Turning Savings Into Income

| July 3, 2019 | 0 Comments

One of the most common questions we hear from people preparing for retirement is, “How do I access my savings now that I won’t be working anymore?” It requires a bit of a shift in thinking, especially for those who’ve diligently saved funds into retirement and savings accounts.

What you need is called a “Withdrawal Strategy” and it’s just as important to a successful retirement as a savings strategy. The goals of a withdrawal strategy should include:

  • Providing enough distributions to meet your spending needs;
  • Maintain your purchasing power;
  • Preventing excessive investment losses in the accounts you are withdrawing from.

A successful withdrawal strategy will balance each of these objectives to help you determine which accounts to withdraw from each year and how to position those accounts for the timing of those withdrawals.

Here are some common withdrawal strategies:

Total portfolio strategies. The most basic withdrawal strategies involve investing your savings in a balanced mix of assets (usually stocks and bonds) and periodically withdrawing funds to support your spending. A small part of the portfolio is kept in cash to be available for withdrawals. As dividends and interest are paid, they add to the available cash. Stocks and bonds may need to be sold periodically to fund distributions. The goal with this strategy is to provide for your spending needs while also keeping most of the accounts invested for long-term inflation protection.

The four percent rule is a variation on this strategy in which your first year withdrawal is four percent of your savings (or $40,000 on $1,000,000 savings). Each year, you adjust this amount by inflation, so if the cost of living went up three percent, you would increase your withdrawal by that amount. This adjusts your withdrawals for inflation and should prolong your savings, but will take a bigger bite out of your savings during market declines.

A Fixed Percentage Rule is another variant in which the percentage of your portfolio never changes, no matter the value of your portfolio. It’s simple, but your withdrawals may vary considerably as your portfolio changes in value (up or down). Adjusting your spending to variable withdrawals can be challenging.

Segmentation or “bucket” strategies. With a segmentation strategy you essentially have two portfolios: a withdrawal portfolio and a growth portfolio. The withdrawal portfolio is invested with an income and principal preservation focus, and all regular withdrawals are taken from it. The growth portfolio should be invested more aggressively with a goal of long-term growth, with the goal of keeping up with inflation and allowing for longevity in mind. Periodic transfers from your growth fund refills your withdrawal portfolio. More buckets can be used, but at the cost of greater complexity.

Annuitization. Annuitization means turning your savings into an income stream. The simplest form is a Single Premium Immediate Annuity (or SPIA), which pays the policy-holder a set amount each month during his or her life. A Joint and Survivor annuity will pay income over the life of both spouses. An annuity like this reduces the risk that you will last longer than your money. On the other hand, you lose control over that money, and it won’t be available for large or unexpected expenses. Also, you will lose the ability grow the money and outpace inflation.

While annuities can be indexed for inflation, that option often costs more than it’s worth. Annuitization works well to cover fixed or non-discretionary expenses, especially when combined with a growth portfolio that can supplement the annuity income to keep up with inflation over time.

Annuities can be very complex contracts, with a dizzying array of options and add-ons, and you should always seek a second opinion before purchasing one, since the sales presentations often present the best possible scenario for the annuity and rarely cover the costs or downsides of these products.

The transition into retirement can be a wonderful time, and a little bit of planning will help reduce the stress and prepare you for the changes you’ll need to make. A Fee-Only fiduciary financial planner can help guide you smoothly through this phase into a successful retirement, and help you make any course corrections necessary along the way.

This column is prepared by Rick Brooks, CFA®, CFP®. Rick is Director/Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in financial planning and investment management for people preparing for retirement. Brooks can be reached at (858) 755-5166, or by email at rbrooks@bfadvisors.com. Brooks and his family live in Mission Hills.

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