Taking Out Retirement Money

Staying the course in a rollercoaster stock market challenges both you and your financial advisor – a challenge made even tougher when you take your retirement distributions. Here’s how a withdrawal policy statement (WPS) helps avoid panicked investing moves.

When market volatility coincides with your ongoing withdrawals in retirement, too many bad returns in a row can deplete your portfolio. Retirement researcher and financial planner Jon Guyton suggests a WPS to articulate parameters and guidelines about funding your withdrawals, clarify how you respond to a market calamity and determine in advance what you and your advisor do to keep your plan on track.

As Guyton explains, the WPS must be broad enough to handle unexpected situations and specific enough to leave little doubt about what you do in down markets using recorded expectations, tools and tactics.

Rebalancing your portfolio, for instance, might be difficult for you in a heated moment when the market plunges. A policy that already stipulates periodic rebalancing under certain conditions removes your uncertainty of what to do. The real key for a WPS is not about how your portfolio will change with market volatility but how to adjust your spending.

Guyton suggests that your WPS cover five key areas:

·         your income goals that withdrawals must meet;

·         your assets to fund your goals;

·         your initial withdrawal rate;

·         the method for determining the source of each year’s withdrawal income from the portfolio; and,

·         the method for determining the withdrawal amount in subsequent years, including both the trigger points for adjustments (other than an inflation-based increase) and the size of the adjustment.

The first two are already in a good financial plan. The third seems straightforward to set without a WPS. The real keys are the last two items, which truly establish a plan for funding, implementing and adjusting as needed your retirement cash flow.

For instance, the fourth item might stipulate withdrawals primarily from cash and fixed-income assets but not from equities, unless the latter finished up in the prior year, or no other cash or fixed funds remain. Another possible stipulation: You hold interest and dividends in cash and do not reinvest to further supplement the withdrawals pool.

The fifth item might specify something like the rules in Guyton’s prior research on decision rules-based withdrawal rates. Under these, you increase retirement spending each year by the rate of inflation (if your prior-year returns were positive) and continuously monitor the withdrawal rate and cut spending if the rate rises more than 20% from where it started (for example, rises above 6% if it was 5% initially). Conversely, you boost your spending if the current withdrawal rate falls more than 20% from its origin.

A WPS also works well paired with an investment policy statement that spells out your investment changes in response to a market rise or fall.

For example, let’s say your $1,050,000 portfolio plummets in value to $930,000. If you spend $55,000 a year, your withdrawal rate just jumped from 5.2% to 5.9%. Your WPS, though, stipulates no action until your withdrawal rate exceeds 6%.

You then clearly see no need to worry until your portfolio falls below $916,000. Even then, as your written and set action plan says simply (and unemotionally), “Cut spending 10% if the current withdrawal rate rises above 6%.” You might even plan exactly what those 10% spending cuts will be so you know what to do if or when the time comes.

Compared to the terrifying uncertainty inherent in such panicky questions as ”Have I lost too much money? When am I down too much to recover? How do I know when to act?”, your WPS sets clear targets regarding actionable market declines and appropriate action to get you back on track – without more drastic actions like bailing out of the market.

(Take a look at this sample WPS.)

A WPS doesn’t take all emotions out of your investment and portfolio decisions. It does define a clear moment for action in what will likely be a scary time. And your policy isn’t just about disasters: It also specifies conditions under which spending rises, giving you something to shoot for on investing’s upside.

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Michael Kitces, MSFS, MTAX, CFP, CLU, ChFC, is a partner and the director of research for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Md., that oversees approximately $1 billion of client assets, and Pinnacle Advisor Solutions, a firm that provides outsourced investment management services for financial advisors. He is the publisher of the e-letter The Kitces Report and the blog Nerd’s Eye View through his website www.Kitces.com. Kitces is also one of the 2010 recipients of the Financial Planning Association’s “Heart of Financial Planning” awards for his dedication to advancing the financial planning profession. Follow Kitces on Twitter at @MichaelKitces or connect with him on Google+.

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