Author Topic: Strategies when withdrawing less than planned in retirement  (Read 3068 times)

CanuckExpat

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Strategies when withdrawing less than planned in retirement
« on: August 23, 2017, 11:00:55 PM »
I'm looking for thoughts, articles, and studies on draw down methods that account for either "lumpy" spending, or what strategies you might employ in retirement for years when you find yourself drawing down much less than you planned

Would you keep it invested, adjust your asset allocation, withdraw the planned annual amount but use the unspent portion to increase cash reserves (perhaps with maximum set on cash reserves)?

I imagine from portfolio growth perspective, the preferred method would be to keep the unspent portion invested, however, I think there will be trade offs with a risk management and psychological perspective (i.e. taking risk off the table if you've already won the game).

Hopefully this is clear as I've written it, but can add more details on what has me wondering this if helpful.

honeybbq

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Re: Strategies when withdrawing less than planned in retirement
« Reply #1 on: August 24, 2017, 11:01:47 AM »
Well, what else could you do with the money? Assuming you have a buffer, are you leaving an estate? Can you give more to charity? Take another trip?

I guess I'd just leave it invested and keep on keeping on.

GuitarStv

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Re: Strategies when withdrawing less than planned in retirement
« Reply #2 on: August 24, 2017, 11:08:03 AM »
If it was a bad idea to keep piles of cash sitting around before being retired, it's still a bad idea.  Money that you don't use should do what money that you don't use has always done . . . stay in the investment accounts.  If your asset allocation is way off, re-balance it.

K60

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Re: Strategies when withdrawing less than planned in retirement
« Reply #3 on: August 24, 2017, 11:31:04 AM »
This is a good reference:

http://jlcollinsnh.com/2014/08/25/stocks-part-xxvi-pulling-the-4/

Interesting how Jim is transferring from traditional IRA to ROTH even after he has retired.  But, basically, keep funds invested as long as you can.

Also, Nords has commented about this on these boards.  As I recall, he put 3 years expenses in laddered CDs after he retired and renewed one every year to safeguard against a severe market downturn.  Otherwise, keep funds invested.


Mr. Green

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Re: Strategies when withdrawing less than planned in retirement
« Reply #4 on: August 24, 2017, 06:07:32 PM »
Leave it invested. The extra growth will add extra padding so that if the future does end up being worse than the past you'll be that much more likely to still be okay. Then if things turn out to be just like they have been you'll be able to make some large donations, or raise your spending a bit, later in life!

CanuckExpat

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Re: Strategies when withdrawing less than planned in retirement
« Reply #5 on: August 25, 2017, 01:08:28 PM »
Well, what else could you do with the money? Assuming you have a buffer, are you leaving an estate? Can you give more to charity? Take another trip?

It's too early to say that we are spending less than planned long term, if that was the case I could find some ways to increase mindful spending and more charity. Right now we've had one year of much lower than planned withdrawals, but I would say there's a possibility of some years of higher than planned withdrawals in the future. Wondering how to use the lower withdrawal years to best plan for and mitigate the possible but unknown future higher withdrawal years.

If it was a bad idea to keep piles of cash sitting around before being retired, it's still a bad idea.  Money that you don't use should do what money that you don't use has always done . . . stay in the investment accounts.  If your asset allocation is way off, re-balance it.

The difference is once you start retirement, you have to worry about sequence of returns risk, and what I'm wondering about I suppose could be called sequence of withdrawal. I'm wondering if you can mitigate any risks somewhat if it seems your withdrawal needs are very uneven.

I'll try making up an example of what I'm worried about. Person A and Person B both retire with one million dollars, and plan to spend $40k annually.
Person A ends up withdrawing $40k each year as planned.
Person B withdraws $10k the first year and $70k the second year.
Say markets go down 10% the first year and up 20% the second year (both people withdraw their money on the first day of year for simplicity)

Person A ends up with $3,600 more invested at the end of the two years, even though they took out the same total amount of money and had the same market returns. In this case, Person B could have forced their withdrawals to be the same as A (though it's only with hindsight we know that would have been beneficial).

So going through that exercise, I see I had to make a pretty extreme example of uneven withdrawals and market swings to make a small difference over two years. Not sure if it's a sign of nothing to worry about at all, or something that could possibly build up over time. Also I know you can just as easily make an example where Person B comes out ahead because of the uneven withdrawals.

