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Another way to tap your savings for income in retirement is to select a reasonable percentage rate and withdraw that same percentage each year, with limits on the actual annual dollar amount you withdraw.
Withdrawing a fixed percentage from your remaining savings forces you to adjust your spending along with your portfolio’s performance. Therefore, you’re less likely to run out of money. And by putting a ceiling and floor on the amount you can withdraw, you’ll limit the amount you have to cut back in down times.
For instance, one academic study* concludes that you can withdraw a fixed 5% each year and expect your savings to last 30 years if you set limits on your withdrawal amount. Importantly, this study assumes that you would maintain a portfolio made up of 63% large-company stocks and 37% intermediate-term Treasury notes.
Specifically, in years when your investment returns are either exceptionally good or extremely bad, you would cap the dollar amount you withdraw by a designated ceiling or floor percentage. Therefore, when your returns decrease, your withdrawals will decrease and you would have to rein in your spending. Alternatively, when your returns increase, your withdrawals will increase.
For example, if you have $500,000 in savings and you withdraw 5%, you can initially withdraw $25,000. If your portfolio falls to $400,000, you can only withdraw $20,000, but if it increases to $600,000, you can withdraw $30,000 – assuming these amounts are within the ceiling and floor limits you set.
* The Journal of Financial Planning: January 1994, December 1997, April 2001, May 2001, December 2001, May 2003, October 2004
Article is for educational purposes only and is not intended to provide specific tax or legal advice. For answers to tax questions, please see your tax professional. For legal questions, consult an attorney.
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