There is no such thing as a free lunch. This popular adage, suggesting it is impossible to get something for nothing, comes from a common practice in the 1930s where American bars would offer a free lunch to entice drinking customers. Since the 1970s, it has been used in economic literature to describe opportunity costs, or trade-offs, in financial decision making. For retirees, we think the concept applies quite well to decisions about withdrawal strategies from their investment portfolios.

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• Fixed Real Withdrawal Rate– the most commonly used strategy. The retiree starts with a fixed withdrawal amount in the first year of retirement. Today that would be 4% of the portfolio (based on the 2023 safe withdrawal rate). Subsequent withdrawal dollar amounts are adjusted by inflation every year.
  
  Pros:
  
  • Predictable paycheck like income
    
  • Likely high ending portfolio value at death for beneficiaries
    
  Cons:
  
  • Doesn’t maximize lifetime withdrawal rates
    
  • Can lead to lower than preferred lifestyle and may leave too much money to beneficiaries
    
  Good balance of lifestyle and opportunity to leave money to heirs.
  
• Forgo Inflation Adjustment– compared with Strategy 1, the retiree starts with a higher fixed withdrawal amount in the first year of retirement. Subsequent withdrawals amounts are typically adjusted by inflation every year. However, to increase the likelihood of success, when the portfolio goes down substantially in value, you forgo the inflation adjustment in the following year. This change has a ripple effect through all subsequent withdrawal amounts.
  
  Pros:
  
  • Paycheck like equivalent, with some minor variation
    
  • Allows for higher initial spending than Strategy 1
    
  • The tradeoff for higher initial withdrawals is modest income reductions in the future if portfolios decline
    
  • Leads to lower but still healthy ending portfolio values than Strategy 1
    
  Cons:
  
  • While starting withdrawal amounts are higher, lifetime withdrawals will be lower in the case of adverse portfolio performance
    
  Good for retirees who want consistent income but a higher starting withdrawal amount.
  
• Treasury Inflation Protected Securities (TIPS) – This strategy involves purchasing individual TIPs foreach year of retirement and creates an essentially risk-free fixed withdrawal retirement strategy. Each year, an individual TIP matures and provides a fixed dollar amount adjusted for inflation.
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  Pros:
  
  • 100% success rate assuming the U.S. Government doesn’t default
    
  • Provides a higher safe withdrawal rate
    
  Cons:
  
  • Very rigid strategy and portfolio goes to zero after the last TIP matures
    
  • No equity upside for possible beneficiaries
    
  • More difficult strategy to implement
    
  Good for retirees who don’t have longevity risk and don’t plan to leave anything behind.
  
  Primary Objective: Highest Possible Withdrawal Rate
• Required Minimum Distributions (RMDs) - calculated by dividing the prior year’s ending account balance by your remaining life expectancy. The resulting number is the dollar amount you can withdraw during the year. This strategy allows for the highest starting and lifetime withdrawal rate of all the strategies analyzed by Morningstar.
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  Pros:
  
  • Much higher starting and lifetime withdrawal rates than other strategies
    
  Cons:
  
  • Annual spending amounts vary significantly - by 60% on a typical 60% equity/40% bond portfolio
    
  • Portfolio values at death are low if you want to leave money to beneficiaries
    
  Good for retirees with shorter than average life expectancy or have substantial other sources of income to cover fixed living expenses and don’t plan to leave money to beneficiaries.
  
• Higher Spending in Early Years – Withdrawal rates are based on a specific plan of spending, more in the first part of retirement and less in later years. Beware if income in later years is too low to support long term care unless a long-term care plan is in place.
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  Pros:
  
  • High cash flow predictability
    
  • More money available for spending when retirees are likely to spend the most
    
  • High expected ending portfolio value at death
    
  Cons:
  
  • Very low spending late in retirement can be a problem for long-term care
    
  • Does not maximize lifetime withdrawal rates
    
  Good for retirees who want to spend more in early retirement but still want the opportunity to leave substantial money to beneficiaries.
  
• Guardrails – After an initial withdrawal rate is set, guardrails determine future withdrawal rates dependent on market performance. If the portfolio goes up substantially withdrawal rates can increase, and if portfolio values decline substantially, withdrawal rates must decrease. This strategy is similar to the RMD, but it has slightly more stable cash flows.
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  Pros:
  
  • Allows for high initial and lifetime withdrawal rates.
    
  Cons:
  
  • More complicated and difficult to implement.
    
  • Highest cash flow volatility other than RMD strategy.
    
  • Low portfolio value at death if you want to leave money to beneficiaries.
    
  Good for retirees who prioritize spending over leaving money behind and don’t mind altering their spending based on portfolio performance.
  

• Even though you may have been good at saving for retirement, living off a retirement portfolio is entirely different.
  
• Understand your risks - those you can control and those you can’t control
  
• Over time, your goals may change, and you can always readjust your strategy.
  

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