Leave it invested. The extra growth will add extra padding so that if the future does end up being worse than the past you'll be that much more likely to still be okay. Then if things turn out to be just like they have been you'll be able to make some large donations, or raise your spending a bit, later in life!

This is probably right on average. I'm not sure how to make the risk adjusted choice between trying to even out spending if possible and needed as opposed to just leaving as much invested as possible and hope you don't run into a bad sequence of returns and withdrawals. There probably is no way to answer that prospectively, but was wondering if anyone had examined it in more detail.

CanuckExpat

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Re: Strategies when withdrawing less than planned in retirement
« Reply #6 on: August 25, 2017, 01:10:16 PM »
I have very lumpy annual expenses too so what I do is just have a set amount go into a money market savings account each year (or month) and draw on that. If anything is left beyond the EF cushion amount I keep in that account I either spend on fun stuff or re-invest. I might lose out on some earnings but because my expenses (other than low barebones expenses) can vary a lot I feel more comfortable this way.

I like this and it's similar to what I have been thinking about leaning towards, more for peace of mind, liquidity, and lazyness reasons. How do you decide the amount of that cushion?

GuitarStv

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Re: Strategies when withdrawing less than planned in retirement
« Reply #7 on: August 25, 2017, 02:40:03 PM »
If it was a bad idea to keep piles of cash sitting around before being retired, it's still a bad idea.  Money that you don't use should do what money that you don't use has always done . . . stay in the investment accounts.  If your asset allocation is way off, re-balance it.

The difference is once you start retirement, you have to worry about sequence of returns risk, and what I'm wondering about I suppose could be called sequence of withdrawal. I'm wondering if you can mitigate any risks somewhat if it seems your withdrawal needs are very uneven.

I'll try making up an example of what I'm worried about. Person A and Person B both retire with one million dollars, and plan to spend $40k annually.
Person A ends up withdrawing $40k each year as planned.
Person B withdraws $10k the first year and $70k the second year.
Say markets go down 10% the first year and up 20% the second year (both people withdraw their money on the first day of year for simplicity)

Person A ends up with $3,600 more invested at the end of the two years, even though they took out the same total amount of money and had the same market returns. In this case, Person B could have forced their withdrawals to be the same as A (though it's only with hindsight we know that would have been beneficial).

So going through that exercise, I see I had to make a pretty extreme example of uneven withdrawals and market swings to make a small difference over two years. Not sure if it's a sign of nothing to worry about at all, or something that could possibly build up over time. Also I know you can just as easily make an example where Person B comes out ahead because of the uneven withdrawals.

You've planned a particular withdrawal rate in retirement.  Your goal should be to be at or below that rate every year.  In your example, year two is nearly double the withdrawal rate of year one.  The reason that scenario is failing is that they've totally thrown the plan out the window.

If you're living on investment income and the markets do poorly you should be aiming to reduce expenses, not to double them.

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Re: Strategies when withdrawing less than planned in retirement
« Reply #8 on: August 25, 2017, 03:04:39 PM »
I know people who do it both ways - save the "unspent" in additional cash reserves, or put it back in the portfolio for further growth.

To me it really comes down to what is the best marginal increase in happiness for each additional "extra" dollar:

1.  Spend it now on something fun,
2.  Give it away to kids or charity,
3.  Save it in cash which reduces short-term risk, or
4.  Stick it in investments which reduces long-term risk.

Mostly I am choosing door #3 because I'm newly FIREd and have higher expenses the next three years (well, 1009 days, but who's counting?) until my child support ends, so that is what, dollar-for-dollar, makes me happiest.  But that is just me.

Really large cash reserves can have slightly deleterious effects on long-term portfolio survival.  I would periodically check one's AA and duration and WR in cFIREsim to make sure one is still comfortable with the results.

As time goes by my priorities and situation could change and I could see myself choosing one of the other options.  I think it is good to remain flexible and re-evaluate as things change.

Eric

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Re: Strategies when withdrawing less than planned in retirement
« Reply #9 on: August 25, 2017, 07:12:03 PM »
Has anyone mentioned taxes yet?  Without doing the math, I'd guess that $10k + $70k would result in a higher tax bill than $40k + $40k.

CanuckExpat

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Re: Strategies when withdrawing less than planned in retirement
« Reply #10 on: August 25, 2017, 09:28:13 PM »
You've planned a particular withdrawal rate in retirement.  Your goal should be to be at or below that rate every year.  In your example, year two is nearly double the withdrawal rate of year one.  The reason that scenario is failing is that they've totally thrown the plan out the window.

