When you set up an investment account so that you automatically take money out on a regular basis, it's called a systematic withdrawal. A systematic withdrawal can simplify personal money management, particularly in retirement. It can also 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.
- When you set up an investment account so that you automatically take money out on a regular basis, it's called a systematic withdrawal.
- To keep your asset allocation in balance, you can sell shares proportionately across funds, opt for one balanced fund, or use a retirement income fund.
- The money you withdraw will be taxed as income, so consider having taxes automatically withheld.
- You can opt for systematic withdrawals based on a percentage instead of a set amount, in order to reduce losses during a down market.
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.
Here's an example: Let's say you own three mutual funds. You have 50% of your money in ABC fund, 30% in XYZ fund, and 20% in QRS fund. If you wanted to set up a $1,000 monthly systematic withdrawal, your withdrawal would be disseminated across all three of the funds. In that case, 50% of your withdrawal amount ($500) would come from ABC fund, 30% ($300) would come from XYZ, and 20% ($200) would come from QRS.
Instead of using several funds, you could also 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, keep in mind that the money will be taxed as income. When setting up your systematic withdrawal plan, you can typically set it up so that federal taxes are automatically withheld. Some investment firms also allow you to have state taxes withheld.
Consider working with a tax advisor to ensure that you're paying the correct federal and/or state tax rate on your withdrawals.
The Downside of Systematic Withdrawals
There is one potential downside of the systematic withdrawal plan: 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.