Retirement planning: the withdrawal question

Part of Financial 101 — free, plain-language reference guides. Not personalised advice. Download the one-page Order of Operations checklist.

The question that changes at retirement

For thirty or forty years the question was simple: how much can I save, and where should it go. The order of operations answers that. At retirement the question flips, and it is harder. You have a pile of money, you no longer add to it, and you need it to produce income for a length of time you cannot know. Getting this wrong in either direction has a cost: spend too freely and you outlive the money; spend too cautiously and you die with a fortune you could have used.

Most retirement planning is an attempt to answer that one question with some confidence. Here are the main tools.

The 4% guideline

In the mid-1990s a financial planner named William Bengen tested a simple rule against every historical period of US market returns he could find: withdraw four percent of the portfolio in the first year of retirement, then increase that dollar amount with inflation every year after, from a portfolio of roughly half stocks and half bonds. In the historical record, that approach survived thirty years in every starting year tested, including retirements beginning just before the Great Depression and the 1970s stagflation.

That is the origin of “you need 25 times your annual spending.” It is a useful benchmark and a terrible commandment. Its critics point out several things, all fair: the historical US record was unusually kind; a thirty-year horizon is too short for early retirees; future returns from today’s starting valuations may be lower; and a rule that never adjusts spending is not how anyone actually lives. Later research suggests that being willing to trim spending in bad years lets you start higher, and that rigidly following any fixed rule is less important than having a plan for adjustment. Treat four percent as a sanity check on whether you are in the neighbourhood, not as a switch you flip.

Sequence-of-returns risk

Here is the thing about retirement that surprises people who have only ever accumulated. During your working years the order of returns does not matter much: a bad decade followed by a good one ends in roughly the same place as the reverse. In retirement, while you are withdrawing, the order matters enormously. A severe market decline in the first few years — while you are selling assets to live on — can permanently impair the portfolio in a way the same decline fifteen years later would not.

This is why retirees hold more bonds than accumulators, why a few years of spending in cash or short-term bonds is common practice, and why flexibility in spending during the early years is worth more than any clever product. It is also the strongest argument for what the annuities guide describes as the simple case: covering essential spending with guaranteed income so a bad early sequence cannot force you to sell at the bottom.

Social Security timing

For most Americans this is the largest guaranteed, inflation-adjusted income stream they will ever have, and the claiming decision is one of the few retirement choices with a large, mostly one-way effect. You can claim as early as 62 at a permanently reduced benefit, at your full retirement age — 67 for anyone born in 1960 or later — for the standard amount, or delay to 70 and receive delayed credits of roughly eight percent per year past full retirement age. Delaying is, in effect, buying more inflation-protected lifetime annuity income at a price no insurer can match.

The right answer depends on health, whether you are still working, other income, and — for couples — on survivor benefits, which usually argue for the higher earner delaying. This is the kind of decision a one-time session with a fee-only planner earns its fee on. See how planners are paid before you book one.

The withdrawal order

Which accounts to draw from first is a tax question more than an investing one. The conventional sequence — taxable first, then traditional, then Roth — is a starting point, not a rule; filling lower tax brackets with traditional withdrawals or Roth conversions in the years between retirement and Social Security can be worth a great deal. Required minimum distributions from traditional accounts begin in your seventies and are mandatory. This is a second place where a planner or a CPA earns their fee.

Healthcare

Medicare begins at 65. Retiring earlier means bridging the gap with marketplace coverage, an employer plan, or a spouse’s, and that bridge is frequently the largest and least-anticipated line in an early retiree’s budget. Price it before you decide.

Checklist

Essential vs discretionary annual spending written down · Portfolio compared against roughly 25× spending as a sanity check · Stock/bond split adjusted for withdrawal, not accumulation · A few years of spending held in cash or short bonds · Social Security claiming strategy modelled, especially for couples · Withdrawal order and Roth conversion window discussed with a professional · Healthcare costs priced through age 65.

Related: Annuities explained · Index funds · How planners get paid