Different strategies to address investment portfolio withdrawals in retirement

Investment portfolios are made up of stocks, bonds, mutual funds, exchange-traded funds, and cash that make up your net worth. This includes all your IRAs, 401(k)s, and non-retirement brokerage accounts.

Understanding the 4% rule

There’s a rule of thumb in retirement planning that you should plan to withdraw 4% of your investment portfolio per year after retirement to satisfy your spending needs and allow your savings to last through your later years.¹ 

The 4% rule, while it represents a good starting point for retirement planning, may not be the right number for you. That’s because people have different spending requirements, which affect how much you need to withdraw each year. And people have many different investment strategies, which affect the size of your investment portfolio.

How the 4% rule works

During your first year of retirement, you would take out 4% of your investment portfolio for spending. Then, in the second year, you take out the same amount adding the inflation rate.

• So, if you have a $1.25 million portfolio, you’d take out $50,000 in the first year. 

• If inflation was 2%, you’d take out $51,000 in the second year. 

• Then you’d take out $51,000 plus inflation in the third year, etc. 

• The purpose is to maintain your purchasing power each year.

According to the rule, your portfolio would last for 30 years under this formula. 

• So, if you retired at 65, you’d have enough money until you turn 95. 

• The rule assumes that you allocate 50% of your portfolio to stocks and the other 50% for bonds. 

• It also assumes a 10% return on your stock investments and a 5% return on your bond portfolio.

Exceptions to the 4% rule

The 30-year period may be a problem. If you expect to live more than another 30 years, you want to make sure your portfolio lasts that long, so you may want to take out less than 4% a year. The 50-50 allocation between stocks and bonds may not work for you either. With bond yields near record lows, there’s a good chance bond returns won’t reach 5% in coming years, and may not even be close to that level.

That could mean you’d want to have a larger stock weighting, say 60%. All of this is predicated on your risk tolerance, of course. Bonds are generally safer than stocks, so you could keep your bond weighting at 50% or even higher if that makes you more comfortable. In that case, you’d want to withdraw less than 4% from your portfolio each year.

How much you need to withdraw annually also depends on your spending. One theory of spending says you’ll start at a “go-go phase,” progress to a “slow-go phase,” and finally end in a “no-go” phase. This means that people do a lot of spending in early in retirement, and then the spending gradually slows.

Heavier spending may come early in retirement 

The thinking is that you’ll be most active — and thus spend the most — during your early years of retirement, taking trips, spending on your home, etc. Then gradually, you’ll grow less interested in more costly activities.

But there’s another issue that will likely require more spending as you get older — healthcare. It’s difficult to know how much you’ll need to spend on your health in later years. But if you decide to enter assisted living at some point, the price can be hefty.

Finally, depending on how financial markets perform in a given year, you may want to adjust your withdrawals accordingly. In other words, if the stock market plunges one year, pushing down the value of your investment portfolio, you may want to make a smaller withdrawal and perhaps cut your spending. That would help ensure that your nest egg is safe for the long term.

Points for consideration in making withdrawals

Important issues to consider when establishing a withdrawal plan include: 

• How long are you likely to live? Your current health profile and the longevity of your family members can help guide you here.

• How do you want to allocate your investments between stocks, bonds and cash? In general, stocks are the riskiest and provide the largest return potential, while cash is the least risky and provides the lowest return potential.

• What investment or spending changes are you willing to make? For example, you might consider a more conservative investment strategy and lower spending, apart from healthcare, as you get older.

A financial professional can help

To figure out what withdrawal plan works bests for you, a financial professional can walk you through all the options, helping you figure out the pros and cons. Consider reaching out to a Voya financial professional today who can help you answer the questions based on your unique circumstances.