Your Retirement Savings: How to Strategize Spending

You’ve put in a lot of effort saving for retirement, but have you considered how you’ll actually use those savings once you’re retired?

A recent report from Morningstar recommends that future retirees start by withdrawing 3.9% of their portfolio in the first year and then adjust that amount annually based on inflation.

The study indicates that beginning with a 3.9% withdrawal rate gives a 90% chance of maintaining your funds over a 30-year retirement, assuming your investments are roughly 30% to 50% in stocks, with the rest in bonds and cash.

So, what does this look like in practical terms for retirees?

For example, if you have around $1 million saved, you’d be looking at a first-year withdrawal of $39,000. The following year, factoring in an inflation rate of about 2.46%, you’d withdraw around $39,959.

What This Means for You

Your withdrawal strategy is an essential part of retirement planning, but there are other significant aspects to consider, like taxes, investment fees, and when to claim Social Security.

Retirees would continue adjusting their withdrawals each year based on inflation rates. In most scenarios, if your retirement lasts 30 years, you’re likely to have some funds remaining.

While this guideline serves as a helpful reference, it’s merely a starting point. Other factors, such as taxes and investment fees, can take a toll on your investment returns.

For instance, someone with the majority of their retirement savings in a Roth IRA and invested in low-cost index funds might find fewer funds available for withdrawal compared to someone with a traditional 401(k) heavily invested in actively managed funds.

This difference arises because withdrawals from a Roth IRA are tax-free, while distributions from a traditional 401(k) incur ordinary income taxes on both the investment income and contributions withdrawn.

Don’t Forget Social Security

It’s crucial to evaluate your retirement plan as a whole, which includes understanding how Social Security will play into your retirement income.

The Morningstar report indicates that individuals who follow the 3.9% withdrawal strategy and wait until age 70 to start collecting Social Security generally experience the highest total lifetime expenses.

Ideally, waiting until age 70 to claim Social Security and working until then is advantageous. But if that’s not feasible, the researchers offer several strategies to bridge the financial gap between ages 67 and 70, which is the full retirement age for those born after 1960.

• Create a TIPS ladder for three years: Withdraw three years’ worth of expenses from your savings and invest that into three separate Treasury Inflation-Protected Securities (TIPS), maturing at ages 68, 69, and 70.
• Postpone inflation adjustments for three years, if necessary: Withdraw 3.9% of your portfolio plus what you expect to receive from Social Security each year. If your portfolio sees a negative annual return during ages 67 to 70, skip the inflation adjustment for the subsequent year.
• Limit spending temporarily post-retirement: Spend only 80% of your expected retirement expenses until you reach age 70, without adjusting for inflation following market declines. To determine your annual expenses with this method, calculate 3.9% of your portfolio plus anticipated Social Security income, then multiply that total by 0.8.