Case study: Jim and Barbara take withdrawals from their portfolio
(A hypothetical example)
Jim, an engineer, is retiring at age 66; his wife Barbara, a teacher, is 65. Jim plans to retire at the end of the year, and Barbara plans to shift from a full-time to a part-time schedule. They want to provide enough income to live comfortably, while preserving savings for the long term.
Jim and Barbara start by listing their sources of retirement income, which include savings, Social Security, and pension benefits:
- Jim has $200,000 in a 401(k) invested equally between stock mutual funds and bond mutual funds.
- Barbara has a pension that will pay $950 a month.
- Jim will receive $1,900 a month in Social Security retirement benefits.
- Barbara will earn $1,150 a month from her part-time teaching position.
Rolling over to an IRA
Jim and Barbara decide to move Jim's 401(k) savings into a rollover IRA. They can withdraw from the IRA to provide income, plus have the flexibility to meet financial emergencies that may arise.
Taking the first withdrawal
The first day of his retirement, Jim withdraws 4% of the IRA balance, or $8,000, and deposits it into a money market fund. He arranges automatic monthly transfers of $667 from the money market fund to his bank checking account. When combined with Social Security, Barbara's pension, and Barbara's teaching income, they'll have retirement income of $4,667 a month.
Keeping up with inflation
As the years go by, Jim increases his initial withdrawal amount by the rate of inflation. Inflation ranges between 2% and 4% in the first four years of Jim and Barbara's retirement.
Here's how they decided to adjust withdrawals to keep pace with the rising cost of living:
|Calculation||Withdrawal amount||Inflation rate|
|Year one||$200,000 x 4% =||$8,000||3%|
|Year two||$8,000 x 1.03 =||$8,240||2%|
|Year three||$8,240 x 1.02 =||$8,405||4%|
|Year four||$8,405 x 1.04 =||$8,741||2%|
Staying in balance
Every year when he makes the IRA withdrawal, Jim also rebalances his IRA to maintain its allocation of 50% stocks and 50% bonds. He does so by taking his withdrawal from the higher-performing investment category. For example, if his stock funds were up 10% and his bond funds down 5%, Jim would withdraw money from his stock funds until he restored the 50:50 allocation.
Handling required distributions
After Jim turns age 70½, he needs to make sure that his annual withdrawals satisfy his required minimum distributions (RMDs). Using a calculator on vanguard.com, Jim determines that his required withdrawal amount is $7,299. His current withdrawal rate exceeds that, so Jim isn't required to make any change to meet his RMD.
Looking to the long term
If the couple earns a 5% after-tax return on their funds and sticks with a disciplined withdrawal plan, the IRA balance could provide a steady stream of income for more than 30 years.
- All investments are subject to risk. Investments in bonds and bond funds are subject to interest rate, credit, and inflation risk. Past performance is no guarantee of future results.
- When taking withdrawals from a tax-favored account, such as an IRA or 401(k), before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax.
- The information provided here is for educational purposes only and isn't intended to be construed as legal or tax advice. We recommend that you consult a tax or financial advisor about your individual situation.