Spending the same amount every year can run you out of money.

Spending the same amount every year can run you out of money

A fixed yearly withdrawal feels like discipline, and in a long bad stretch it is the thing that empties the account.

Most retirement plans come down to one number. Take out 4 percent in the first year, raise it with inflation, and spend that amount every year no matter what the market does.

A fixed number is easy to follow, and that is why it became the standard. It is also the reason a plan can end at zero, because the amount does not know the size of the balance it is coming out of.

A rule that takes a share of what is actually there behaves differently. When the balance falls, the withdrawal falls with it, and a share of something is never all of it.

That rule has a cost, and it is not a spreadsheet cost. A flexible rule cuts the income in the same year the portfolio drops, which is the year a retiree least wants to hear it.

Two retirees, one bad stretch, two rules

For the first two years the flexible rule gives up almost exactly what it saves, which is what makes it so hard to keep.

Two readers retire on the same day with $500,000 each. Both plan to live on $25,000 a year from the portfolio, which is 5 percent of the starting balance.

The first reader uses a fixed rule and takes $25,000 every year regardless of the market. The second uses a flexible rule and takes 5 percent of whatever the balance is on the day of the withdrawal.

In year one the market falls 40 percent, and both portfolios drop from $500,000 to $300,000. The first reader takes the planned $25,000, which is now 8.3 percent of what is left, and the second takes 5 percent of $300,000, which is $15,000.

That is $10,000 less to live on in a single year. It is a canceled trip, a delayed project, or a tighter year than the one that was planned for.

In year two the market falls another 10 percent. The first reader's $275,000 becomes $247,500, and after another $25,000 the account holds $222,500.

The second reader's $285,000 becomes $256,500, and a 5 percent withdrawal of about $12,800 leaves about $243,700.

Over those two years the first reader spent $50,000 and the second spent about $27,800, a difference of about $22,200. The second reader ended with about $21,200 more in the account, so at the two year mark the trade is close to even.

What changed is the rate. The first reader is now pulling $25,000 out of $222,500, which is 11.2 percent a year, and if the market does not recover, that share climbs again next year. The second reader is still pulling 5 percent, the same share as on the first day.

A rising share of a shrinking balance has an end at zero. A fixed share does not, because the withdrawal shrinks at the same rate the account does.

The risk in the flexible rule, stated plainly: your income falls in the same year your portfolio falls. If most of your spending is fixed, meaning housing, insurance, food, and medicine, a 40 percent cut to your withdrawal is not something you can absorb, and a rule that protects the portfolio can still fail the person holding it.

The fixed rule carries the opposite risk. It protects this year's spending and lets a bad stretch quietly raise the odds that the money ends before the retirement does.

Illustrative example with round numbers and assumed market returns, not a forecast. General education, not advice.

A spending number feels like a promise, and a portfolio feels like weather.

A withdrawal plan gets set once, usually years before anyone lives on it, and by the time it is running it has become part of the person. The number is the trip, the gifts, the standard of living that was earned.

Cutting it feels like admitting the plan failed. A market drop, by contrast, feels like something that happened to you, and few people respond to weather by changing how they live.

So the number survives and the portfolio absorbs the damage. The loss is happening either way, and the only real choice is whether it shows up as a smaller year now or a shorter retirement later.

There is a second reason, and it has to do with how the rule was taught. A single percentage was easier to publish than a policy, so a generation learned the number and never learned the part where you are allowed to adjust it.

That is the issue. Short, on purpose. This week's move takes two minutes: write your yearly spending on one line, then split it into two.

The first line is what cannot move, meaning housing, insurance, food, medicine, and required payments. The second line is everything else.

The second number is your flex. It is how far your income could fall in a bad year without changing where you live or what care you get.

If that second number is small, a flexible rule is not really available to you, and finding that out this week is better than finding it out in a down market.

Hit reply and tell us what your two lines look like. We read every response, and it shapes what we write.

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