Traditional tactics of drawing down a portfolio in retirement have some flaws.
* The 4 percent rule. Here, you withdraw 4 percent of your portfolio the first year of retirement. Then you increase your withdrawal amount to keep pace with inflation. This rule is very rigid so you might wind up withdrawing too much or too little, depending on investment performance.
* The percentage play. You can simply withdraw, say, 4 percent or 5 percent of your portfolio each year. With this approach, your retirement income can fluctuate wildly, as your portfolio swells and shrinks in volatile markets.
Another strategy calls for a modified percentage play. You might withdraw, say, 5 percent of your portfolio each year. However, you wouldn’t change your annual withdrawal by more than 5 percent.
Suppose you retire with $500,000 in your portfolio. In Year One of retirement, you withdraw $25,000 (5 percent of $500,000). The next year, you withdraw 5 percent of your new portfolio amount. However, you put a band around your withdrawal.
In this example, 5 percent of your $25,000 first year withdrawal is $1,250. Therefore, in the second year you’d withdraw no more than $26,250 if your portfolio increases and no less than $23,750 if your portfolio shrinks. This process allows you to withdraw a reasonable amount each year yet avoid large year-to-year swings in your cash flow. As you grow older, you can increase the withdrawal percentage to 6 percent, 7 percent, etc.
