More and more people are relying less and less on traditional pensions and turning to tax-qualified vehicles like 401(k)s and IRAs to fund their retirement years.

This is largely uncharted territory, so a lot of the advice that is out there is not yet tried and tested. Adding to the difficulties, there are a huge number of unknown factors such as:

  • How long will we live?
  • What changes will there be in the cost of living?
  • How much will we have to spend on health care?


The biggest question: How much we will need? Financial advisors have traditionally told us that we will need 70% to 80% of our salaries in retirement. The good news is that we may not need that much. 

The second big question: How should we go about taking distributions from tax-qualified vehicles? Here, four different models are often suggested,1 as well as some suggestions in overcoming rough spots, no matter which model you use.

  1. A CONSTANT SPENDING MODEL: This model assumes that you will need the same amount of money each year from the beginning of your retirement to its end, adjusted for inflation. The traditional rule of thumb calls for taking out 4% the first year, then taking the same amount, adjusted for inflation, in subsequent years. 
  2. A STAGES-OF-RETIREMENT MODEL: This model breaks retirement into stages, with distributions calculated accordingly. In early retirement, between the ages of 65 and 75, retirees tend to travel, engage in recreational activities, and pursue hobbies and cultural interests. They are also likely to assist their adult children. Their expenses will be relatively high. In middle retirement, between ages 75 and 85, retirees tend to cut back on travel and recreational pursuits, and stick closer to home. Their expenses will be relatively low. In later retirement, from age 85 on, medical expenditures tend to go up, and long-term care is often needed. 
  3. AN INVESTMENT-RETURNS MODEL: This model assumes that you will reduce distributions when the value of your portfolio falls and increase them when it rises. Since people tend to vary their spending as their net worth rises and falls, this model incorporates something we do naturally. Those who take their required minimum distributions (RMDs), and nothing else, are following a variation of this model.
  4. A FLEXIBLE SPENDING MODEL: This model incorporates expected expenses from a number of different categories and combines them into one distribution plan. Medical expenses, for example, are expected to rise as we get older, while clothing and recreational expenses are expected to fall. A large number of factors are combined, and suggested distributions are calculated from the combined numbers.


With any of these distribution models, there will be inevitable rough spots. But there are a few things we can do to smooth them:

  1. SAVE A PORTION OF YOUR DISTRIBUTIONS WHEN TIMES ARE GOOD. You may need those savings when you hit a bumpy patch. Whatever distribution plan you choose, you will have to start taking RMDs the year you reach age 70½. They are calculated by dividing the amount of money in your tax-qualified accounts with the number of years a person your age is expected to live. Be aware, though, that RMDs are not government-approved spending guidelines.
  2. CONSIDER PURCHASING LONG-TERM CARE INSURANCE. One of the biggest unknowns in retirement is whether we will eventually need long-term care. Getting a good long-term care policy in place removes a major source of anxiety.
  3. CONSIDER PURCHASING AN ANNUITY (OR TWO, OR THREE). An annuity acts like a traditional pension and guarantees2 you a certain amount of income for life. This diversifies your retirement holdings and leaves you less vulnerable to the gyrations of the stock and bond markets. Some advisors suggest that you ladder annuities, purchasing one when you are 65, for example, another when you are 70, a third when you are 75, etc. This way, you can benefit from the higher payouts you get when the annuity is purchased at a later age.
  4. TAKE ADVANTAGE OF THE SECURITY THAT LIFE INSURANCE PROVIDES. Knowing you have a legacy in place can allow you to enjoy your retirement without worrying that there will be nothing left for your children if you treat yourself to something special. In addition, cash value life insurance can be a potential source of tax-advantaged supplemental income* should your needs for life insurance change and if extra money is needed when the markets slump.

*You can access the cash value in your policy, generally tax-free, via partial surrenders and policy loans. Policy loans and surrenders reduce the policy's cash value and death benefit. Loans also accrue interest.

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1 "Models of Spending as Retirement Progresses," Bogleheads.org. http://www.bogleheads.org/wiki/Models_of_spending_as_retirement_progresses

2 The guarantees of an annuity are based on the claims paying ability of the annuity issuer.