a. the “Guardrails Approach”).
4. Draw each year a fraction of your portfolio determined by your age, using the government’s Required Minimum Distribution (RMD) table.
5. Use the structure of the 4% rule, but reduce each year’s inflation adjustment by 1%.

How Much “Dynamic” Retirement Income Can the Median Portfolio Provide?

The Guardrails Approach offers the highest initial draw — 5.3%, and the second highest average lifetime draw — 4.8%.

The RMD approach starts lower — 4.4%, but has a higher lifetime average — 5.4%.

This increases the median retirement income (including Social Security) from $24.4k a year by 5% to $25.5k initially for the Guardrails Approach (2% increase to $24.8k for the RMD approach).

The Guardrails (RMD) lifetime average is 3% higher at $25.1k (5% higher at $25.6k).

While not life-altering, a 5% retirement income boost without increased risk of running out makes a real difference for retirees who struggle to make ends meet.

If you have to live on just over $2k/month, the extra $100/month may help stay afloat in an emergency.

Pros and Cons of Each Approach

Each of the 5 dynamic strategies has its own advantages and drawbacks.

Drawing on the above table, here are the pros and cons of each, and who it may serve best.

Strategy 1 (cut 10% in market declines) Pros and Cons

This simple approach offers a slightly higher initial draw than the static strategy and the same 3.8% lifetime average draw for a 50/50 portfolio. Better, it slightly increases lifetime average draw to 3.9% for a lower-risk 40/60 portfolio.

This means you may have fewer years when your portfolio declines and you need to cut spending. Further, once the portfolio starts growing again, your draw snaps back, so you relax the austerity.

It leaves a higher median ending balance for a 50/50 portfolio compared to the Guardrails and RMD approaches. For its best allocation — 40/60 — the median remaining balance nearly matches that of the static and “shaved inflation correction” methods and exceeds that of the RMD and “skip inflation correction” ones.

Having said all that, with a 50/50 allocation its initial and lifetime averages are lower than all other dynamic approaches, and its remaining balance is lower than most.

For its best allocation, lifetime average is lower than all but one dynamic approach and only slightly higher than the static method.

This method may be best for someone who:

• Needs only a slightly higher draw than offered by the fixed strategy
• Is risk averse.
• Values simplicity.
• Values stability but has relatively low essential expenses (with a higher discretionary spending desire) so can periodically absorb a 10% cut.
• Wants to leave a sizable bequest.

Strategy 2 (skip inflation adjustment in market declines) Pros and Cons

This method offers significantly higher initial draws and somewhat higher lifetime average draws than the (3.8%) fixed strategy, with relatively little variability over time and a relatively high median balance after 30 years.

However, it offers far lower initial and lifetime average draws than either the Guardrails or RMD approaches, especially if one increases equity allocation to near 100%.

This method may be best for someone who:

• Needs only a somewhat higher draw than offered by the fixed strategy.
• Values stability.
• Wants to leave a sizable bequest.

Strategy 3 (Guardrails) Pros and Cons

This method offers far higher initial and lifetime average draws than the fixed strategy and all dynamic alternatives other than the RMD approach. It also leaves significantly more for heirs than the RMD approach.

However, this method results in more variations in annual draws than all but the RMD approach.

Further, at a 50/50 allocation, it leaves less than half as much for heirs as the static approach and all dynamic ones except the RMD approach. Note, however, that at 100% stock allocation the median ending balance outstrips all other approaches.

Finally, this method requires a slightly more complicated annual process than other approaches for setting the new year’s draw amount.

This method may be best for someone who:

• Seeks as comfortable a retirement as possible.
• Wishes to leave a sizable bequest.
• Is comfortable with higher than average risk.
• Has relatively low essential expenses (with a higher discretionary spending desire) so is able to periodically absorb a 10% cut.
• Is comfortable with slightly more complicated calculations.

Michael Mezheritskiy, President of Milestone Asset Management Group says of this approach, “We believe retirement consists of three stages: go-go, slow-go, and no-go years. Thus, we believe it’s okay to front-load your retirement and spend more while you’re in better health and willing to do things. However, you have to accept a downward adjustment later in life. We tell clients how much their portfolios would need to decline before they must reduce spending — their guardrails. Such dynamic distributions make a lot of sense to clients. They understand it’s ok to spend more than projected now if they accept the future trade-off.”

Strategy 4 (RMD) Pros and Cons

This method, by design, is simple and efficient in spending as much as possible, for a comfortable retirement.

However, draws increase each year, whereas research shows retiree spending decreases by about 10% per decade. Thus, the increased draws are unlikely to be very useful beyond the first few years.

Late in life, balances drop quickly, and a large, unexpected expense, unexpected longevity, or having a younger spouse can drain the portfolio too early.

Finally, this method leaves very little for heirs.

This method may be best for someone who:

• Seeks to spend as much as possible during retirement.
• Isn’t likely to have an especially high longevity.
• Has little or no interest in leaving a bequest.
• Is comfortable with higher than average risk.

Strategy 5 (shave 1% from inflation adjustments) Pros and Cons

This is the simplest dynamic approach and works well with the observed gradual decline in retiree spending (also about 1%/year).

It leaves a relatively high median ending balance, similar to the 3.8% static approach without the risk of a 100% equity allocation.

Further, it offers a similar lifetime average draw even with as conservative a portfolio as a 20/80 allocation.

However, the initial draw is far lower than that of the Guardrail Approach, and the lifetime average withdrawal is the lowest of all approaches (slightly lower even compared to the static approach).

This method may be best for someone who:

• Values simplicity.
• Values stability.
• Desires slightly higher initial draws than possible with the static case.
• Is willing to accept lower draws in later years.
• Desires to leave a sizable bequest.
• Is highly risk averse.

The Bottom Line

It’s time to move beyond the static 4% rule (and even its future-adjusted variants).

Whether you’re approaching your “work optional” phase or expect to be forced to retire before accumulating a large enough nest egg, it’s time you consider dynamic alternatives.

The above examines multiple dynamic withdrawal strategies that offer advantages relative to static rules. With 5 strategies examined, anyone should be able to find a strategy that fits their needs and preferences.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

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Disclaimer: This article is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.