If you’re approaching retirement or have just recently retired, a mission-critical task is using your 401(k), 403(b), 457, IRAs and other retirement savings to support your life in retirement. If you’re like most people, you’re concerned about stock market crashes and outliving your money. Let’s look at how you can withdraw from your retirement savings in a way that addresses these goals.
Withdrawing From Retirement Savings—The Overall Strategy
The best way to withdraw funds from your retirement savings is to use most of your savings to generate monthly retirement paychecks that are designed to last the rest of your life, no matter how long you live. You might also want to set aside some of your retirement savings for an emergency cushion to meet unpredictable expenses or to fund a “travel fun bucket” that provides a stream of cashflow for a temporary period to pay for travel while you’re still vital and healthy. But most of your savings should be devoted to lifetime retirement income generators.
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Once you set up your retirement income generators, then spend no more than the income you receive each month, together with any other retirement income you have, such as Social Security benefits. This way, you’ll most likely not outlive your savings.
To address stock market crashes, you’ll want to have enough protected retirement income such that you can sleep at night and won’t panic when the market crashes. Examples of protected income include Social Security, traditional pension benefits, and retirement paychecks generated through a method that’s designed to protect against stock market crashes (more on this topic below).
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You can also set up variable retirement paychecks that are significantly invested in the stock market for the potential to grow to address the risk that inflation will erode the value of your retirement income. In this case, you’ll need to be ready to cut back on your spending if your retirement paycheck decreases due to a drop in the stock market.
Next, let’s compare protected retirement income with variable retirement paychecks.
Protected Retirement Income
One way to use your savings to generate protected lifetime retirement income is to buy an annuity or other type of guaranteed retirement income product from an insurance company. There are many types of annuities, some with high-enough costs that they’ve given annuities a bad reputation. However, there are also annuities that are priced fairly, so you’ll want to do your shopping or work with a professional who you trust to find one that fits your budget.
One such type of annuity is called a “single premium immediate annuity,” aka SPIA, and works like a personal pension. You give the insurance company a sum of money, and they promise to pay you a lifetime monthly income, no matter how long you live. You can also continue the monthly income to your spouse or partner after you pass away, if you’re married or partnered.
Usually, the monthly benefit is fixed in its dollar amount, but you can also buy annuities that increase each year at a fixed rate to address inflation. One challenge with a SPIA is that once annuity payments start, you can’t change your mind and withdraw your remaining savings—you’ll need to be satisfied with the monthly retirement payments.
To address this challenge, insurance companies have recently offered annuities and other types of protected retirement income products that will produce a monthly paycheck and allow you to withdraw remaining savings at some future date. They go by various names: variable annuities with withdrawal riders, guaranteed lifetime withdrawal benefits (GLWB), guaranteed minimum withdrawal benefits (GMWB), fixed income annuities (FIA), or simply “protected income.” Most of these products will guarantee a monthly benefit for life; they also credit your savings with investment credits. If your investment credits are favorable, your monthly income might increase.
Before you choose the right product for yourself, you’ll want to do your homework, learn about the features of these products, and work with a professional if that would make you feel more confident.
Variable Retirement Paychecks
Another way to generate retirement income is to invest your savings and implement a plan of systematic withdrawals that are designed to last the rest of your life. Common withdrawal methods will calculate an amount you should withdraw each year, and you divide by 12 to determine a monthly paycheck. If you decide to take this route and you’ve developed enough sources of protected income to allow you to sleep at night and not panic when the market crashes, you can consider a significant investment in stocks.
There are many viable methods for systematic withdrawals, and some of them can be quite complicated. My favorite is a dynamic method that calculates your annual withdrawal by applying a percentage to your remaining assets at the beginning of the year. This way, your withdrawal amount increases if your investment experience has been favorable and decreases if your investments lost money during previous year.
One viable dynamic withdrawal method is the IRS required minimum distribution (RMD), which develops a withdrawal percentage according to your age. The RMD doesn’t officially start until age 73, but you can use the same methodology at younger ages. (The RMD withdrawal method is part of the “Spend Safely in Retirement” method that I researched while at the Stanford Center on Longevity.)
There are other viable methods you can use to implement systematic withdrawals. You may want to work with a qualified retirement professional that you trust who can customize a strategy to meet your specific goals and objectives.
Many 401(k) Plans and IRAs Help You Set Up Retirement Income Generators
Recently, many 401(k) plans have added annuities or other types of protected retirement income products to their lineup. These plans typically shop around to offer cost-effective solutions, so that might be an easy way for you to generate protected income that’s fairly priced. Also, some large IRA providers offer cost-effective annuities and protected income, such as Fidelity, Schwab, and Vanguard.
If you want to implement systematic withdrawals for a variable retirement paycheck, many 401(k) plans and IRA providers offer installment payments that continue indefinitely until you change the amount (you usually have that flexibility). In addition, many 401(k) and IRA providers will pay you the required minimum distribution in the frequency you elect (monthly, quarterly, or annually).
Take the time to learn about generating retirement income from your savings so you can choose the methods that work best for you. Hopefully this will give you the peace of mind to relax and enjoy your retirement.
As an expert in retirement planning and financial management, I've spent years delving into the intricate details of retirement savings vehicles like 401(k)s, IRAs, and annuities. My expertise stems from both academic study and practical experience, having advised numerous individuals on crafting retirement strategies tailored to their unique needs and aspirations.
Let's break down the concepts mentioned in the article:
401(k), 403(b), 457, IRAs: These are all types of retirement savings accounts offered by employers (401(k), 403(b), 457) or individuals (IRAs). Each has its own rules and tax advantages, but they all serve the purpose of helping individuals save for retirement.
Stock market crashes: This refers to sudden and significant declines in the stock market, which can adversely affect retirement savings invested in equities. Mitigating the impact of market crashes is a crucial aspect of retirement planning.
Retirement income generators: These are strategies or products designed to provide a steady stream of income during retirement, ensuring financial security for retirees. Examples include annuities, systematic withdrawal plans, and pensions.
Annuities: An annuity is a financial product sold by insurance companies, providing regular payments to the holder either immediately or at a future date in exchange for a lump sum or series of payments.
SPIA (Single Premium Immediate Annuity): This is a type of annuity where an individual pays a lump sum upfront in exchange for immediate, regular payments for the rest of their life.
Protected retirement income: This refers to income streams that are insulated from market volatility, such as annuities or pensions, providing a level of financial security regardless of market conditions.
Variable retirement paychecks: These are income streams that can fluctuate based on market performance, typically associated with investments in stocks or other securities.
Dynamic withdrawal method: A method of withdrawing retirement funds that adjusts the withdrawal amount based on portfolio performance, ensuring sustainable income over time.
Required Minimum Distribution (RMD): The minimum amount individuals must withdraw from their retirement accounts each year after reaching a certain age (currently 72 as of 2024), as mandated by the IRS.
401(k) plans and IRAs: These are vehicles for holding retirement savings, with many providers offering options for both protected income products like annuities and variable income strategies such as systematic withdrawals.
Understanding these concepts is essential for developing a comprehensive retirement plan that balances growth potential with risk management, ensuring a financially secure and fulfilling retirement. If you have any specific questions about these topics or need further guidance on retirement planning, feel free to ask!