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By Christine Benz | 06-11-2014 10:00 AM

A Prudent Plan for Retirement Withdrawals

Withdrawal policy statements provide concrete lines for retirees to identify when they need to adjust their spending rates and avoid on-the-fly decisions, says financial-planning expert Michael Kitces.

Michael Kitces is a partner and the director of research for Pinnacle Advisory Group, and publisher of the financial planning industry blog Nerd's Eye View. You can follow him on Twitter at @MichaelKitces or connect with him on Google+

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Investors have probably heard about the importance of having an investment policy statement, but they may be less familiar with a withdrawal policy statement.

Joining me to discuss why you might need one is Michael Kitces, a financial-planning expert. Michael, thank you so much for being here.

Michael Kitces: Great to be here again today.

Benz: Michael, you've got a great blog post on your website about withdrawal policy statements. People have heard about investment policy statements. I'd like to just start by doing a little stage setting. Why do we need policy statements for our portfolio and investment plans at all?

Kitces: To me the idea of policy statements at the most basic level is we're trying to come up with a framework about how we're going to deal with uncertain futures. I don't know everything that's coming down the road; I don't know what it's going to look like. It's really hard for us to react to everything that comes at us from life in real time because we get emotional and these are challenging times. And of course, it only matters when things are often more stressful and most difficult.

The whole concept of policy statements to me at the most basic level is having this framework about how we're going to deal with an uncertain future. Investment policy statements may say things like here are the parameters about how much we can adjust the portfolio, and which ways we can adjust it, and what kinds of investments we can own, and what kinds of investments we can't own. So at least we got a framework that as an investment manager is executing on an investment plan in the future, they know the rules of the game. They know how this is going to be played; they know what they're allowed to do and what they're not allowed to do.

To me the idea of a withdrawal policy statement functions in a very similar manner, except what we're doing with it in this case is that it's not necessarily for an investment manager who is managing the portfolio to know what the rules are and how to handle things. It's for us, or for our clients as retirees in our case, about how they are going to handle some of these uncertain futures. And so, its things like how will we handle market volatility with our spending? How much of a decline requires a spending cut? How much of a decline is actually OK? How much can markets go up before we can raise our spending? How much can markets go up where we just kind of stay where we are?

So, the idea is, if we set a series of policies and series of rules about that, then we know how to handle the situations when they come up, and we don't have to make what are often difficult decisions in real time.

Benz: You won't be making [decisions] on-the-fly, and it sounds like if you have taken the time to document what you are doing, you're maybe less likely to override it in the heat of the moment?

Kitces: Yes. That's part of the idea, as well. When we write down things, and we commit to them, it tends to make us a little bit more comfortable in sticking with them. To me in the truer sense, the real purpose of having a plan is kind of literally we know what we're going to execute on as we go. Plans can shift and change over time, and to me that's why we have policy statements, as well. So the plan is, "Well, here is what we're going to do if everything goes well, and maybe we can have a couple of contingency scenarios."

A policy statement sets a higher level that just says on an ongoing basis, "Here is how we're going to continue to execute that if and when and as plans change because life changes when circumstances change."

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