Systematic Withdrawal Plans Defined
Systematic withdrawals are a disciplined method of using an investment
When you set up an investment account so that you automatically take money out on a regular basis, it's called a systematic withdrawal. Why do it? Because it can simplify personal money management, particularly in retirement, and it can help you avoid tax issues.
You don't have to wait until you stop working to make this method work for you. Systematic withdrawals can be used for mutual fund accounts, annuities, and even brokerage accounts—at any point in life.
How a Systematic Withdrawal Plan Works
When you have a systematic withdrawal plan in place, shares of your investment are liquidated or sold as necessary to provide the amount you wish to withdraw. If you own several mutual funds or have several sub-accounts inside a variable annuity, shares are sold proportionately to what you own. This helps keeps your overall asset allocation in balance.
If you were to own three mutual funds, with 50% of the money in ABC fund, 30% in XYZ fund, and 20% in WGT fund, you could set up a $1,000 monthly systematic withdrawal. Your withdrawal would be disseminated across all three of the funds—50% of your withdrawal amount ($500) would come from ABC fund, 30% ($300) would come from XYZ, and 20% ($200) would come from WGT.
Instead of using several funds, you could use one balanced fund and take systematic withdrawals from that, or you could use a retirement income fund that's managed specifically for the purpose of providing you with monthly income.
Making Tax Time Easier
When you use a systematic withdrawal from an IRA account, you can typically set it up so that federal taxes are automatically withheld. Some investment firms also allow you to have state taxes withheld.
One Downfall of Systematic Withdrawals
There is one breakdown in this system, however; more shares must be liquidated to meet your withdrawal needs during times when your investments are down in value. In a market correction or bear market, this can have the reverse effect of a dollar-cost averaging strategy, lowering your overall internal rate of return when compared to other withdrawal strategies.
To overcome this, you might consider systematically withdrawing a percentage instead of a set amount. In this manner, you could reduce the losses you take when the market is swinging down. You will receive less, but when the market swings back up the value of your assets will increase along with the withdrawal amounts because you have held on to more shares than you would have otherwise.
Alternatives to Systematic Withdrawals
One alternative to a systematic withdrawal plan is to keep a year’s worth of withdrawals in a money market fund and take your monthly withdrawals from this source instead. Then you can rebalance your account once a year, selling the investments that had the highest rate of return and using the proceeds to replenish the funds spent from the money market fund.
Other alternatives to a systematic withdrawal plan include:
- Following a specific set of withdrawal rate rules
- Using a time-segmented strategy or "bucket" strategy
- Taking only the investment income produced
So what's the best withdrawal plan for you? It depends on your personal financial circumstances, your age, and your tolerance for risk. Each type of withdrawal plan has its pros and cons, so the one that's best suited to you might not be suitable for someone else. A retirement income planner can help you sort through your options and find the approach that works best for your circumstances.