Retirement Withdrawal Strategies – Which to Adopt?

Arguably, one the most important financial-planning decision you’ll ever make is deciding when can you retire, it can be hard to decide when you can make that crossover from accumulating assets to de-accumulating your assets to pay for your monthly expenses throughout retirement.

As you enter the de-cumulation phase, their biggest questions are:

  • Have I built up sufficient retirement assests to retire?
  • How should I be budgeting for and spending my retirement assets, so that I would have enough for the rest of my life?

Instead of leaving retirement drawdown to chance and risk outliving your assets due to lack of planning, having a proper retirement drawdown plan can help guide your spending during retirement. The benefits of such an exercise are powerful:

  • You know with better clarity how much can you spend every month
  • You stop losing sleep over wondering if their retirement assets are true enough

There are 4 common strategies which are well researched and commonly considered by financial planning professionals:

Drawdown StrategyCentral Principle
1. The 4% Strategy (Systematic Withdrawals)You withdraw inflation-adjusted 4% each year. Under historically measured worst-case investment scenario, you should not run out of money for 30 years.
2. The Bucket Strategy (Time Segmentation)Divide your Retirement Assets into 3 buckets, based on when you plan to spend. You can then more appropriately allocate to the investment of appropriate risk-return characteristics to prolong your Retirement Assets to last until the later years of retirement.
3. The Flooring Strategy (Essential vs. Discretionary)Factor for and allocate for essential expenses with a perpetual income stream. Allocate the rest for discretionary spending, where level of spending, and therefore discretionary lifestyle, will be determined by investments outcome.
4. Dividends-only StrategyDividends-only Strategy
(Capital Preservation) You aim to preserve your Retirement Assets and live on the income your assets generate.

1. The 4% Strategy (Systematic Withdrawals)

At the core, this strategy is about determining a % to withdraw from your Retirement Portfolio. 4% has been the typical rate endorsed by research based on numerous modelling based on historical data.

Research results have shown that this is a relatively fail-safe withdrawal rate to have your money last for 30 years.

Nuances in actual implementation

The 4% method can come with variations:

  • Fixed-rate
  • Inflation-adjusted
    • Assume Retirement Savings of $750,000, a withdrawal rate of 4% and inflation at 2%
    • Withdraw $30,000 in the first year, $30,600 in year 2, $31,212 in year 3, etc

Strength of this strategy

Ease of implementation

Weakness of this strategy

Invite the question: is 4% indeed fail-safe? Or should you withdraw at a higher or lower rate?

Some critics argue the 4% rate is too high. They point to forward-looking Monte Carlo analysis and say things could get worse if future returns can’t live up to historical returns; pointing to the low-interest-rate environment (that will seemingly never come to an end).

Others argue that 4% is too low. They argue that you can choose 5% or even 6% if you are willing to curtail spending when markets decline. They point to research that says that 4% will leave you with all of your money when you die, 96% of the time. And in many instances, you will die with more than you started with.

2. The Bucket Strategy (Time-Based Segmentation)

This strategy involves thinking of and setting up your Retirement Portfolio into distinct buckets:

Bucket 1: Savings/investments with lowest-risk instruments for the near-term expenses;

Bucket 2: Somewhat higher-return investments for the mid-term (therefore higher volatility);

Bucket 3: The highest growth asset-allocation (therefore highest volatility) for the long-term

Monthly income is drawn from Bucket 1, and Bucket 2 will replenish Bucket 1, and Bucket 3 will replenish Bucket 2.

Nuances in actual implementation

  • Duration of each bucket. E.g.:
    • Bucket 1: 5 years (i.e.: first half of Retirement)
    • Bucket 2: next 10 years (i.e.: first half of Retirement)
    • Bucket 3: beyond first 15 years (i.e.: second half of Retirement)
  • Emptying of the buckets: Some plan to empty bucket 1, then move on to bucket 2, then 3. Whereas some plan to not empty one bucket before they start the next one. The long-term bucket flows constantly to the mid-term bucket, which flows constantly to the short-term bucket.
  • The number of buckets: some plan for more than 3 buckets to micro-simulate the many phases of retirement.

Strength of this strategy

Many clients find this intuitive and feel more confident to deal with the double whammy of inflation and longevity.

Weakness of this strategy

Compared to the 4% Strategy, this will require more oversight and management of the implementation

Like the 4% Strategy, the uncertainty of investment returns may leave you in a position of spending too little while still running the risk of running out of funds.

3. The Flooring Strategy (Essential vs. Discretionary spending)

This strategy involves setting a floor for your retirement expenses. It is also called an “essential vs. discretionary” approach because you will classify your retirement expenses as essential or discretionary:

  • Essential expenses: food, housing, utilities, other monthly bills and regular activities
  • Discretionary expenses: travel, additional hobbies, and other unanticipated expenses

Low-risk investments or guaranteed income (such as CPF LIFE, Retirement Plans) are used to fund essential expenses and a mix of medium- and high-risk investments are selected to fund discretionary expenses.

Income is drawn from the respective pools to cover respective expenses. Also, by annualizing a portion of the portfolio to pay for everyday expenses, you can secure a perpetual fixed income for the necessities, regardless of longevity.

This is a strategy with a high level of customisation since this is expense driven and is determined by retirement lifestyle.

To use this strategy, you can project how much will your essential expenses be. Then work backwards to determine the percentage of retirement assets to set aside for a perpetual income stream that pays for food, housing, utilities and other essential monthly bills.

Strength of this strategy

Many clients also find this intuitive and helps them budget better

Clients can better visualise how does CPF LIFE fit into their Retirement Plan

Unlike the prior strategies, you don’t run the risk of running out of money at the end of retirement

Weakness of this strategy

What percentage to annuitize? You do run the risk of underspending and living at a reduced lifestyle and running short on liquidity if you annuitize a too much of your retirement assets

Are you willing to forfeit some money if you die younger than expected?

How will you handle inflation in your “flooring”?

Some say that you can do better by investing your retirement assets instead of locking up a portion into an annuity?

4. The Interest-only Strategy (Dividend Strategy)

Some people set out to pursue the straightforward strategy of leaving their retirement assets untouched and use only dividends or interest to provide their retirement income.

A derivation of this strategy is to buy a rental property and live on the rental income.

Strength of this strategy

No need to worry about outliving retirement assets

Meet objective of leaving a legacy

Weakness of this strategy

Obviously, a massive amount of retirement assets must be accumulated. In fact, only a small percentage of people will be able to afford to use this strategy.

Fluctuating monthly income, since income is dependent on interest rates, bond coupon rates, dividends rate, rental rate

By |2018-07-05T18:14:58+00:00October 8th, 2017|Retirement|

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