The Biggest Threat to Your Federal Retirement

Having the right withdrawal strategy for spending money in retirement is critical to ensuring your savings will last.

The entire reason that we save and invest while we’re working is so that we have money to spend when we’re retired. It stands to reason that the whole point of retirement is to enjoy the fruits of your labor and spend the wealth you’ve accumulated. 

One of the biggest challenges that most federal employees have is figuring out how to turn a pile of money into a predictable and sustainable source of income for the rest of their lives. 

As retirement planners, we can tell you that this is easier said than done because nearly every family’s financial situation is a little different and requires precise adjusting to get right. There are tons of retirement income strategies out there that can help retirees spend their savings while mitigating the risks of running out of money.

Federal employees are ahead of the game because of their pensions, but we still find that a lot of them don’t really know how to safely create their retirement income for all of retirement, or maybe they’re not sure how to accurately interpret their plan through different markets and life events. 

There’s no shame in this; understanding all the different retirement withdrawal strategies out there, finding one that fits your unique plan, following all the rules in a plan, and implementing it properly year over year for 30-40 years can be very daunting.

This leaves many retirees gravitating to something simple like the 4% rule, but the problem is that it doesn’t address one of the biggest threats to retirement. While the 4% rule has some relevance, it struggles with the age-old adage: the difference between theory and practice is that in theory, they’re both the same.

Your income system is the heartbeat of retirement and getting it wrong could be catastrophic.

Making Practice Out of Theory

To help protect retirees, we implement something called a dynamic withdrawal strategy. Unlike the 4% rule, which would be a static withdrawal, dynamic withdrawal strategies can help retirees adjust their spending rates according to certain variables. Albeit more technical, it accounts for factors that the 4% rule ignores and may help create a safer and more sustainable retirement. 

Dynamic withdrawal strategies can allow for higher spending during some years but require slight moderation in others. This can help retirees have a much higher starting withdrawal rate than the 4% rule, which aligns neatly with being able to better enjoy your golden years. 

When you first retire, you enter what we call your go-go years. It’s the phase of your life that you’ll likely have the most money, time, and energy to get up and book those flights, take those trips, and check off items from your list. On average, being 60 years old means you have roughly 260 months left in your lifetime. Some will have more, others will have less, but many retirees want to maximize the time they are still flush with cash and energy. 

Well, that comes with spending money, and creating a withdrawal strategy that allows for higher spending earlier in retirement without jeopardizing your plan in the long term requires some advanced planning. 

There are two elements you need to determine for this to work. First, you need to calculate what level of investment returns will allow you to sustain your retirement. Next, you need to figure out your monthly expenditures separated into two categories: fixed expenses and discretionary expenses. 

Fixed expenses are things you need to spend money on. Things like food, housing, gas, insurance, etc. You have some control over them, but you can’t eliminate them from your life altogether. 

Discretionary expenses are things that you do have full control over. These are things you want to spend money on if your plan allows, but they aren’t necessary. These would be things like traveling, eating out, country clubs, philanthropy, etc. While we always want to have room for these, you could cut these out entirely in a dire situation. 

Once you have calculated your required rate of return and bifurcated your expenses, then you can create parameters that allow you to have higher levels of discretionary spending, because under specific conditions your plan will adjust for moderated discretionary spending. Note that your fixed expense needs are always met. 

How this breaks down: if you fail to correctly categorize fixed versus discretionary, you could get yourself in a heap of trouble. For instance, buying a car that is way over budget could mean that the car payment turns into a “fixed expense”. These errors cannibalize your wealth over the long haul. There are reasonable boundaries that must be applied. A car payment is normal. A $1,300/mo car payment may not be or possibly comes with tradeoffs.

For example, to keep the numbers simple, let’s say your total monthly cashflows for both fixed and discretionary expenses combined are $10K/mo. Of that, we’ll say that $6K/mo is fixed. That leaves $4K/mo in discretionary spending for dining out, travel, etc. 

Let’s say that this requires a 6% withdrawal rate from your portfolio to support this. Ordinarily, an ongoing 6% annual withdrawal is a bit too high, but let’s look at how this might be able to work.

This example means that you have $48K in the year to spend on lifestyle ($4k/mo for 12 months). Perhaps this translates into two $10K vacations during the year and spending the rest on leisure during the months. 

But then let’s assume there’s a year in the markets like 2022 and your portfolio has an overall 20% decline. In dynamic withdrawal strategies, you may be hitting a guardrail here because you would have set certain parameters like: if my portfolio declines by X%, then that means we need to reduce our discretionary spending by Y%.

Lest we forget: you’re doing this because your discretionary spending may have been higher than “normal”, thereby allowing you to spend more freely to enjoy your retirement. So you may decide to only take one $10K trip for that year, and trim back discretionary spending (dining out, clubs, etc.) by 30% for a period of time.

The same is true in reverse. Let’s say you determined your required rate of annualized returns is 6% and the markets had a 15% return year. That’s great! First, how does this gain annualize with the years prior, and how much more will you be able to spend on leisure because you’ve moderated your spending rates in weaker years?

The beauty of a dynamic retirement income strategy is that it may allow federal retirees to meet all their income needs to be able to stay financially independent, and it grants them a hall pass to go on a mini-spending spree in years that allow for it so that they can make the best of their golden years. 

The Achilles’ Heel

A dynamic income strategy only works when the portfolio is in harmony. Not achieving the required rate of return or having a portfolio that’s too risky relative to returns (for math nerds like us: Sharpe ratio) will cause this strategy to fail. 

If you decide to use a dynamic withdrawal strategy, you’ll need to watch for two elements in your portfolio: allocation and rebalancing. 

If you know that you really want to be able to spend more on (insert your desire here) for the first several years of retirement, then there are investment strategies that can help you generate the cash for this in a much more stable way compared to relying on the market’s timing. 

Having the right allocation can help you continue meeting those goals without having to worry too much about what’s happening in the overall markets. Read that again, for it is the epitome of a successful retirement plan. 

Even the greatest asset allocation goes bust without a rebalancing system. If you’re not systematically reallocating your portfolio back to the given appropriate allocation, then you’re creating greater risk and volatility inside your accounts, which could greatly influence your ability to continue taking withdrawals. 

There’s no one-size-fits-all strategy when it comes to retirement income planning. There are too many variables that change with each family, but I hope that this gives you a better idea of how you should be thinking about your own retirement so that you too can lead a more confident and fulfilling life in retirement. After all it’s not just your money, it’s your future. 

About the Author

Thiago Glieger, AIF®, ChFEBC℠ is a Director and advisor at RMG Advisors, a premier private wealth management firm in the Washington, DC metro area. As fiduciaries, he and his team have served federal employees for over 40 years by helping them grow, manage, and protect their wealth. Their program, The Fed Corner, produces content specifically designed to help federal employees make better financial decisions.