Varying Your Spending

WHEN WE THINK ABOUT THE FINANCIAL TOOLS available to us, we often overlook a key lever: our ability to control how much we spend. It is typically a lot easier to cut our spending than to increase our income. That is especially true once we are retired and no longer pulling in a paycheck.

No matter what, you’ll always have to cover your fixed monthly costs. That is why it’s important to know what that number is and keep it at a reasonable level. By contrast, it is pretty easy to cut out discretionary spending—things like eating out, going to the movies and taking vacations. This is discussed further in the chapter on spending.

That brings us to your retirement-income strategy. While a 4% withdrawal rate is a good guideline, you might potentially spend more, but with one proviso: If the markets have a major downturn, you immediately slash your spending and hence your portfolio withdrawals.

In fact, you might try a variation on the 4% withdrawal rate, which assumes you increase the sum withdrawn each year along with inflation. As an alternative, you could simply withdraw a sum each year equal to 5% of your beginning-of-year portfolio balance. Any dividends and interest payments would count toward the 5%.

In good markets, your annual withdrawals will automatically go up along with your portfolio’s value. In bad years, your withdrawals will go down. Because you’re always withdrawing a percentage of whatever you have left, you would never run out of money, though a string of bad years could leave you with drastically reduced income.

In the chapter on taxes, we discuss required minimum distributions, or RMDs. This is the sum those age 70½ and older must pull from their retirement accounts each year. Instead of using a 4% withdrawal rate or a similar strategy, some retirees base their annual spending on RMDs. This works pretty well as a rough-and-ready strategy and it does indeed force you to raise or lower your withdrawals, based on your retirement account’s performance. Still, just because the government says you have to withdraw a certain sum from your retirement accounts doesn’t mean that’s the right amount to spend—and you could be safe spending even more.

Next: Introduction to Social Security

Previous: Sequence-of-Return Risk

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