One of the key aspects of retirement planning is determining the amount of time that it will take for you to exhaust your retirement savings. But there are several variables that must be considered in this somewhat complex equation, and some of these must be based upon reasonable assumptions. Lifestyle, longevity, long-term care, Social Security and the rate of return received on your investment portfolio are all critical issues that can materially impact the rate of your retirement plan withdrawals. However, all of these components can be computed in several different ways, depending upon some of the assumptions that you make. We will look at some of the common ways to calculate the drawdown of your retirement funds.

TUTORIAL: Retirement Planning

1. Percentage Withdrawal
If you take a certain percentage of your retirement funds each year, then the amount that you withdraw may be at least somewhat dependent upon the amount of investment income earned in your portfolio. If your portfolio grows substantially during the year, then the amount you withdraw will also increase proportionately. If the portfolio shrinks, then so will your distribution.

2. Flat Dollar Withdrawal
A systematic withdrawal of a fixed dollar amount from your retirement plan will make it easier for you to create and maintain a budget during your retirement, but it can be either good or bad for your portfolio, depending upon investment performance. If your portfolio grew during the year, then your distribution will constitute a lower percentage of assets. In contrast, a year of adverse performance means that you are taking out a proportionately larger chunk of your funds.

3. Required Minimum Distribution
All owners of IRAs and qualified plans that are regulated by ERISA are required by the IRS to begin taking a mandatory minimum amount out of their accounts by April 1st of the year after the year in which they turn 70 and a half years old. This amount is calculated according to life expectancy and is usually done automatically by the account or plan custodian, although it can also be calculated manually by the beneficiary using the tables posted on the IRS website in IRS Publication 590. Those who take no more than this amount out of their plans can usually expect to see their funds last longer than those who take larger amounts or percentages each year. (To help you determine if a systematic plan is right for you, read Will A Systematic Withdrawal Plan Work For You?)

4. Investment Income Only
Those who wish to leave the principal of their retirement plans and accounts to their heirs may wish to live solely on the income from their portfolio if it is large enough to allow this. The amount of income earned will, of course, determine the kind of lifestyle that you are able to live during retirement, although you could dip slightly into your principal if necessary.

5. The Monte Carlo Scenario
Professional portfolio managers can run hypothetical investment scenarios that may include one or more severe market downturns within the period of time of the projected growth for the investment or portfolio. This type of illustration is known as a Monte Carlo scenario. Those who are planning for retirement may also wish to account for the possibility of a bad year in the markets for their own portfolios, but other types of financial setbacks should be factored in as well. For example, the need for long-term care may require substantial withdrawals for anywhere from one to three years that are above and beyond what you take out to cover normal living expenses.

6. Total Depletion
Some financial experts espouse the idea of dying broke. Those who follow this train of thought will try to use up every bit of their retirement savings before they are lowered into the ground. This type of drawdown calculation is fairly simple; merely estimate your life expectancy and divide your savings by the number of years that you think you have left. Then simply withdraw this amount for your annual distribution. But be careful to leave some margin for error here; if you live past your expectancy, you will still need some funds to live on!

The Bottom Line
Of course, determining which of these methods is best for you will depend upon the size of your portfolio, your risk tolerance, your time horizon and various other factors. But someone with a large portfolio may want to explore whether they can live off of the income from their funds even if they have to pay for major medical expenses. Someone with a smaller portfolio need to use most or all of their savings. In most cases, these scenarios will also require a financial computer program to calculate correctly, due to the number of variables involved. If you are not comfortable doing this yourself, then consult a retirement or financial planning professional who can run an accurate illustration that incorporates all of the necessary data. Don't let the complexity of this issue prevent you from moving forward; these calculations can provide a reasonably accurate picture of what you still need to do in order to adequately prepare yourself for your nonworking years. (An important topic in retirement planning is determining if you have accumulated enough funds to retire, for more info read Will Your Retirement Income Be Enough?)

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