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Investing Specialists

7 Retirement-Portfolio Withdrawal Mistakes to Avoid

Asset allocation, time horizons, and taxes can complicate withdrawal-rate planning.

Note: This article is part of Morningstar's September 2016 Retirement Matters Week special report. A version of this article appeared on June 25, 2015.

Some errors in retirement-portfolio planning fall into the category of minor infractions rather than major missteps. Did you downplay foreign stocks versus standard asset-allocation advice, or hold a bit more cash than you needed? It's probably not going to have a big impact on whether your money lasts throughout your retirement years.

But other errors can have more serious repercussions for the viability of retirement-portfolio plans. For example, holding too much company stock or maintaining a much-too-meek asset allocation can more seriously affect a portfolio's long-run viability.

Withdrawal rates are another spot where retiree-portfolio plans can go badly awry. If a retiree takes too much out of her portfolio at the outset of retirement--and, worse yet, that overspending coincides with a difficult market environment--she can deal her portfolio a blow from which it may never recover. Other retirees may take far less than they actually could, all in the name of safety. While their children and grandchildren may thank them for all they left behind, the risk is that they didn't fully enjoy enough of their money during their lifetimes.

Here are seven common mistakes in the realm of retirement-portfolio withdrawals, as well as tips on how to avoid them.

Mistake 1: Not Adjusting With Your Portfolio's Value and Market Conditions
Some of the most important research in retirement-portfolio planning over the past decade has come in the realm of withdrawal rates. One of the conclusions of all of this research? Even though the popular "4% rule" assumes a static annual-dollar-withdrawal amount, adjusted for inflation, retirees would be better off staying flexible about their withdrawals, taking less when the markets and their portfolios are down, while potentially taking more when the market and their portfolios are up.

What to Do Instead: The simplest way to tether your withdrawal rate to your portfolio's performance is to withdraw a fixed percentage, versus a fixed dollar amount adjusted for inflation, year in and year out. That's intuitively appealing, but this approach may lead to more radical swings in spending than is desirable for many retirees. It's possible to find a more comfortable middle ground by using a fixed percentage rate as a baseline but bounding those withdrawals with a "ceiling" and "floor." Financial planner Jonathan Guyton delved into a flexible withdrawal rate with "guardrails" in this research paper, and this Vanguard research takes a similar tack.

Mistake 2: Not Building In a 'Fudge Factor'
Another drawback to employing a fixed-dollar withdrawal method--especially if the viability of your plan revolves around a fixed annual dollar amount that's too low--is that it won't account for the fact that your actual expenses are likely to vary from one year to the next. Try as you might to anticipate them, discretionary expenditures like travel or new car purchases, or unplanned outlays for home repairs or medical expenses, have the potential to throw your planned withdrawal rate off track. If you calibrate your anticipated spending based on your basic monthly outlay alone--groceries and utilities, your property-tax bill, and so forth--and don't leave room for these periodic unplanned expenses, your actual spending rate in most years is apt to run higher than your planned outlay. In short, a withdrawal plan that looked sustainable on paper actually may not be.

What to Do Instead: Smart retirement planning means forecasting not just your regular budget items but those lumpy outlays, too, whether special travel plans or new car purchases. In addition to building those extraneous items into your budget, it's also wise to add a "fudge factor" in case those unplanned outlays exceed your forecasts. How much padding to add depends on both how specific you have been in forecasting your expenses (the more specific and forward-looking your forecasts, the less of a fudge factor you'd need to add) as well as how conservative you are (if you don't want even the slightest chance of running out of money, you'll need to add more padding/assume a higher spending rate). Armed with that more-accurate depiction of your anticipated spending, you can then test the viability of your withdrawal rate. This article provides a step-by-step framework for customizing your in-retirement spending.

Mistake 3: Not Adjusting With Your Time Horizon
Taking a fixed amount from a portfolio--whether you're using a fixed dollar amount or a fixed percentage rate--also neglects the fact that, as you age, you can safely take more from your portfolio than you could when you were younger. (That assumes, of course, that you're planning to spend most of your portfolio and are not planning to leave behind large sums for your heirs or for charity.) The original "4%" research assumed a 30-year time horizon, but retirees with shorter time horizons (life expectancies) of 10 to 15 years can reasonably take higher amounts.

