One of the biggest mental shifts new retirees have to make is the sudden change that takes place when they go from accumulation mode to withdrawal mode. It’s a major adjustment that can leave some retirees feeling stressed and unprepared for certain aspects of their financial transition.
For example, while working, their retirement accounts function very much like a one way street in a sleepy town. Personal and employer contributions go in on a regular basis and while markets can fluctuate up and down, the regular stream of new money helps offset losses. Furthermore, fees are often hard to see reflected in the account balance, and a pre-retiree rarely considers using their life savings to remodel the house or take that once in a lifetime European river boat cruise.
However, with retirement comes a change in the direction of those funds and in an instant, a retiree’s portfolio can suddenly become a bustling intersection in a much bigger town. For example, a new retiree with $300,000 starts withdrawing $1,000 per month. The first few months go fine and while the portfolio declines by the withdrawal amount, dividends and interest help offset some of the loss in principal. Mentally, this is easy to comprehend and follow along with.
But after a few months of this, an unexpected drop of 5% in the stock market can skew how things look and feel. Add in a very untimely withdrawal of $2,500 to cover a home or auto repair, and collectively, it can feel like a head-on collision for a new retiree.
In a matter of months, a few innocent withdrawals and a temperamental stock market can zap what would appear to be over a years’ worth of withdrawals… and there is still eight months left to endure. It leaves some retirees wondering if their money will last, if they need to get out of the stock market, or at least start working part-time to offset these new developments.
The issue is that one single account is being used to manage all the traffic and that can make it difficult to see if things are working the way they should be or not. This is one reason why I suggest new retirees consider setting up a separate withdrawal account. It can be a huge sanity saver and allow them to better see how their investments are working as well as encourage them to find ways to save throughout retirement.
With this strategy, a retiree would take their entire retirement account distributions for the year (or six months if preferred) at the start of the year. These funds would be transferred and held in a separate, non-IRA account, essentially segregating the net distributions for each subsequent month. From there, a monthly distribution could be sent out to their checking account on a predetermined date.
The benefit is three-fold. First, retirees see and understand that they have money set aside in this separate account that will allow them to maintain their lifestyle no matter what the stock market does. There is less anxiety because they can look and plan ahead accordingly.
Second, it’s much easier to see if their portfolio is doing what it is supposed to. When the stock market goes down by 5%, they can see its real impact and decide if they have the right asset mix or need to make adjustments. They’re not looking at a compounded problem where previous withdrawals or one-time distributions magnify their level of stock market risk.
This works the other way as well. If the market jumps up by 5% they can also see if their portfolio is responding the way it’s supposed to based on their asset allocation.
Thirdly, this approach lets retirees see the importance of finding ways to save in retirement. One-time distributions that are done on a regular basis, can be account killers over time. Its starts with something simple like a remodel or repair for a few thousand dollars but can quickly grow exponentially.
With the separate account strategy, retirees can be encouraged to use a portion of their remaining income for the year to cover those costs. That has a very different look and feel than just pulling from a large pot of money and assuming things will work out down the line. In other words, they are more likely to put off small one-time distributions that may disrupt their income pattern until they are able to save up for them.
The process helps retirees better organize the traffic going in and out of their accounts and can help them see how each aspects of a withdrawal strategy impacts their long-term plans… and maybe save them a little sanity.
