It’s the day you’ve been anxiously waiting for. It’s finally time to retire. While you may be dreaming of traveling, spending more time with family and friends or pursuing hobbies, there’s a key part of retirement some people have not taken into consideration. After diligently contributing to a 401(k) plan for decades, fewer than 50 percent of people polled by Kiplinger between the ages of 35 and 64 said they have a withdrawal plan – a critical and often overlooked part of retirement planning.
“Americans are often focused on, what’s my number or how much do I need to save by the time I’m 65, 66 or whenever you decide to retire,” says Mark Solheim, personal finance editor at Kiplinger. “Unless you are deliberate about how much money you are withdrawing every year and you watch those totals and what the market is doing, you are shooting in the dark.”
The risk of not having a withdrawal plan? Running out of money in retirement. A survey by the Employee Benefit Research Institute found that only half of the more than 2,000 workers they polled said they know how much income they will need each month in retirement. Only 1 in 8 said they were very confident how to withdraw income from their savings and investments.
“You don’t want to use the money too quickly,” says Solheim. “Another odd thing that we found is that people actually way underspend what they are able to spend. Having a firm, logical withdrawal plan helps you spend the right amount of money so that you have a comfortable lifestyle.”
One of the most common retirement withdrawal methods is the 4 percent rule.
“The 4 percent rule is widely accepted among financial planners,” he says. “It’s actually been tested under various scenarios of stock market fluctuations – bear markets and bouts of high inflation. In your first year of retirement, you withdraw four percent from your nest egg. Most people’s nest eggs are in tax-deferred accounts – a 401(k) or IRA. Every subsequent year you adjust that for the rate of inflation. It’s been shown statistically your money is very likely to last 30 years.”
Solheim says the 4 percent rule can be a starting point for your retirement strategy. You should first test it out to see how it works for your situation. He notes that retirees may need to adjust the withdrawal amount up or down based on stock market fluctuations.
“If the market tumbles, the amount of money in your account goes down and your withdrawal will decrease as a result,” he says. “Then you might need to make up some of that money somewhere else. You need to know where that money is coming from.”
How does the 4 percent rule translate into real dollars? Vanguard analyzed the data of over 4.6 million participants with defined contribution plans, such as a 401(k). On average, those who earned between $50,000 and $74,999 had a retirement account balance of $62,450. If you have $62,450 saved in your 401(k), the 4 percent rule dictates you should withdraw almost $2500 in your first year and adjust for inflation every year after that. With that small amount, you would also need to rely on other sources income such as Social Security or a pension. If that is the case, Solheim says you would need to readjust the amount of money you withdraw.
As a parallel process to the 4 percent rule, Solheim says some retirees opt to use the bucket strategy. With this system, you split your nest egg into three buckets: the ‘now’ bucket, the ‘soon’ bucket, and the ‘later’ bucket. He explains the purpose of each account:
The “now” bucket: This bucket should handle your short-term needs. Solheim recommends saving one to two years of liquid cash assets such as a savings account or a CD in this bucket. While you pull money from this account, you allow money to grow in the other buckets.
The “soon” bucket: You should generally have 10 years’ worth of assets in fixed income securities saved in this account. He says, as you pull money from your ‘now’ bucket, you will redeem money from your “soon” bucket and pour it back into your “now” bucket.
The “later” bucket: Solheim says this bucket should contain stocks or real estate investments that will grow more aggressively and account for longer-term growth.
“If you are taking your 4 percent a year, it will come from your “now” bucket,” he says. “But over the 30-year period, you will be fluidly moving money from the “later” into the “soon” into the now bucket.”
He says it is a great idea to start planning a withdrawal strategy at least five to 10 years before you retire. While some people can put together a plan on their own, you might want to enlist the help of a certified financial planner.
“They will dig a little deeper,” Solheim says. “They will look at what your expenses actually are. They will walk you through a budget. They will also look at your longevity depending on your family history and your health condition. They will try to come up with an amount of money that you will need to last however long you think you will live after you retire, which is often 30 or more years.”
What should you look for in a financial planner? Solheim recommends choosing one that is fee-based. Some charge by the hour, while some have a subscription model where you pay a monthly fee as long as you are seeing them. He says you can often hire someone for only one or two sessions simply to check if you are on track to retire when you want to. They can also recommend withdrawal strategies.
“Back in the day when so many people had pensions, defined benefit plans more or less took care of you,” Solheim says. “You could count on what you were getting. Now, with the rise of employer retirement accounts and defined contribution plans, your savings are going to rise and fall with the stock market and to some extent, with the bond market as well. So it’s on you to make sure you have enough for retirement.”