How to Develop a Sustainable Withdrawal Plan

Note: This video is part of Morningstar's 7 Days to Retirement Readiness week special report.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Setting up a withdrawal system is one of the key jobs to accomplish as you get ready to retire.

First, you'll need to figure out how much you can safely withdraw each year without running out of money during your lifetime. The 4% guideline is a very rough rule of thumb; it assumes that the retiree withdraws 4% of his or her balance in the first year of retirement, then inflation-adjusts that dollar amount in subsequent years. That's a good starting point, but it's important to take your life expectancy and portfolio asset allocation into account. Reining in your spending when your portfolio loses value is another great way to improve your portfolio's staying power.

In addition to figuring out how much you can take from your portfolio per year, you'll also need to determine where you'll go for those withdrawals. Will you rely on income distributions, selling appreciated securities from your portfolio, or a combination of the two? It might be intuitively appealing to rely exclusively on your portfolio's income distributions, but just make sure that you're not building a too risky portfolio in order to do so. I like a blended approach, where you spend current income but also periodically sell appreciated positions to meet additional cash-flow needs.

Finally, you'll want to consider the sequence you'll use to tap your various accounts for cash flows. The standard rule of thumb is that you'll tap taxable accounts first, followed by tax-deferred accounts like traditional IRAs and 401(k)s, followed by Roth assets. But in high- or low-tax years, that rule of thumb might not hold up. Get some tax advice to be sure.

Thanks for watching; I'm Christine Benz for Morningstar.com.