• Home
• About Myself
• Ask A Question
• Blog
• Disclaimer Statement
• Privacy Policy

Withdrawing Funds in Retirement

Because I do not have an employer provided pension or health care benefits, and I will not be eligible for the Social Security or Medicare Programs for many years, 100% of my retirement income comes from assets invested in the real estate and financial markets. Consequently I cannot afford any big mistakes in my investments. Yet when the Dow Jones Industrial Average Index drops 900 points in one day,  I do not lose a wink of sleep at night about my retirement income.

To be sure I do worry about what the long term impact of our country’s current fiscal and monetary policies will have on every American’s purchasing power. But on a short term basis, I do not worry about the movement of the different markets I am invested in. You may wonder, without any guaranteed annuity income, how I can be so secure about my retirement income in the current turbulent markets we are experiencing. The answer is I have set up my asset withdrawals in such a way that the day-to-day, month-to-month, or even year-to-year volatility of the markets do not impact my annual income. This is possible by setting up a fixed income ladder.

Why Do Retirees Need an Income Ladder?

Some retirees are wealthy enough to live off the income generated by their portfolio. However, accumulating the assets necessary to generate that amount of portfolio income to live on in retirement is probably beyond what most people can hope to save in their working lives. So, due to the decline of employer provided pensions and other reasons, it is necessary for most retirees to spend portfolio principal as well as any income. This is especially true in today’s low yield environment.

Because of this necessity to spend portfolio principal, there has been a shift in how financial planners prepare for retirement income withdrawals. The latest thinking among financial planners is to create several separate pots of money based on when the money will be withdrawn to fund retirement. I will talk more generally about this strategy in a future post, but in this post I want to discuss one important step that each person nearing retirement should take. This step is setting up a fixed income ladder to fund your early years of retirement. Even if you are collecting an employee pension or receiving social security benefits, setting up a fixed income ladder is important if you will be withdrawing any funds from your financial portfolio to supplement your income.

Why is a fixed income ladder necessary? There are two reasons. First, everyone needs to have a stable income source to pay expenses without worrying where these funds will come from. Second, from a portfolio longevity standpoint, retirees face their maximum risk exposure in the first few years after they retire. If a retiree’s portfolio is heavy in stocks and suffers a huge loss of value in the first few years after retirement while withdrawals are being made, the portfolio longevity will be shortened. This is why retirement assets need to be set up in an income ladder which eliminates the risk during this period.

Setting Up an Income Ladder

The first step to setting up an income ladder is determining how much income the ladder must provide each year. This is the reason I went into such detailed discussion in my last post on Tracking Living Expenses as this information is needed to create the income ladder.

The reason I call it a “fixed income” ladder (sometimes referred to as a “bond” ladder), is that the income needs to be guaranteed. Equities do not provide any guarantees, therefore, fixed income products need to be used to set up the ladder. Many people use bonds for this purpose. Bonds are certainly much less risky than equities; however bonds are not completely risk free. But if you have the ability to select safe corporate of municipal bonds, then bonds can serve as the instrument to fund your income ladder. Some people use US treasury bonds and this is OK too.

Personally, I use bank Certificate of Deposits (CDs) to fund my income ladder. Although today’s CD yields are a little lower than most bonds, CDs are as safe as US Treasury notes and have comparable yields. The reason I use CDs is because they are easier to work with than bonds or Treasuries. Bonds and Treasuries come in set face values (usually a multiple of $1,000) which makes it harder to create a specific annual income that you may need. A CD however is more flexible because you can create a CD stipulating any face value you want. This factor allows you to create a custom income product for each year of the income ladder.

The following example shows how one would go about setting up a fixed income ladder. The process is the same regardless of what “fixed income” instrument you use. However this example is based on bank CDs because their flexibility better illustrates the concept I am trying to convey in building the ladder.

Let’s say, after several years of tracking living expenses and estimating your tax liability in your first few years of retirement that, you and your spouse decide that you will retire in one year and that you need $60,000 annual income to fund your retirement lifestyle. Let’s assume your family retirement income includes some annuity income as shown in the table below.

So, based on your $60,000 income requirement and the assumed guaranteed income in the table, an income ladder needs to be created to pay $28,000 each year for five years in today’s dollars. (Note: Based on the 4% Rule, in order to be able to comfortably withdraw $28,000 from your financial portfolio for 30 years, your starting portfolio should be about $700,000).

To illustrate how to create a five year income ladder providing $28,000 per year in today’s dollars, an assumption needs to be made about future inflation. For this example I will use an estimate of 4% per year as the average inflation rate for the next five years. This 4% annual inflation rate is used to calculate the annual required income shown in column (3) of the table below. The dollar figures in column (3) are the amounts needed to be provided in each year to maintain today’s $28,000 purchasing power (assuming 4% annual inflation). Column (4) shows the CD rates currently available from my credit union for each of the five CD durations. Column (5) shows how much must be invested today in each of the five CDs (assuming the CD rates shown in column (4)) to create the required annual income shown in column (3).

Example of 5-Year Income Ladder

In summary the table illustrates that, in this scenario, you would need $149,187 in liquid funds as of today to invest in a 1-year, 2-year, 3-year, 4-year, and a 5-year CD. The amounts invested each year shown in column (5) at maturity will provide the corresponding dollar figures in column (3), each of which is the equivalent of $28,000 of spending power in today’s dollars.

Ideally, it is best to set up your income ladder several years before retirement. The reason for this is when you first create the income ladder; the shorter term CDs will have a lower interest rate than the longer duration CDs as shown in the above table. After the ladder has been created, each year a CD will mature. If you are a few years away from retirement, you would roll over each annual maturing CD into another 5-year CD at a higher interest rate. After four years of rolling over maturing CDs, all five CDs will have the same interest rate as the original 5-year CD. This increases your average interest rate for the group. Higher interest rates mean you need to commit less liquid assets today to buy the CDs required for the annual inflation adjusted payouts you need when you do retire. In the above example, if you rolled over 4 CDs into new 5-year CDs just before retirement, all five CDs would have an interest rate the same as your original 5-year CD of 2.25%. This means the amount needed today to invest in the 5-year ladder would drop from $149,187 to $147,354. If interest rates go up in the next couple years where all five CDs have a rate of 3%, the amount needed to invest today would drop further to $144,130. Every little bit helps.

There are internet sites where the math for calculating an income ladder can be done for you. IncomeLadders.com is the site I used to handle these calculations. The instructions at the top of this web page for the “Simple Income Ladder Calculator,” clearly explain how to use this tool.

The only other decision to make is how many years should your income ladder be? This depends on several other factors such as when other income sources kick in, the size of the total retirement asset base, and other factors. If your retirement commences before you start receiving social security benefits, your ladder should continue at least until this other income begins. In my opinion it is a good idea to hire a financial planner experienced in the area of retirement income withdrawal to advise you before setting up an income ladder.

My wife and I will not collect any social security benefits for 10 years after the start of our retirement, so our income ladder is 10 years long. This is why I do not worry about the volatility of the equity markets. I will not touch any of my equity assets for at least 10 years. By then the value of my equity holdings are very likely to be much higher than today.

One might ask why not just create a 30-year income ladder and forget about the equity markets altogether? Because, for most people, it is not realistic to accumulate the assets needed to create a 30-year income ladder. This is why the higher return of equities over fixed income assets is needed to help your portfolio grow large enough to fund the later years of retirement.

How to integrate equities into your retirement withdrawal strategy will be the subject of the next post.

Did you enjoy this post? Why not leave a comment below and continue the conversation, or subscribe to my feed and get articles like this delivered automatically to your feed reader.