Yet another withdrawal strategy thread

[NameRedacted]

Apologies if this has been discussed ad-nauseum already.

Just 3 weeks left now and I've been thinking a lot more carefully about my withdrawal strategy. The initial plan was to withdraw around 4.5-5% until SS kicks in and then reduce that to less than 4%. However, with the recent market rise and the fact that I've diversified to about 30% bonds and cash from 100% stocks I think I can get away with a 4% withdrawal rate now and still have the income I was expecting.

I've never really liked the idea of drawing the same fixed amount adjusted for inflation every year. Nor do I like the idea of a fixed percentage of the portfolio one a year - so I decided to create a customized strategy that I'm more comfortable with. It's likely that variations of this have already been proposed.

It's designed for a 40 year retirement. Here it is:

I'm planning to keep about 1 year's expenses in a savings account at Ally bank and switch money from there as needed to checking to pay ongoing bills and expenses.

On the first of each month I'm planning to withdraw 0.33% (this will change - see below) of my total portfolio value and transfer it to my Ally account. This will consist of accumulated dividends paid in the previous month plus I plan to sell sufficient stocks or bonds to reach the 0.33% value. The decision as to which stocks or bonds to sell will likely depend upon what is most tax efficient.

However, to prevent sudden large jumps or declines in income, I'm going to limit the monthly increase or decrease to 1%. So for example, if the portfolio goes down 1.5%, I'll limit the decrease to 1%. If the next month it goes down another 0.4% then the decrease will be 0.9% (0.5% carried over from the previous month + 0.4% this month). I like this idea because it means I can confidently predict how much money I'll have to spend well into the future. For example:

Jan $x
Feb $x +- 1%
Mar $x +- 2%
Apr $x +- 3%

Plus it's reactive to market conditions - it just smooths out some of the volatility.

It would limit the increase/decrease in spending per year to about 12%. I looked at what I expect is the worst case scenario where the market goes down 50% and stays down for a while. With my current asset allocation of 70% stocks I expect that would result in my portfolio falling around 35%. With this strategy it would take almost three years for my income to decline by that amount. That should give me plenty of time to think about getting a part time job and/or drastically cutting expenses.

That leads in to my second idea. I plan to carefully monitor the amount in my Ally account and if it reaches a level of more than $10,000 greater than the starting value, I'll skip a month's withdrawal - this is an expection to the 1% rule. This would happen if I start to cut expenses significantly or if I get income from other sources (such as a part-time job).

On the other hand if the market rises significantly, it may take a while for my 'income' to catch up but then again that's probably not a bad thing. I'd just be banking money that I should eventually get to spend anyway if the rise is not just a temporary blip, and if it is just a blip it's probably a good thing I didn't spend it.

Finally I wanted the strategy to take account of the fact that as I age the length of time needed for the strategy to work will decrease so I want to slowly increase the base 4% draw every month. For example:

Month 1 0.3300%
Month 2 0.3305%
Month 3 0.3310%

Reaching about 7% annually after 40 years. I'm not sure if this is such a great idea though.

In month 1 I'd be drawing .33% which is about 3.96%
After 10 years the withdrawal rate would have increased to 4.68%
After 20 years it would be 5.4%
After 30 years - 6.12%
After 40 years - 6.84%

This may be too rapid a rise. I expect that it would be more appropriate to have a shallow increase at the start of the 40 year period and a steeper one later.

Anyway, as always comments would be appreciated.

 

[DrRoy]

This seems to be a bit overdetailed for me, but I see that for you it provides comfort and predictibility. The math works and you like it. What more do you need. You have my vote.

 

[jebmke]

I know and do volunteer work with a lot of retirees. To my knowledge, none of them use a mathematical method for withdrawal. I'm not saying it isn't done, I just have never run across anyone that does. Usually they fall in one of three camps (1) spend as needed and monitor assets, using judgement (2) Pensions + annuities/SS for base spending, assets for one-offs or (3) spend only dividends and interest, never touch principal.

 

[NameRedacted]

I do have a degree in math - I guess it shows huh? I also like to plan things in great detail - it drives my gf nuts when we go on vacation.

I do expect that as I get older the plan may change.

 

[The Rodent]

I agree, your model seems to be overly detailed.

Just google: "Vanguard floor to ceiling dynamic spending". This model allows you to adjust your annual withdrawals based on market performance, within limits.

Also you could look into the "guardrails model" which is similar. The guardrails model will produce fewer adjustments but bigger swings. Of course, there's the basic "four percent model".

