Can Your Portfolio Supply the Retirement Income You Need?

RETIREMENT PLANNING: If you're looking to establish a sane, sustainable withdrawal plan, then these tips are for you

Christine Benz 28 January, 2013 | 6:56PM
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The ‘bucketing’ concept has resonated with many retirees and pre-retirees because it helps turn a portfolio geared towards accumulation into one that provides in-retirement income. It also enables a retiree or pre-retiree to back into a logical stock/bond/cash mix given his or her time horizon.

An essential first step before creating any retirement portfolio—bucketed or otherwise—is to determine whether that portfolio can deliver the income you need from it. Coming up with a safe withdrawal rate—the amount that you can withdraw from a portfolio per year without depleting it during your lifetime—is an essential part of the retirement planning process. Retirement calculators can help you get your arms around whether your planned withdrawal rate is reasonable, but you can also run the numbers yourself, thereby employing the withdrawal rate method of your choice. Here are the key steps to take.

1) Determine the Pay Cheque You Need From Your Portfolio
If you're attempting to create the equivalent of a pay cheque from your portfolio, the first step is to gauge your income needs during retirement, either on an annual or a monthly basis. Start by tallying your total expenditures, then subtract steady sources of income that you can rely on, including government benefits and state pension income. What's left over is the amount that you'll need to extract from your portfolio each month or each year.

2) Choose Your Distribution Method
Next, determine the strategy you'll use for extracting the money from your portfolio. Among the most popular methods are the income-only approach, whereby you subsist on whatever income your holdings kick off; the fixed-percentage method, whereby you withdraw a fixed percentage of your portfolio per year; and the fixed-pound amount plus inflation adjustment method, which is the approach underlying the 4% rule for retirement portfolio withdrawals. These approaches all have pluses and minuses. In this video, Morningstar Investment Management's director of retirement research David Blanchett discusses the results of his stress test of the various strategies.

3) Check Its Viability
If you're using the income-only approach, you can test the viability of your strategy by looking at the income your portfolio currently kicks off and comparing that amount to your desired income level. Of course, the income you're receiving today might not be there tomorrow, but with bond and dividend yields as low as they are, it's not unreasonable to use today's yields as a proxy for future income distributions.

If you're using the fixed-percentage method, the beauty of the strategy is that you'll never run out of money, so sustainability isn't an issue. But liveability is: Under the fixed-withdrawal method, your income will fluctuate from year to year depending on how your portfolio performs. If the initial withdrawal amount is reasonable and you're comfortable with the uncertainty of a fluctuating income stream, then such a method is a good fit.

If you're withdrawing a level pound amount from your portfolio per year, you'll have the peace of mind of a predictable income stream. But you'll first need to evaluate whether your desired portfolio withdrawal amount is too large or just about right. One widely used rule of thumb is that an initial withdrawal amount of 4% of your balance, combined with annual upward adjustments to accommodate inflation, is a safe withdrawal amount. It's helpful to sample an array of opinions on this all-important important topic. For another check, Morningstar's Asset Allocator toolT. Rowe Price's Retirement Income Calculator and Fidelity's Retirement Income Planner can help you determine whether your current portfolio can deliver the dollar amount you need during retirement. (Just bear in mind that some of these tools are using fairly rosy return expectations for stocks.)

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Christine Benz

Christine Benz  is director of personal finance at Morningstar and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances.