How much of your retirement portfolio should you use for spending money after you stop working? One common benchmark is to withdraw 4 percent in Year One. You’ll probably be able to increase that withdrawal each year to keep up with inflation, even if your retirement lasts over 30 years.
This “4 percent solution” assumes that around 50 percent of your portfolio remains in stocks and stock funds to seek the long-term returns you’ll need.
For example, suppose you retire with a $400,000 portfolio. Following this strategy, you’d withdraw $16,000 (4 percent of $400,000) in the first year. Suppose the inflation rate that year is 3 percent. You would increase your withdrawals by 3 percent, from $16,000 to $16,480, the next year.
Suppose that inflation moves up to 5 percent in the following year. Then you’d increase your withdrawal by 5 percent, from $16,480 to around $17,300. This process would go on, year after year. As the cost of living increases, your portfolio withdrawals would increase at the same rate, eventually reaching $20,000, $25,000, etc.
You’ll probably want to tap your taxable accounts before age 70 1/2, when you’ll be required to take minimum required distributions (MRDs) from your IRA, TSP or other tax-advantaged retirement savings. Tapping your taxable accounts first provides you with valuable extended tax deferral.
From your taxable accounts, you can elect to have your interest and dividends paid to you, rather than reinvested. Those payments will count towards your portfolio withdrawals.
Say you expect to pull $16,000 (4 percent) from your $400,000 portfolio. That $400,000 is evenly divided between your IRA and your taxable accounts, so you’d be taking $16,000 from your $200,000 in taxable accounts.
Suppose interest and dividends from your taxable accounts total $5,000. Then you’d need to withdraw another $11,000: $16,000 minus $5,000.
That $11,000 would come from selling securities in taxable accounts. You could sell the securities that have appreciated the most–selling your winners while leaving the other holdings time to gain value.
The situation changes when you pass age 70 1/2 and have to take MRDs. Then you’d pull money out of your tax-deferred accounts. If you wanted to withdraw $20,000 that year, for example, and your MRD was $11,000, the other $9,000 would come from your taxable accounts.
You probably won’t follow the above example precisely but the concept is what counts.