It's quite easy to create a spreadsheet and compare the models side by side across your retirement horizon. I did it with google sheets. Then you can even plug in various scenarios of market performance. My favorite is to use the 1973 to 2002 DOW performance then further tweak the numbers to take full loss years but adjust the gains years to 50% of actual but nothing over 5%. This is a stern test.

I personally like the floor to ceiling model.

 

[Pilot2013]

I can't remember where it is, but I modeled (in my SS for AWD) the plan that someone put out that takes your age, divided by a factor (mine starts out divided by 20) which changes as you age. I put in estimated starting value, estimated annual gain, both on the conservative side, and took a look at what output $'s it gave. Seemed simple enough to manage as I get older.

 

[Gotadimple]

If you like spending a bit of time each month determining what to sell to fund your retirement, then it's a great plan. If you want to be involved with other things, and sitting at a computer isn't one of them, then you've created a mine field.

You want to take the cash from your dividends as soon as they are earned. Why? How will selling assets monthly fit in with maintaining your asset allocation throughout your retirement? I am assuming your assets are with a low-cost broker and you are using only those investments that do not have a commission fee associated with them.

Anyway, food for thought. Other recommendations here also provide some ideas. Most rebalance annually, and take distributions (earnings and sales) annually just for simplicity. In the big scheme of things you aren't changing much by doing this annually rather than monthly. If anything, earnings on the portfolio may mitigate the need for sales in a good year.

- Rita

 

[W2R]

I agree, your model seems to be overly detailed.

+1
The problem with overly detailed models is that sometimes, one misses the forest for the trees, especially as one becomes older and older and more easily distracted (which I suspect happens to most of us at some point). Personally I really like simplicity in my financial and investment planning.

I know and do volunteer work with a lot of retirees. To my knowledge, none of them use a mathematical method for withdrawal. I'm not saying it isn't done, I just have never run across anyone that does. Usually they fall in one of three camps (1) spend as needed and monitor assets, using judgement (2) Pensions + annuities/SS for base spending, assets for one-offs or (3) spend only dividends and interest, never touch principal.

I generally spend around 2%, which is slightly less than my dividends, plus my pension and SS. But, I am not getting any younger and 3.5% plus pension and SS would not be a crime either so I keep that in mind.

 

[jazz4cash]

If you like spending a bit of time each month determining what to sell to fund your retirement, then it's a great plan. If you want to be involved with other things, and sitting at a computer isn't one of them, then you've created a mine

- Rita

I agree with this. The cost of making many small trades rather than a few larger ones might be an issue along with the effort of tracking basis in taxable accounts for me, but YMMV.

 

[SecondCor521]

For me personally, I think I will want to cut back my spending rapidly and commensurately if the portfolio takes a significant nosedive, because that seems to provide survivability better than a more gradual/buffered approach that the OP has in mind.

On the upswings, I think I would also want to take advantage of the good market to enjoy myself a little.

So in my case I am ending up more with essentially a straight 4%-of-current-portfolio approach, although I am a relatively new FIREee.

 

[Hyperborea]

The problem with a fully variable withdrawal is that we don't have fully variable expenses. That's what you're attempting to account for by the limits on the changes in withdrawals. The other way to go about it is to split your withdrawal into two parts a fixed part to account for the fixed expenses and a variable part to account for the variable expenses.

So, for example, you could have a 2% withdrawal with inflation adjustment to look after the fixed expenses. Then you could take 50% of the gains over and above the 2% withdrawal. Even then the extra money each year will be highly variable leading to luxury cruises and caviar one year followed by canoe trips and crackers the next. You could further refine it by adding an averaging pool - taking only the average of the last 3 years extra money and then putting the rest into a money market or CDs or something to use to balance out lower years later. You can vary the base fixed amount, the percent of the gains, and the size of the averaging pool.

This idea was put forward maybe 15 to 20 years ago by a poster known as Gummy - actually Peter Ponzo a retired math prof at the University of Waterloo. I took a mathematical modeling class (applied differential equations) with him a long time ago. The archive of his old postings is here - sensible withdrawals The format of the post is actually very much like taking his class was.

 

[OverThinkMuch]

I almost never post about my withdrawal strategy, since I've personalized it and don't expect others to benefit from it. But in this one case, maybe it could.

My approach before this year (*) was to withdraw in 0.5% increments when needed. When the market has a great year, I deliberately withdraw an extra 0.5% that I don't need. When times are rough, I skip a 0.5% withdrawal. So for example with a 3% withdrawal rate, I'd normally withdraw 0.5% six times... but in a good year I'd add one (3.5%) and in a bad year remove one (2.5%). It captures the idea of a variable withdrawal rate, smooths the withdrawals over time, but isn't very complex.

