What is the Best Way to Take Retirement Withdrawals?

If you are looking to retire in the near future or are recently retired, you may be interested to learn that how you take withdrawals from your portfolio may have a dramatic impact on the success of your retirement plan. Here’s a summary of a recent article in the Journal of Financial Planning.

Researchers considered a 60/40 portfolio with 4% withdrawals for retirement to examine different withdrawal strategies. They used historical equity returns since 1970, an assumed 2% rate of return for bonds, 1% in fees, 3% annual inflation increases, and a 30 year retirement horizon. They tested four different ways of withdrawing funds from a $1 million portfolio and calculated the percentage of success of each approach as well as the median portfolio value that was left over at the end of 30 years.

Most advisors suggest annual rebalancing. This approach keeps your portfolio pegged at a 60/40 allocation even as 4% annual withdrawals are taken. Note the success rate here was 80%, which means that in 1 out of 5 trials, the strategy failed to provide 30 years of inflation adjusted withdrawals. Annual Rebalancing also had the lowest Median Ending Value, which is important for a cushion if you or your spouse should live longer than 30 years, or if you would like to leave assets to heirs or charity.

The best result was obtained by Spending Bonds First. That means that a retiree would not touch their stocks at all while they spent down their entire 40% in bonds. At 4% withdrawals, it would take about 11 years until you had depleted your bonds and for the following 19 years, you would have a 100% equity portfolio. This type of strategy is sometimes called a “Rising Equity Glidepath” by Michael Kitces and other researchers.

Spending Bonds First might provide the best return because it begins with more than a decade of stock growth, with no withdrawals, which in most periods would have been a significant rate of return. However, this approach is controversial, because most practitioners (and regulators) believe that the typical retiree in their seventies or eighties does not have the risk tolerance to be 100% in equities. But, if you did have the stomach for this type of approach, there is evidence from this article and several others that validates the potential benefits of spending bonds first.

The Simple Guardrail may be easier for most retirees to tolerate and for advisors to adopt because it does not require moving to a 100% equity portfolio. The guardrail is simply this: no withdrawals are taken from stocks following a down year to give them a chance to rebound. The portfolio is also rebalanced back to 60/40 annually. While it doesn’t have the dramatically higher median ending value of Spending Bonds First, the guardrail still offers a noticeable improvement in success versus standard rebalancing, from 80% to 94%.

While Spending Bonds First may offer the best hypothetical results, it may be too aggressive for most retirees. The Simple Guardrail improves results on a more basic premise of giving equities an opportunity to rebound after a down year. In our next down year in equities, we will be talking with clients who are taking distributions about this idea.

The study is interesting, but it assumes one account and does not consider the real world complexities of taxes, multiple types of accounts, or Required Minimum Distributions. We look very thoroughly at each client’s withdrawal strategy to fulfill their income needs in the most efficient manner possible.

Source: Determinants of Retirement Portfolio Sustainability and Their Relative Impacts, DeJong and Robinson, Journal of Financial Planning, April 2017, pp. 54-62.