Increase the certainty of retirement while maximizing spending

A flexible withdrawal method for retirement accounts may be beneficial for some retirees.

An analysis of retirement withdrawal rates is not the most exciting topic in the world. What is exciting is a retirement filled with spending on trips, meals and socialising with family and friends. And unfortunately, the amount of money that can be safely withdrawn from super each year will dictate if your retirement means sipping champagne in Paris or eating canned beans in your child’s spare bedroom.

The challenge with retirement is that we don’t know how long it will last. That is a nice way of saying we don’t know the date of our death. We also don’t know what market returns will be during our retirement. Too much spending, a long life and poor market returns and it might be time to start being nicer to your children and developing a taste for beans.

The good news is that Morningstar has dug through the minutia of retirement withdrawal rates in our annual State of Retirement Income Report. The report is a comprehensive review of withdrawal rates. The intricacies of withdrawal rates and estimating how much you need for retirement.

What is the traditional withdrawal strategy?

Before defining flexible withdrawal rates it is important to understand the traditional way the financial planning industry has approached withdrawal strategies. A retire will select a percentage of a portfolio that will be withdrawn in the first year of retirement. A rate of 4% has traditionally been the figure used but there are lots of other considerations.

That percentage withdrawal rate will dictate how much is taken out of a portfolio the first year of retirement. After that the dollar figure will increase by inflation. That is why it is called a fixed withdrawal rate. While the dollar figure may increase by inflation the standard of living of fixed.

The ATO is not concerned with your safe withdrawal rate. They are trying to get money out of the tax advantaged super account. Money withdrawn from super does not need to be spent and individual spending decision should be based on individual circumstances and not on ATO rules.

What is a flexible withdrawal strategy?

Now that we have covered fixed withdrawal strategies we can explore flexible withdrawal strategies. The purpose of a flexible withdrawal strategy is to make retirement savings last longer and increase the amount that can be withdrawn in decent market conditions. To understand we need to explore a concept known as sequencing risk.

As an investor starts to sell off assets in a retirement account the return that is received in the early years of retirement matter. They matter a lot. If a portfolio is falling significantly in value during the early years of retirement while a retiree is selling off assets, retirement savings will not last as long. Even if the market rebounds there will be lower account balances due to the withdrawals to take advantage of climbing markets.

A flexible withdrawal strategy can help retirees that have the misfortune of retiring into a bear market. The benefits are not simply downside protection. Flexible withdrawals also allow all retirees to support a higher withdrawal rate.

There are several different types of flexible withdrawal strategies but all of them involve adjustments to the amount of money withdrawn based on market conditions.

While protecting a retiree if market conditions are poor early in retirement a flexible wirthdrawal strategy allows higher spending early in retirement.

Conclusion

Retirement spending is complex as there are a significant number of variables that influence how long a portfolio will last. All of these variables are based on an unknown future. The important consideration for a retiree who uses a flexible withdrawal strategy is that spending can shift year to year based on market conditions. This may be difficult in practice as retirees will need to constantly adjust their yearly spending.

Do you want to eliminate the uncertainties of how your life will look as you approach retirement? Humble Goode Financial is here to assist in ensuring that you are in the best position for the future.

Original Source: https://www.morningstar.com.au/insights/retirement/244743/increase-the-certainty-of-retirement-while-maximising-spending

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