Our firm has worked with retirees for over 30 years, and it is a common practice to help our clients turn their nest eggs into a reliable retirement income stream.
Investors seem to have a variety of preferences on how to take distributions from their retirement accounts. Some investors prefer to take income from their nest eggs monthly. Other investors prefer taking annual lump sum distributions that are placed in their bank accounts. They will typically draw income from these bank accounts throughout the year to help supplement their retirement income needs. It is common for investors to ask us what the best strategy is for retirement withdrawals.
The purpose of this article is to shed light on a few common distribution strategies investors use in retirement.
Three Popular Strategies For Taking Income From Investments In Retirement
To help understand the historically best options for taking income from investments in retirement, I will focus on three popular strategies.
First, some people like to take a large distribution at the beginning of the year. Frequently, this distribution is transferred to a bank account the investor sporadically withdraws money from over the year to help supplement their retirement income.
Second, some investors prefer to take one large distribution at the end of the year, which is also invested into a bank account and used as income during the following year.
The third and final popular strategy is to take monthly income distributions from the investor’s nest egg, which are typically wired to a bank account of the investor’s choosing.
Historical Back Test
Since our firm receives many questions on which of the three strategies is the best, I felt it would make sense to do a historical back test. The historical back test our firm conducted is designed to simulate an actual retiree distribution strategy based on the three strategies mentioned above by utilizing historical market returns.
For this analysis, we assumed an investor began their retirement with a $1,000,000 portfolio value. We also assumed this investor had a starting withdrawal amount of 4% of the portfolio’s value. This starting distribution is indexed to keep pace with inflation by increasing the annual withdrawal amount by a 3% inflation rate. For example, in year one, the investor would have withdrawn $40,000 which is 4% of $1,000,000. Year two’s distribution would be $41,200, which represents a 3% inflation increase to year one’s income. Each subsequent year would continue to get an additional 3% inflation increase.
We also assumed the investor continued to take this income stream from their nest egg over a 30-year time horizon. Finally, we assumed that the investor had a portfolio that was 60% invested in the S&P 500, 40% invested in the aggregate bond index and that the portfolio was rebalanced back to those same percentages on an annual basis.
We analyzed this for every 30-year time horizon as far back as we could get consistent data for both indices used, which started in 1976. The first 30-year time horizon started in 1976 and ended in 2005. The second 30-year time horizon started in 1977 and ended in 2006. We continued this until the starting year of 1994, which ended in 2023 because this is the last 30-year time horizon available, as of this writing.
Which Popular Strategy Is The Best?
The Results
• 1st place: End-of-the-year withdrawal.
• 2nd place: Monthly withdrawals.
• 3rd place: Beginning-of-the-year withdrawal.
Taking income at the end of the year yielded the best results and improved the average 30-year ending portfolio balance by 8.65% over the beginning of the year withdrawal strategy, and 3.84% over the monthly income strategy. The results make sense as both bonds and stocks tend to go up more years than they go down, which provides the end-of-year withdrawal strategy greater time for the portfolio to experience this market appreciation.
It’s important to note, however, that the hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
Additional Considerations
End-Of-Year Strategy
In addition to providing the greatest wealth accumulation of the three strategies analyzed, the end-of-year strategy has additional strategic benefits. It can be excellent for tax planning as the investor will have a better understanding of the year’s tax situation at the end of the year, which can help them determine the most beneficial retirement accounts to take the distribution from.
Monthly Strategy
It could be argued the monthly strategy also has strategic benefits from the perspective that it can provide a built-in budget. Receiving a monthly distribution can be more manageable than trying to stretch out a lump sum distribution over a full year.
Beginning-Of-Year Strategy
I find that many people choose this strategy for peace of mind, especially after a strong performance in the markets. I think investors appreciate the certainty of having their money in hand and therefore do not have to worry about taking a distribution if a downturn occurs later in the year.
Conclusion
Each retirement distribution strategy carries its own benefits and drawbacks. Determining the one that is best for you depends on a combination of psychological and financial considerations.
Hopefully, this article has provided you with the knowledge necessary to help you make a more confident retirement distribution strategy.
Originally published in Forbes on May 7, 2024.
The use of Ty Bernicke’s research or publication of articles he has written does not indicate an endorsement of his work as an Investment Advisor. The publications did not receive compensation for publishing Mr. Bernicke’s work.
The views expressed represent the opinion of Bernicke Wealth Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Bernicke Wealth Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Bernicke Wealth Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in equity securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations.
