Managing Withdrawal Rate Risk: How To Sustain Your Income Over the Next Decade

A smart withdrawal strategy isn’t just about numbers; it’s about finding the right balance between enjoying your retirement and making your money last. By staying flexible and planning for the unexpected, you can create a plan that fits your life.

You’ve spent decades saving and planning for retirement, but now a question looms: How do you make sure your money lasts? Whether you hope to leave a financial legacy or prefer to enjoy every penny, running out of money is not an option.

Figuring out how much to withdraw from your savings isn’t just a numbers game. Markets fluctuate, expenses evolve and surprises can throw even the best plans off track. The good news? With a bit of strategy, you can create a flexible withdrawal plan that adapts to life’s twists and turns. 

What Is the 4% Rule? And Why It May Not Be Enough

The 4% rule has been a go-to guideline for retirees since financial planner William Bengen introduced it in the 1990s. The premise is simple: Withdraw 4% of your retirement savings in the first year, and then adjust for inflation annually.

This strategy assumes your portfolio is invested in a 60/40 mix of stocks and bonds and is designed to last 30 years. For example, if you’ve saved $500,000, you’d withdraw $20,000 in year one and slightly more each year to account for inflation.

While this approach is a helpful starting point, it’s not perfect. Here’s why:

• Markets have changed. 
• Life isn’t static. 
• The rule is rigid. 

Markets Have Changed

When the 4% rule was created, bond yields were much higher, providing retirees with a predictable income stream. Today’s lower interest rates mean bonds generate less income, making it harder to rely on them for stability. At the same time, market volatility has increased, exposing retirees to sequence of returns risk, where withdrawing during a market downturn can deplete savings much faster than expected. Retirement plans need to account for these modern challenges.

Life Isn’t Static

Retirement spending is rarely the same year after year. Unexpected health care costs, which often rise as you age, can take a major bite out of your savings. Family obligations such as supporting children, grandchildren or aging parents can also throw off your budget. Even lifestyle choices such as early retirement travel or downsizing your home can shift your spending needs. Flexibility is key because life doesn’t follow a perfectly straight financial path in retirement.

The Rule Is Rigid.

The 4% rule assumes you’ll withdraw the same percentage annually no matter how the market or your life changes. If your portfolio dips, continuing to withdraw at the same rate could deplete your savings faster. Alternatively, if your investments outperform expectations, you might leave money on the table unnecessarily. A rigid approach doesn’t adapt to life events or portfolio performance.

Bottom line: While the 4% rule can help you set initial expectations, it’s not a one-size-fits-all solution.

A Flexible Alternative: Guardrails for Your Retirement Spending

Think of your spending plan as a journey. Guardrails act as boundaries that keep you from veering too far off course, whether you’re overspending or being unnecessarily frugal. 

What Are Guardrails?

Guardrails adjust your withdrawals based on your portfolio’s performance. When markets are up, you can spend more. When they’re down, you scale back to avoid depleting your savings too quickly. How you set your guardrails and at what amount you scale up or down your spending is an individual decision. Factors to consider are portfolio volatility, the inflation rate, and length of your remaining retirement.

Here’s how the process works:

1. Set a baseline spending range. Start with your basic needs, and then add “wants” such as travel and hobbies.
2. Establish upper and lower limits. If your portfolio grows beyond a certain point, you can safely increase spending. If it dips below a threshold, it’s time to cut back.
3. Make gradual adjustments. You stay on track by tweaking your spending in small amounts without making drastic changes.

Case Study: Guardrails in Action

For example, let’s say you retire with $1 million in savings. You could set guardrails to adjust spending based on the initial spending level and your portfolio’s future value:

• If your savings grow to $1.2 million, you increase withdrawals by $5,000 a year. 
• If your savings drop to $800,000, you reduce spending by $5,000 a year.

This approach keeps your plan dynamic, ensuring you neither overspend in good years nor put yourself at risk in bad ones. As you progress in retirement, you may decide to change these thresholds or the amount you adjust your spending. 

Adapting When Markets Decline

Market downturns are inevitable, but they don’t have to derail your retirement. Here’s how to handle them:

• Pause discretionary spending.

 During market downturns, it’s important to temporarily cut back on discretionary spending such as vacations, new cars and home improvements until the market recovers. This approach helps protect your savings from additional drawdowns when your portfolio may already be underperforming. By focusing on essential spending, you can avoid further depletion of your retirement funds and give your investments a chance to rebound.

• Lean on cash reserves. 

Maintaining a dedicated cash buffer can be a game changer during market downturns. Cash reserves allow you to cover immediate living expenses such as housing, food and health care without withdrawing from your investments at a loss. This strategy gives your investments the time they need to recover without the pressure of needing to perform in the short term.

• Rebalance your portfolio. 

Consider reallocating by selling assets that have outperformed or become overrepresented in your portfolio. Use the proceeds to buy assets that have underperformed or are undervalued, aligning your portfolio with your original investment strategy and risk tolerance. This proactive step can prevent the need for panic-driven changes when markets are at their lowest. 

Example: Riding Out a Downturn

During a market slump, a retiree with $500,000 reduces discretionary spending by 10% for two years. By leaning on cash reserves and postponing large purchases, their portfolio recovers faster than if they’d withdrawn at their usual rate.

The Role of Guaranteed Income

Guaranteed income sources such as Social Security, pensions and annuities provide a steady stream of money, reducing the pressure on your investment portfolio. 

Consider how the following income sources fit into your overall plan.

Social Security

To maximize your benefit, carefully consider when to start claiming your Social Security. While delaying your benefits can significantly boost your monthly payout — up to 8% per year from your full retirement age until age 70 — it’s also worth considering claiming at your FRA or sooner if you need the income. Balancing the need for income with your longevity expectations can help determine the best strategy.

Annuities

Annuities are insurance products that can provide a guaranteed income stream for life, which is particularly valuable for retirees concerned about outliving their savings. However, they can come with trade-offs — typically, lower flexibility and higher fees. Evaluating your financial goals and risk tolerance and the terms of the annuity before investing is crucial. Annuities can be an effective way to cover basic living expenses, but they should be considered as part of a broader retirement strategy.

Tax Strategies for Smarter Withdrawals

Taxes can eat into your retirement savings if you’re not careful. Here’s how to minimize the impact:

• Use tax-efficient withdrawal strategies. Start with taxable accounts, and then move to tax-deferred accounts such as traditional individual retirement accounts. Leave Roth accounts for last, as withdrawals are tax-free.
• Plan for required minimum distributions. You’re required to take RMDs from traditional retirement accounts once you turn 73. Plan ahead to avoid penalties.
• Consider Roth conversions. If you’re in a low tax bracket early in retirement, converting some savings to a Roth IRA can reduce taxes later.

The Emotional Side of Spending in Retirement

Spending your hard-earned savings can feel uncomfortable. Many retirees struggle with guilt about withdrawing funds or anxiety about running out of money.

To ease those fears, do the following:

• Understand your plan. Knowing your guardrails can provide confidence and reduce the stress of day-to-day decisions.
• Focus on what you can control. While you can’t predict the market, you can control your spending and savings habits.
• Work with a professional. A financial planner can help you navigate the emotional and practical sides of retirement spending.

Final Thoughts

Managing your withdrawals isn’t just about crunching numbers; it’s about balancing financial security with an enjoyable retirement. By adopting flexible strategies such as using guardrails, leveraging guaranteed income and planning for taxes, you can create a retirement plan that fits your goals and lifestyle.

Editor Norah Layne contributed to this article.