There's a new, so-called "dynamic" approach to dipping into your retirement funds, according to recent research.
While conventional wisdom holds that the "four percent rule" is golden--whereby retirees are allowed to take out a maximum of four percent of their retirement savings each year--some experts have grown skeptical that this really is the best, most lucrative method, as a recent Wall Street Journal article discusses. In fact, according to Michael Kitces, a director of planning research at Pinnacle Advisory Group Inc., this method is antiquated, and "would have worked if you had retired during a historic catastrophe...[but] if you start at five percent, there's a decent chance you won't ever have to make spending cuts," he told the Journal.
As it turns out, financial advisors are starting to adjust their recommendations to better reflect the times, with many advocating more flexible approaches to withdrawing funds. Rather than fixing a set rate, these methods take the financial market's inevitable fluctuations into account.
With possible benefits including the freedom to spend more at the beginning of your retirement--when you're likely to be more nimble--here's a breakdown of three alternative withdrawal strategies to use later in life. It's worth keeping in mind that each will require you to become more frugal later on, depending on when (and by how much) the value of your portfolio decreases.
1. The Adjusted 4 Percent Rule
For more traditional savers and spenders, consider a derivative of the traditional 4 percent mandate: Simply do not make any adjustments for inflation to your spending in any year that your savings diminish, advises mutual fund company T. Rowe Price Group Inc. You can still take out five percent in your first year of retirement and--provided you hold 60 percent in stocks and 40 percent in bonds--you have a very good chance of not running out of money in the long run.
This, however, is still a relatively conservative approach: You risk a steady decline in inflation-adjusted income over time, with your heirs likely to keep what's leftover if your portfolio does exceptionally well throughout your retirement.
2. The Floor-and-Ceiling Rule
As the name suggests, the floor-and-ceiling rule requires you to define maximum and minimum withdrawal amounts to account for market fluctations: Over time, the idea is that you accrue more money when the market is up, which can help provide padding for when it goes down.
With this method, keep in mind that your income is liable to fluctuate more frequently, and you'll have to work on spending less money as time goes on.
3. The Guardrail Rule
This requires you to implement a 10 percent pay cut in any year following a 6 percent withdrawal, says creator Jonathan Guyton, a Minneapolis-based financial advisor. Conversely, you can give yourself a 10 percent raise when you withdraw less than 4 percent. For anywhere in-between the 4 and 6 percent rate, adjust your most recent withdrawal to account for inflation.
The guardrail rule all but guarantees that you won't run out of money, but remember that if you're up against a sustained drop in the stock market, you could be forced to cut 10 percent repeatedly, year after year.