Another problem with complexity is testing it. The online simulators won't be able to capture your idea, which means it's harder to understand if it works. For me, I take a 3% withdrawal rate and make sure that works, then stress test until I see it break. With a varying 5-7% withdrawal rate (after 10 years) I don't see how you'll simulate it. You need something you can test independently so you aren't mumbling about your retirement mistakes from the safety of a homeless shelter. Although if you then become a janitor solving math problems, make sure you write a movie about it.

(*) After a recent move I'm expecting my withdrawal rate to be even lower, and there may no longer be much point to varying it. The further below 4% you go, the less a withdrawal strategy matters to the end result.

 

[SecondCor521]

The words "more" and "essentially" were waffle-words to avoid giving every gory detail of my thoughts and ideas and plans, which are probably of little interest to anyone besides me and my heirs.

Of course I have an expense floor, but you can bet if we have a *protracted and significant* downturn that I'll be figuring out how low that floor can go and whether to go back to work if it lasts a long time and I get really panicky.

If we have a protracted good market, you can bet that I'll feel OK splurging for the organic strawberries or whatever. But I'll probably never fly first class and stay at the Waldorf regardless.

Personally I prefer not to look at things in terms of buckets or side pools for my retirement funds, although I do segregate between my FIRE pool and my kids college fund pool.

 

[Mdlerth]

I do have a degree in math - I guess it shows huh? I also like to plan things in great detail - it drives my gf nuts when we go on vacation.

I do expect that as I get older the plan may change.

No doubt your plan is a work of genius and certain to sweep the Nobel and Zee-Magnees prizes, but if I had to keep track of that many numbers, I'd never retire. It's more w*rk than w*rking!

 

[audreyh1]

The problem with a fully variable withdrawal is that we don't have fully variable expenses. That's what you're attempting to account for by the limits on the changes in withdrawals. The other way to go about it is to split your withdrawal into two parts a fixed part to account for the fixed expenses and a variable part to account for the variable expenses.

So, for example, you could have a 2% withdrawal with inflation adjustment to look after the fixed expenses. Then you could take 50% of the gains over and above the 2% withdrawal. Even then the extra money each year will be highly variable leading to luxury cruises and caviar one year followed by canoe trips and crackers the next. You could further refine it by adding an averaging pool - taking only the average of the last 3 years extra money and then putting the rest into a money market or CDs or something to use to balance out lower years later. You can vary the base fixed amount, the percent of the gains, and the size of the averaging pool.

If you realize that money withdrawn does not have to be all spent that same year, it's easy to set aside funds for future trips, for example, after good years so that you aren't "forced" to take elaborate vacations one year and take none after a bad market year. I think to many folks this type of averaging comes naturally. After a great market year perhaps some folks ramp up spending immediately, but I bet most do it more gradually, setting aside funds unspent to be available for the next year just in case the market falters in the mean time.

Well, actually quite a few folks here tend to reinvest unspent funds, but that's a whole separate topic. Totally a personal choice depending on the retiree's goals.

We take a fixed % of remaining portfolio each Jan, and at the end of the year set aside unspent funds to be available for the next year or two. As our unspent funds accumulate, we try harder at spending - well, of course. One of these days our investments will take a huge haircut, but it won't affect our spending immediately — we'll have a chance to ramp down if the bear market is prolonged.

I like our scheme because it's a simple once a year deal and independent of inflation. Once we have withdrawn the funds for the current year we can ignore our portfolio for a year. We let our distributions (most paid in Dec) accumulate in cash, and this almost always covers the withdrawal in Jan. Then we rebalance after the withdrawal in Jan - but really only if the allocation is significantly off from target. These last two techniques help limit taxes in our taxable retirement portfolio.

 

[Pilot2013]

I just reviewed my AWR based on the age/factor that was in a post several months ago. Based on that model, and what I thought I would NEED to withdraw, I had a sizeable balance at 100 years old...

It dawned on me to look at the RMD calculation, and with what the GUVM'T says I MUST WD, I run out at 88 years old. What a crock.

 

[tmm99]

We take a fixed % of remaining portfolio each Jan, and at the end of the year set aside unspent funds to be available for the next year or two..

Where do you keep the unspent funds? Just curious. Last year was my first full FIRE year, and I am still deciding on what to do with unspent funds.

 

[audreyh1]

Where do you keep the unspent funds? Just curious. Last year was my first full FIRE year, and I am still deciding on what to do with unspent funds.

