Spending It

Jonathan Clements · Jan 11, 2025 · 48 replies

RETIREES ENDLESSLY debate how best to draw down their retirement savings, and yet it all comes down to two simple rules: Don’t spend too much each year, and don’t sell stocks during down markets.

How do we put these two rules into action? Retirees can pick from a host of withdrawal strategies, including the five popular choices listed below. You’d likely fare just fine with any of the five strategies—but that doesn’t mean you shouldn’t pick carefully.

1. Four percent rule. This rule specifies that retirees should spend 4% of their nest egg’s value in the first year of retirement, thereafter stepping up the annual sum withdrawn with inflation. History suggests that, with this approach, retirees shouldn’t run out of money over a 30-year retirement.

To avoid selling stocks during rough markets, it’s important to have at least enough in conservative investments to cover five years of portfolio withdrawals. For extra safety, some folks might want to hold seven or even 10 years’ worth.

2. Fixed withdrawal rate. Instead of the 4% rule, I’ve suggested in the past that retirees opt for perhaps a 5% withdrawal rate, and then each year withdraw that percentage of their portfolio’s beginning-of-year value.

This approach has two benefits. First, our spending is tied directly to our portfolio’s performance, and we could potentially spend more if the financial markets have great returns. Second, we’d never run out of money, because we’re always withdrawing a fixed percentage of whatever remains.

3. Required minimum distributions. Government-mandated withdrawals from retirement accounts involve drawing a rising percentage from these accounts each year as you advance through retirement and your life expectancy shortens.

Experts have suggested that retirees take these withdrawal percentages and apply them to their entire portfolio, including both retirement-account and taxable-account money. The IRS has a variety of tables for required minimum distributions. Those intrigued by this strategy should probably use the so-called uniform lifetime table.

4. Emptying buckets. There’s no universally agreed-upon bucket strategy, but the notion is that retirees employ perhaps three buckets of varying investment riskiness. These might include a low-risk bucket to cover spending over the next five years, a medium-risk bucket holding another five years of spending money, and a high-risk bucket that’s mostly invested in stocks.

As the low-risk bucket empties, retirees might refill it using dividends, interest and investment sales from the other two buckets. Many find the strategy comforting, because it offers the reassurance that spending money for the years ahead isn’t at risk of being devoured by a stock-market crash.

5. Setting a floor. How much do you spend each month on fixed living costs, such as housing, insurance premiums, utilities, groceries and so on? Between Social Security, dividends, interest, annuity income and any pension, you might aim to have enough regular income to cover at least these fixed costs, so a stock market crash wouldn’t derail your ability to pay the bills.

What about discretionary expenses, such as eating out, gifts to family and travel? For these costs, retirees could arrange even more regular monthly income. Alternatively, we might have a separate pool of money that’s invested more aggressively and hence offers the chance for growth. This will offer longer-term inflation-protection, though it also means we may need to trim discretionary spending during bad financial markets.

Which of the above strategies should folks favor? Each will give you slightly different annual income. Still, don’t assume the strategy generating the most spending money is necessarily the best.

Remember, the five withdrawal strategies are all layered on top of a retiree’s basic mix of stocks, bonds, cash and other investments. To be sure, we might tweak that investment mix to fit better with our chosen withdrawal strategy. Still, if we opt for a higher allocation to stocks, we’ll likely enjoy some combination of greater annual income and larger portfolio values over the course of our retirement, no matter which withdrawal strategy we use.

So, how should we pick among the various withdrawal strategies? I’d view them as behavioral aids, helping retirees to figure out how much they can spend each year and making it easier to cope with wild financial markets.

Think of these strategies as similar to dollar-cost averaging. While dollar averaging comes with some mathematical justification, it’s really a behavioral prop, making it emotionally easier for folks to buy into the stock market. There’s nothing wrong with that. But we shouldn’t kid ourselves: Folks may tout dollar-cost averaging as a superior way to invest, but it’s mostly about supplying the discipline we need.

Ditto for the withdrawal strategies outlined above. They’re just devices for taking the portfolio we have and generating income in a way we find emotionally palatable. Which strategy do you find most appealing? That’s probably the right one for you.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier articles.

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Spending It

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