I'm not sure if you are being to strict with your requirements. In practice expenses are going to be variable from year to year, and some years you are going to spend less than your planned rate, and some years more (unless you are just more diligent or lucky with planning than I imagine my self to be). If you average to roughly your planned spending, I'd consider that following the plan, you seem to be imposing stricter requirements than I would.
Most of the studies that withdrawal plans are based on do follow spending patterns closer to what you are suggesting, but I think that's only because it's easier to model, not because it's what happens in reality.

I've been surprised by how much more variable our spending (and associated side/fun) income has been in first bit of retirement compared to while working. Granted some of that is because our life is irregular while travelling, etc. The good news is it's been irregular towards the conservative side: spending less, making a bit more than planned. But I don't want to be caught unprepared when the other shoe drops and it ends up being higher withdrawals.

Has anyone mentioned taxes yet?  Without doing the math, I'd guess that $10k + $70k would result in a higher tax bill than $40k + $40k.

That's another complicating factor. I was thinking the best time to reconcile some of this stuff is towards the end of Dec annually. i.e. we spent this much so far, it deviates, so much form our plan. We have so much tax free room remaining if we want to withdraw extra.

I know people who do it both ways - save the "unspent" in additional cash reserves, or put it back in the portfolio for further growth.

To me it really comes down to what is the best marginal increase in happiness for each additional "extra" dollar:

1.  Spend it now on something fun,
2.  Give it away to kids or charity,
3.  Save it in cash which reduces short-term risk, or
4.  Stick it in investments which reduces long-term risk

...

As time goes by my priorities and situation could change and I could see myself choosing one of the other options.  I think it is good to remain flexible and re-evaluate as things change.

That's a good way of thinking about it, both points. I find myself drawn to #3 as well, thought I'm not sure why. I think it's because this withdrawal phase is so new, I'm more worried about short term risks. I imagine with several years under your belt, you start to take it all more in stride.

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Re: Strategies when withdrawing less than planned in retirement
« Reply #11 on: August 26, 2017, 07:58:00 AM »
You've planned a particular withdrawal rate in retirement.  Your goal should be to be at or below that rate every year.  In your example, year two is nearly double the withdrawal rate of year one.  The reason that scenario is failing is that they've totally thrown the plan out the window.

I'm not sure if you are being to strict with your requirements. In practice expenses are going to be variable from year to year, and some years you are going to spend less than your planned rate, and some years more (unless you are just more diligent or lucky with planning than I imagine my self to be). If you average to roughly your planned spending, I'd consider that following the plan, you seem to be imposing stricter requirements than I would.
Most of the studies that withdrawal plans are based on do follow spending patterns closer to what you are suggesting, but I think that's only because it's easier to model, not because it's what happens in reality.

I've been surprised by how much more variable our spending (and associated side/fun) income has been in first bit of retirement compared to while working. Granted some of that is because our life is irregular while travelling, etc. The good news is it's been irregular towards the conservative side: spending less, making a bit more than planned. But I don't want to be caught unprepared when the other shoe drops and it ends up being higher withdrawals.

Sure, there are going to be occasional one time expenses . . . stuff like needing a new roof.  These should largely be something that you can plan for ahead of time though.  If you're expecting to need a new roof on the house and 100% in stocks, then I'd pull out and save some money to put towards that expense in cash each year.

My investments are a mix of stocks and bonds.  If the market tanks or does really well, I'd rebalance before withdrawing money . . . which would minimize losses/lock in gains due to volatility.  If something really wacky happens and it looks like I'd lose a tremendous amount doing that, I'm not above taking a job for the year to protect my investments.

Nords

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Re: Strategies when withdrawing less than planned in retirement
« Reply #12 on: August 27, 2017, 01:26:11 PM »
This is a good reference:

http://jlcollinsnh.com/2014/08/25/stocks-part-xxvi-pulling-the-4/

Interesting how Jim is transferring from traditional IRA to ROTH even after he has retired.  But, basically, keep funds invested as long as you can.

Also, Nords has commented about this on these boards.  As I recall, he put 3 years expenses in laddered CDs after he retired and renewed one every year to safeguard against a severe market downturn.  Otherwise, keep funds invested.
Thanks, K60!

