What is a Systematic Withdrawal Plan?
Systematic withdrawals provide a disciplined way to take money
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 avoid tax issues. But you don't have to wait until you stop working to make use of this method. Systematic withdrawals can be used for mutual fund accounts, annuities, and sometimes for brokerage accounts at any point in life.
How Does a Systematic Withdrawal Plan Work?
When you have a systematic withdrawal plan in place, shares of your investment are liquidated or sold as necessary to provide the stated amount of your withdrawal. 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.
For example, let's say you own three mutual funds. Fifty percent of your money is in ABC fund, 30 percent is in XYZ fund, and 20 percent is in WGT fund. If you set up a $1,000 monthly systematic withdrawal, 50 percent of your withdrawal amount or $500 would come from ABC fund, 30 percent or $300 would come from XYZ, and 20 percent or $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 sending you 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.
The Downside to Systematic Withdrawals
The downside to systematic withdrawals is that 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, actually lowering your overall internal rate of return when compared to other withdrawal strategies.
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 (often called a “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.