When it comes time to start taking withdrawals from your retirement portfolio, there are several withdrawal methods you can use. What is most important to you? Is it having a constant withdrawal amount? Do you need the amount adjusted for inflation each year? Is protection of your principal more important, or do you want to spend it all and be flat broke just in time for the grim reaper? Maybe you want something in-between. Here we will explain some complicated-sounding strategies, such as “constant-dollar” and “constant-percentage.” But don’t worry — it won’t be as difficult as it sounds.

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Constant-dollar

A constant-dollar withdrawal is the most commonly discussed method. The famous Trinity Study considered what annual rate of retirement withdrawals retirees can sustain. In other words, what is the rate at which the retiree is not likely to run out of money?

When you apply this method, you take your first yearly withdrawal based on a percentage of your investment portfolio value (Trinity says 4%). In the second year your withdrawal amount will not be based on your portfolio’s value. Instead, you return to the first year withdrawal amount and adjust it upward at the rate of inflation. For the third and each subsequent year, you go back to the previous year’s withdrawal amount and then adjust it upward using the current rate of inflation.

The advantage of this method is that your withdrawals are predictable and constant in “real dollars.” This means your annual withdrawal amount maintains the same real spending power after inflation. The disadvantage is if the market starts a prolonged downturn just before or during your first few years of retirement, your assets could be substantially or entirely depleted as you continue to take a larger inflation-adjusted withdrawal each year.

You might prefer this method if you have relatively high fixed expenses, and you want the predictability of a constant ‘paycheck.’

Figure 1: Graph of constant-dollar yearly withdrawals and remaining portfolio value.

Constant-percentage

Let’s consider a constant-percentage withdrawal. Do you need to ensure you always have some savings left? If so, withdraw the same percentage annually based on your current portfolio balance. Because the value of your portfolio will change annually with the ups and downs of the financial markets, keep in mind the dollar amount you withdraw will also fluctuate from year-to-year.

The advantage of this method is its simplicity — just multiply your portfolio balance each year by your withdrawal percentage. Your portfolio still might decrease in value, depending on market conditions and the rate of withdrawal you choose, but you will never run out of money. The disadvantage is your withdrawal amounts will always fluctuate with your portfolio’s value. You’ll have to spend less in years when your portfolio value drops, and unless portfolio returns are good, you may not have enough in later years to keep up with inflation. You might prefer this method if you have lower fixed expenses — that is, year-to-year flexibility in spending.