The details are that we kept two years of expenses in cash (8% of our asset allocation, in a money market and laddered three-year CDs) because most bear markets last for two years.

In addition, we only did that for the sequence-of-returns risk which is prevalent during the first decade of a 30-year 4% SWR.  By the end of the first decade it's quite likely that the portfolio has grown way beyond the vulnerability to sequence-of-returns risk.  That was our experience (inherent in the success rate of the 4% SWR) so we no longer allocate two years' expenses in cash.

----------

Canuck, let me start by saying that you might be overthinking it.  Market volatility is a part of the 4% SWR simulation and humans are not mindless 4% SWR robots.  Most years you won't even spend your full amount of your 4% SWR withdrawal.  The first thing you'll do after you reach financial independence is give your expenses a thorough scrub to optimize your spending for the things you really care about.  That will probably reduce your actual expenses below their (already conservative) projected levels.

When a recession hits, then like other humans you'll probably cut back on your discretionary expenses.  Sure, you'll bargain-shop (especially for investments), but I doubt you'll be making it rain at the local club just because the cover charge is now half-price.

It's too early to say that we are spending less than planned long term, if that was the case I could find some ways to increase mindful spending and more charity. Right now we've had one year of much lower than planned withdrawals, but I would say there's a possibility of some years of higher than planned withdrawals in the future. Wondering how to use the lower withdrawal years to best plan for and mitigate the possible but unknown future higher withdrawal years.

The difference is once you start retirement, you have to worry about sequence of returns risk, and what I'm wondering about I suppose could be called sequence of withdrawal. I'm wondering if you can mitigate any risks somewhat if it seems your withdrawal needs are very uneven.

This is probably right on average. I'm not sure how to make the risk adjusted choice between trying to even out spending if possible and needed as opposed to just leaving as much invested as possible and hope you don't run into a bad sequence of returns and withdrawals. There probably is no way to answer that prospectively, but was wondering if anyone had examined it in more detail.
This is why we kept that two-year cash stash for the first decade of FI.  We no longer do so.

If you want to tailor your variable spending to variable market conditions, then Wade Pfau has a good summary here.
https://retirementresearcher.com/10-variable-spending-strategies-retirees-consider/

Here's how our portfolio has fared after 15 years of FI:
http://the-military-guide.com/hey-nords-hows-net-worth/

For those of you bloggers who are interested in search-engine optimization, check out the results when you search for phrases like "Hey Nords" or MMM's "badassity" or "complainypants". 

CanuckExpat

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Re: Strategies when withdrawing less than planned in retirement
« Reply #13 on: August 27, 2017, 09:02:11 PM »
Canuck, let me start by saying that you might be overthinking it.  Market volatility is a part of the 4% SWR simulation and humans are not mindless 4% SWR robots.  Most years you won't even spend your full amount of your 4% SWR withdrawal.  The first thing you'll do after you reach financial independence is give your expenses a thorough scrub to optimize your spending for the things you really care about.  That will probably reduce your actual expenses below their (already conservative) projected levels.
...
If you want to tailor your variable spending to variable market conditions, then Wade Pfau has a good summary here.
https://retirementresearcher.com/10-variable-spending-strategies-retirees-consider/

Thanks for the input Nord. I'll more than concede I probably am over thinking it, but this has raised my curiosity recently. Part of it might be the aspect you mentioned: I wasn't expecting our expenses to drop in FI, but between scrubbing expenses, and a little bit of unexpected income, the withdrawal rates look lower than expected (perhaps temporary). I think I've read Pfau's longer article on the variable withdrawal methods, and that's part of also what got me thinking about it. I like the Variable percentage withdrawal method, and Vanguard's Percentage Floor-and-Ceiling Withdrawals but then I wasn't sure what to do with that. Each of those tell me I can spend more money in an up year, but short of buying hookers and blow, not sure we need nor want to spend more on anything now but what if we do want to in a future year where the markets are down?
Like you said, I'm probably over thinking it and looking for a problem in what should be a good thing.

More specific to our situation, part of my reason to think of increasing cash reserves is that since at some point we might want to buy a primary residence again, for unknown amount of money, I wouldn't mind increasing that reserve fund while we are withdrawing less.

A less good reason is, since the markets are soaring, the variable withdrawal rules tell us we can spend more, and I wouldn't mind "capturing gains" but I think that's a bit of market timing I should avoid...