Retirement Income Strategies
You’re diligently saving for retirement, planning for comfortable golden years. While saving is important, the way you manage your retirement savings is just as important. Your retirement savings becomes your income and ensuring it will last you throughout your retirement starts with a plan.
Let’s dive into the three most popular strategies for living on a fixed income.
The 4% rule:
With this Systematic Withdrawal Strategy, you draw 4% from your savings in your first year of retirement, and then adjust that amount for inflation every year thereafter. For example, imagine you have $800,000 in savings. In your first year of retirement, you’d withdraw $32,000. If inflation was 3% for the year, the following year you’d take out $32,960.
4% of $800,000 = $32,000
+ 3% of $32,000 = $960
Total withdrawal: $32,960
While this approach is a reasonable place to start, it is rigid and you may have to adjust for unforeseen circumstances -- life happens.
The Bucket Method
This Time Segmentation Strategy, divides your retirement savings into segments called the “bucket method”. Investments are set aside for different time horizons in retirement. For example, you might set up three investment buckets. The first bucket will provide income for the near term, perhaps the first five years of retirement. The second might have a more mixed investment allocation of bonds and CDs or mutual funds; providing growth but isn’t fully invested in the market. The third bucket, which you won’t use for over 10 years, can take on more risk because it’s a long-term investment. Liquidation won’t happen for years, and you can invest this bucket entirely in stocks, providing a stronger long-term return approach.
The “Essential vs Discretionary” Approach
This Flooring Retirement Income Strategy somewhat opposes the investment and risk management style of a systematic withdrawal strategy. This strategy divides spending goals between needs and wants.
This strategy involves working to build a “floor” of income from secure income sources to cover essential expenses during your retirement years. You can then add riskier securities and investments to your portfolio to cover non-essential expenses.
There are a number of factors that can make your budget vary from one year to the next, including health care and travel expenses and when you begin to claim Social Security. Individual’s needs are different and it’s likely that annual spending will fluctuate throughout retirement.
In the end, the debate of what strategy is best or most efficient remains. All three strategies provide certain benefits and have their own drawbacks. The strategies should tailor to each individual investor depending on their goals, investment experience, income sources and risk tolerance level.
Systematic Withdrawal tells us we need to take on some market risk to generate higher returns and increase our wealth. The Flooring Strategy tells us the value of having safe income sources to help cover necessary expenses. The Bucket Approach recommends planning for retirement through timed investments. Ultimately, each strategy has its share of strengths so it doesn’t have to be an all or nothing approach – combining aspects of all three could be quite beneficial.
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