Inflation is red-hot right now. With the annual inflation rate currently at the highest level it’s been since 1990, running at 6.2% year-over-year in October 2021, you may be wondering about how it will affect your retirement withdrawal strategy.
One of the biggest concerns that most people have is running out of money in retirement and deciding how much money to withdraw from your retirement savings each year is a complicated process.
The challenge from a higher rate of inflation is that you need more money to maintain your lifestyle.
However, unless your investments provide a higher rate of return, withdrawing more increases the likelihood of running out of money.
At the same time, a popular withdrawal strategy that provides a larger amount of income is falling out of favor.
The 4% rule
One of the most popular withdrawal strategies is the 4% rule.
It’s been around since the mid-1990s.
The basic premise of this strategy is that retirees can withdraw 4% of their portfolio savings in their first year of retirement.
In each subsequent year, that amount should be adjusted to account for inflation.
But some experts say that 4% is now too much money to withdraw.
Recent research from Morningstar suggests that a better starting withdrawal rate would be 3.3%.
Why could withdrawing 4% be too much?
The yields on bonds, which tend to be a popular investment option for retirees, have been extremely low in the last decade, while stocks have been very expensive.
These two factors make it unlikely that the 4% withdrawal rate will remain feasible for retirees.
With inflation high, a lower withdrawal rate would likely mean a reduction in your lifestyle.
However, there are strategies that can help retirees keep up with inflation rate possible without excessive risk:
- The assumptions used in the research skew to the more conservative side, basing on a 90% probability that a retiree won’t run out within 30 years; a less conservative approach could provide for a higher withdrawal rate.
- The 4% (or 3.3%) rule does not consider non-investment income sources like Social Security benefits; if you wait until full retirement age to begin collecting Social Security, you’ll have more income that automatically adjusts for inflation every year.
- Portfolios that have a higher allocation to stocks are riskier than balanced portfolios, but they tend to translate to higher lifetime withdrawal rates; with bond yields low, the case for leaning more heavily towards stocks is stronger than in the past.
- Tax planning within your portfolio that takes advantage of all three tax “buckets” – taxable, tax-deferred, and tax-free – can reduce your tax bill in retirement, leaving you with more money after you make your withdrawal (and reducing how much money you need to take out).
- This is probably the least appealing option but continuing to work will provide additional income and reduce your need to drawdown your savings.
The importance of planning
The combination of high inflation and lower returns make deciding on a withdrawal strategy harder than before.
If you’re thinking about retiring in the next year or two, now is the time to start narrowing down your options.
This challenging task can be made easier when working with a professional advisor.
If you find you need help (or just a second opinion), click here to schedule a free, no-obligation meeting with one of our advisors.
Alli Thomas has worked in the financial services industry for nearly 20 years, with a focus on retirement-related investing. She began her career as a FINRA-licensed participant-services call-center associate at Vanguard, and then moved to Principal Financial Group, where she worked closely with employers, assisting with retirement plan set-up and design, selecting appropriate plan investment offerings, and maximizing employee participation through targeted education campaigns and enrollment meetings. Alli has also worked as a qualified 401(k)administrator and registered investment advisor for several small investment firms. She now writes about all things investment- and finance-related, leveraging her extensive experience and passion for retirement planning to help investors make well-informed financial decisions.