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Replacing Your Paycheck in Retirement

Paydays are special. Whether it is every other week, twice a month, or weekly, we all have that day circled on our mental calendars. Then retirement happens, and everything changes. One of the most significant challenges that retirees face is determining how much money to withdraw from their savings each year while ensuring that they do not run out of money. In this article, we will look at different options for retirees that need to replace their income. 

The 4% Rule

One of the most widely known and followed withdrawal strategies is “The 4% Rule.” The rule stipulates that retirees should withdraw 4% of their portfolio value in the first year of retirement and adjust the amount annually for inflation. This approach is based on historical market data and aims to provide a constant stream of income while preserving the portfolio to last the duration of retirement. The benefit of this approach is simplicity, but that simplicity can also be a drawback. If we encountered an abnormal period in the stock and/or bond market, the 4% rule could require some significant adjustments. 

3 Buckets Alternative


To address the rigidity of the 4% withdrawal rule, an alternative is to divide one’s portfolio into “buckets.” The first bucket typically contains cash and short-term investments for immediate spending needs, the second bucket holds intermediate-term investments such as bonds for income generation, and the third bucket consists of long-term, growth-oriented investments like stocks. The flexibility of this strategy allows for opportunistic “profit taking” during good years while providing a ballast of immediate spending needs during the lean years. Visually, imagine the profits earned from the growth portion filling the second bucket, which in turn fills the first bucket as a retiree happily embarks on the next phase of life.  

Dynamic Withdrawal Strategies


Dynamic withdrawal strategies take an even more flexible approach. These strategies adjust the annual withdrawal amount based on variables such as portfolio performance, remaining life expectancy, and changes in spending needs. One popular dynamic withdrawal strategy is the "guardrail" approach, which sets an upper and lower limit for the withdrawal rate based on the portfolio's value. If the market is up and the portfolio hits the upper guardrail, retirees have permission to take that extra vacation or to put money down on a pontoon boat. If the market is down to a certain level, and the lower guardrail gets hit, it’s time to tighten a few notches on the belt. 



Unfortunately, the correct answer to this riddle is not known until after the fact. If you gave me a retiree’s exact life expectancy along with a clear forecast of market performance over that time, it would be easy for me to craft an ideal solution. We just touched on the investment portfolio aspect here, but other factors such as social security income, pensions, and annuities will also factor into the discussion. What is right for you will depend on these factors and your comfort with stock market fluctuations. We regularly review income projections for our clients to ensure they focus on living their best life in retirement. 

Author: David Rath, CMT, CFA

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