Systematic Withdrawals Retirement Income:Investment, Assets, and Cash
Perhaps the most common way that people create retirement income is through the use of systematic withdrawals from their retirement investment programs. You simply choose how much you want to withdraw, and the mutual fund company, bank, or insurance company complies with your request. Most systematic withdrawals are programmed. This means that the request is automated to make your withdrawals easy and consistent.
The challenge becomes creating your systematic withdrawal program. To start, decide if your withdrawal program will be designed to liquidate that investment over some period of time, usually life expectancy, or to distribute income or earnings, leaving the core investment intact. You can also have the best of both worlds, choosing perhaps to leave 50 percent of the core assets intact.
If you choose to leave the core investment intact, you can simply have the earnings or interest sent to you on a monthly or quarterly basis. If you want to have a level distribution that doesn’t change each month, you’ll have to make some assumptions on the return on the investment and adjust your withdrawals up or down based on actual performance. You have to be careful when doing this, particularly in bear markets because you may eat away at your principal to the point where you’ll exhaust your assets prematurely.
On the other hand, you may want to simulate payments over life expectancy, using the assets. In that case, you have to determine what life expectancy you want to use and the rate of growth you want to assume on the asset. The rest is just math as we calculate the amount you can distribute. Of course, there is no guarantee your life expectancy estimate will be accurate, and you also don’t know in advance if the assumption you use for the rate of return will be accurate.
For illustration purposes, let’s look at how these two systematic withdrawal scenarios work out. We’ll assume an account with $500,000, an assumed interest rate of 4.3 percent for both examples, and we’ll use the combined life expectancy of 26 years for a married couple who are both 65 years old. In the first scenario, we exhaust principal and interest over the 26-year period. In the second scenario, we keep the principal intact and generate only interest income for the 26 years.
If we choose to distribute all of our assets over the joint life expectancy, we generate $30,982 annually. This is $9,500 more than if we distribute principal only, but if we outlive our life expectancy, we’ll be out of income. Using the interest only, we generate $21,500 and still have the original $500,000 in 26 years. Clearly, you can run as many “what if” scenarios as you like, and you’ll need to do that to reach your own conclusion as to how you want to distribute your retirement assets. These are the challenges we face in planning and investing for retirement. You can never start the retirement countdown too early.