What to Do Instead:To help factor in the role of life expectancy, David Blanchett, Morningstar Investment Management's head of retirement research, has suggested that retirees can use the IRS' tables for required minimum distributions as a starting point to inform their withdrawal rates. That said, those distribution rates may be too high for people who believe their life expectancy will be longer than average.

Mistake 4: Not Adjusting Based on Your Portfolio Mix 
Many retirees take withdrawal-rate guidance, such as the 4% guideline, and run with it, without stopping to assess whether their situations fit with the profile underpinning that guidance. The 4% guideline, for example, assumed a retiree had a balanced stock/bond portfolio. But retirees with more-conservative portfolio mixes should use a more-conservative (lower) figure, whereas those with more-aggressive asset allocations might reasonably take a higher amount. 

What to Do Instead: Be sure to customize your withdrawal rate based on your own factors, including your portfolio mix. Figure 3 of this Vanguard research paper discusses the levers that should affect retirees' spending rates. Of course, a financial advisor can also help you create a customized spending target.

Mistake 5: Not Factoring In the Role of Taxes 
The money you've saved in tax-deferred retirement-savings vehicles might look comfortingly plump. However, it's important to factor in the role of taxes when determining your take-home withdrawals from those accounts. A 4% withdrawal from an $800,000 portfolio is $32,000--perhaps on target with your spending needs--but that amount shrivels to just $24,000, assuming a 25% tax hit.

What to Do Instead: Here's another area where it pays to be conservative in your planning assumptions; to be safe, it's valuable to assume a higher tax rate than you might actually end up paying. Pre-retirees and retirees may also benefit from consulting with a tax advisor or a tax-savvy financial advisor to help stay within the lowest possible tax bracket throughout their retirement years; such advisors may also be able to help retirees optimize their sequence of withdrawals from various account types to keep tax bills down.

Mistake 6: Staying Wedded to Your Portfolio's Income Payout
Many retirees operate with the assumption that they can spend whatever income distributions their portfolios kick off--no more, no less. As yields on safe securities like CDs and short-term bonds have shrunk over the past several decades, they've had to make do with less or have ventured into higher-yielding securities with higher risk. They assume that as long as they spend only their portfolio's income distributions, their retirement plans will always be safe.

However, the distinction between income distributions and principal withdrawals is an artificial one, as discussed here; whether your withdrawal comes from income or withdrawal of capital, it all counts as a withdrawal. (People are sometimes surprised to hear that the 4% guideline assumes that 4% is the total portfolio withdrawal, inclusive of both income distributions and withdrawals of principal; it's not safe to take both your income distributions and 4%.)

What to Do Instead: While there's no one single "right" way to manage a portfolio to deliver your spending needs in retirement, it's wise to have a plan. Will your withdrawal come from income distributions, periodic withdrawals of capital (through rebalancing, for example), or a combination of the two? The method that I favor is building a portfolio with an emphasis on long-term total return; retirees can then see how far any income distributions from that portfolio take them, and then use rebalancing proceeds to help make up for the rest. This article can help you home in on the approach that makes the most sense for you.

Mistake 7: Not Getting Help 
As the preceding missteps illustrate, calibrating in-retirement spending rates is more complicated than it appears at first blush, especially when you consider issues such as market fluctuations, taxes, life expectancies, and unplanned expenditures. Withdrawal-rate planning is so complicated and so important that it's one area where even dedicated do-it-yourself investors might consider getting a second opinion, just to make sure they're thinking through all of the right variables and being neither too aggressive nor too conservative in their assumptions.

What to Do Instead: If you'd like to retain control of your portfolio plan while also getting help with your spending-rate assumptions, consider checking in with a fee-only planner who charges on an hourly or per-engagement basis. The website for fee-only advisors, some of whom work on an hourly or per-engagement basis, is