Spending requires work, or at least careful planning. So say financial planners about how they develop a program of retirement income withdrawals. The work, according to advisors, is reaching the balance needed to provide income without spending too much.
Creating that balance right from the start with a “sustainable” withdrawal rate is important because clients do not react well to a downward adjustment after they have become used to a certain level of income, says F. John Deyeso, a financial advisor with Financial Filosophy, New York. Consequently, withdrawals must be adjusted for inflation, he says.
To accomplish this goal, he says, the portfolio’s long-term growth rate target must be greater than the withdrawal rate so that inflation or market downturns do not erode principal. The “safe” withdrawal rate factors in the tax treatment of portfolio returns plus the client’s anticipated longevity, Deyeso notes. In good years, the excess return that is not withdrawn proves to be a buffer for the market’s off-years, he adds.
It is important to establish a withdrawal rate and then maintain it, because a client comes to expect a certain income each month, he says. “It is absolutely step number one. They have to live their retirement, not me. My job is to help them get there,” Deyeso says.
Withdrawals are taken from different assets classes as part of portfolio rebalancing, a process that is done at least quarterly, notes Anthony Benante, an advisor with Baron Financial Group, Fair Lawn, N.J. An asset class should never be drawn down to zero, he explains, because portfolio diversification is important.
Creating income as part of rebalancing makes it possible to adjust portfolios from a position of strength, Benante says.
It is also important to plan for the type of account the withdrawals will come from, he continues. For instance, the client’s tax rate should be considered, he says, adding that, in most cases, it makes sense to draw from taxable accounts before dipping into tax deferred accounts.
George Middleton, a financial advisor with Limoges Investment Management, Vancouver, Wa., says there is an order for spending funds that includes considerations such as withdrawing from both traditional and Roth IRAs so that a client remains in a specific tax bracket.
Joel Ticknor, a financial advisor with Ticknor Atherton and Associates, Reston, Va., maintains that the best withdrawal strategy is to set aside between 2-5 years of distribution funds in high-quality, low cost, short-term bond funds or money market funds, keeping a client’s remaining funds in a globally diversified equity portfolio. When markets are good, withdrawals are taken from equities, and when they are bad, they are taken from fixed income or money market buckets.