Linda P. EricksonLinda P. Erickson, CFP®, is the president of Erickson Advisors and a registered principal offering securities through Cetera Advisor Networks, LLC, 336-274-9403 lindae@ericksonadvisors.net.
You have a nice nest egg, and you think you’re set. Well, maybe.
The withdrawal rate you can sustain from your portfolio may be lower than you think, particularly if you’ve gotten more conservative in your allocations.
A retiree who went to the community of his dreams in the early 1990s, withdrawing a Level Income calculated at eight per cent (seen as prudent at the time) is now in real trouble. Many analysts agree that a sustainable withdrawal rate from a portfolio today invested 50 percent in stocks and 50 percent in bonds is somewhere between four and five percent over a 30 year period. Anyone planning to live longer should adjust that rate lower. For example, a planned annual $50,000 Level Income can get you into trouble if or when annual rates of return fluctuate downward and interest rates fall below earlier, rosier projections.
If you’re willing to work at it, or if you work with a professional, you may be able to be more predictive of a successful outcome by withdrawing a Percentage of Annual Growth. This method requires carving off at least two years of required spending and holding it in cash. The balance can be invested in a diversified and annually rebalanced portfolio.
If our retiree in the above example had taken this approach he would have had a few years in which he lived on the cash balance in his reserve account. In his above average growth years, he would have restrained his income withdrawal to a modest percentage that may have been less than his initial planned withdrawal of $50,000, and he would have then replenished his cash account with the rest of that above average growth. This method will cause retirees to have a variable cash flow, and in some years that will mean taking less than was originally planned. This method, however, may just preserve your nest egg for you and your long-lived spouse.
The most conservative withdrawal plan, but one that may preserve principal over a long retirement period, is the Dividend and Interest Only Income plan. This method is summarized in its name.
Our hypothetical retiree would, upon retirement, design his asset allocation to be diversified over several asset classes such as cash, bonds, stocks and maybe some real estate. His income would consist solely of the interest on the bonds and the dividends from a stock portfolio.
This method creates a much lower income stream than our other two methods, but it offers retirees the most assurance of the three that his or her nest egg will be sustained throughout the retirement years. In addition, this method has in the past produced a rising real dollar income stream that can address the challenge of the erosion of buying power of a portfolio due to inflation.
***Past performance does not guarantee future results.