Most is in high yield savings paying 1% or better. Some is in short-term CDs paying more and a little is in short-term bond funds. I also have a cash buffer in CDs paying 3% - that's in case of a severe drop in income due to a really bad market drop, and I hope never to tap into it.

 

[audreyh1]

I just reviewed my AWR based on the age/factor that was in a post several months ago. Based on that model, and what I thought I would NEED to withdraw, I had a sizeable balance at 100 years old...

It dawned on me to look at the RMD calculation, and with what the GUVM'T says I MUST WD, I run out at 88 years old. What a crock.

You have to withdraw and pay taxes on it. You don't have to spend it.

I don't understand how you would "run out ". The RMD is based on in what is remaining in the IRA.

 

[tmm99]

Most is in high yield savings paying 1% or better. Some is in short-term CDs paying more and a little is in short-term bond funds. I also have a cash buffer in CDs paying 3% - that's in case of a severe drop in income due to a really bad market drop, and I hope never to tap into it.

Thank you Audrey.

 

[Gumby]

We take a fixed % of remaining portfolio each Jan, and at the end of the year set aside unspent funds to be available for the next year or two. As our unspent funds accumulate, we try harder at spending - well, of course.

This is also our plan.

 

[pb4uski]

OPs plan is much more complicated than I would do.

I transfer a fixed amount from our online savings account to the local bank account that we use to pay our bills each month (the amount is ~0.25% of our portfolio on the day I retired). In addition, dividends from our taxable accounts are taken in cash and go directly to our local bank account. This local bank account will have $5-20k in it at any point in time... our home/car insurance and property taxes are in November so some years I need to do a special transfer to cover those cash outflows... but sometimes not. I just do special transfers as needed.

I haven't seen a need to adjust the fixed amount in the 5 years that we have been retired... and I started my pension late last year so I suspect that my local bank account will be growing some... more splurging money... though a lot if it will get sucked up with DD's wedding costs.

Anyway... I suggest that you keep it simple.

 

[big-papa]

There are as many ideas for withdrawal methods as there are people who care about this stuff (myself included). Over at bogleheads.org , you might want to check out VPW. It basically uses the PMT function in excel to calculate withdrawal based on expected returns. You end up with a higher % withdrawal each year up to the final year you planned for at which time 100% is withdrawn. It doesn't take into account inflation, but rather relies on returns to do that, which means withdrawals may fall behind inflation for some time before catching up again if an early 1970's type of scenario arises again. A spreadsheet is available, but once you understand how it works you might want to create your own, especially if your investments are different than what's in their spreadsheet.

And of course there are variants on it as well such as
- updating the expected returns based on additional history as you go through retirement
- using CAPE to adjust the rate used in the PMT function which has the effect of smoothing withdrawals somewhat.
- anything else you could dream up.

Or, there is the method that Taylor Larimore (the big poobah at bogleheads) has used since he retired and it has worked for him up to and including his current 93rd year on this planet. It goes something like this: Withdraw what you need. If you have a good returns year, withdraw a little more. If you have a bad returns year, tighten your belt some. Hard to code that into Excel, though.

Big-Papa

 

[audreyh1]

It doesn't take into account inflation, but rather relies on returns to do that, which means withdrawals may fall behind inflation for some time before catching up again if an early 1970's type of scenario arises again. A spreadsheet is available, but once you understand how it works you might want to create your own, especially if your investments are different than what's in their spreadsheet.

That's what I like about the % of remaining portfolio method rather than constant inflation adjusted withdrawal. In the long run, if your asset allocation includes enough equities, your portfolio will keep up with inflation. In the short run it may fall behind, and so you may go through periods where your income is not keeping up with inflation. But I would rather that than drawing more and making it harder for the retirement portfolio to recover during those periods.

There are as many ideas for withdrawal methods as there are people who care about this stuff (myself included). Over at bogleheads.org , you might want to check out VPW. It basically uses the PMT function in excel to calculate withdrawal based on expected returns. You end up with a higher % withdrawal each year up to the final year you planned for at which time 100% is withdrawn.

Some method of increasing the % withdrawn based on age seems prudent. I just haven't figured it out yet. As we get older it seems more important. Who knows, we might adopt the RMD tables at some point although ramping up sooner seems like a good idea.

 

[jebmke]

I just reviewed my AWR based on the age/factor that was in a post several months ago. Based on that model, and what I thought I would NEED to withdraw, I had a sizeable balance at 100 years old...

It dawned on me to look at the RMD calculation, and with what the GUVM'T says I MUST WD, I run out at 88 years old. What a crock.

The only part you must withdraw is the part that goes to pay your taxes. The rest can remain in your portfolio in a taxable account.