Create Your Own Retirement Cash Flow

For some retirees, making the transition from building up a portfolio to living off of it can be disorienting. How much can you spend each year? Will you have enough? Should you rely just on investment income or actually sell investments?

Creating a sensible spending plan can help clear up the confusion.

Getting started

Working with a financial advisor to create a personalized investment plan is always a great place to start. However, some people also use a basic approach such as the so-called 4% rule, under which you would withdraw 4% of your portfolio in the first year of retirement and then increase that initial amount in line with inflation each year. Of course, the 4% rule is just a rough guideline. People who expect a shorter retirement could consider larger withdrawals, while those with a longer time frame should take less.

No matter how reasonable your assumptions, though, actual future returns and inflation rates will vary. So whether you have a financial plan or use a general starting point like the 4% rule, it’s a good idea to stay flexible.

For example, in years when the markets are down, you may want to scale back on your withdrawals. In up years, you may feel freer to spend a little bit more. That said, if you plan on an initial withdrawal rate of somewhere between 3% and 5% of your portfolio’s value in the first year of a 30-year retirement, there’s a higher probability that your money will last.

Every few years afterward, update your financial plan and consider working with an advisor to update spending rate. As you move through retirement, the amount you can spend each year as a percent of your portfolio may change.

After you’ve determined a reasonable portfolio withdrawal rate, follow these simple guidelines:

  1. Set aside a cash cushion
    Set aside enough cash to cover your spending needs for the next 12 months—minus what you expect to receive from reliable non-portfolio sources of income, such as Social Security, pensions and so on. Place next year’s spending in relatively safe, liquid investment vehicles such as:
  • Money market mutual funds
  • A bank money market deposit account
  • Short-term certificates of deposit (CDs), perhaps laddered with three-, six- and nine-month maturities
  • Checking accounts (preferably interest-bearing)

View this balance as “money spent.” It’s your next year's worth of retirement cash-flow.

  1. Manage your retirement portfolio sensibly
  • Keep equivalent of an additional two-to-four years’ worth of spending in short-term bonds, bond funds, or CDs, as part the fixed income allocation in your portfolio. If your portfolio performs well, you can hold onto or keep rolling over these shorter-term investments. In the event of a lengthy bear market, you can cover expenses with these investments instead of selling stocks.
  • Invest the rest in a diversified portfolio, for income and growth, based on your time horizon and risk tolerance.
  • Diversify your portfolio across and within asset classes.
  • For most retirees, we suggest no more than 60% of the portfolio in stocks and no less than 40% in bonds and cash at the beginning of retirement. Adjust that mix through retirement depending on your short-term needs, time horizon, and risk tolerance.
  1. Boost your potential returns by investing tax-efficiently
  • Every dollar you keep after fees and taxes is a dollar you can use to improve your retirement.
  • Keep tax-efficient investments in a traditional brokerage or taxable accounts. This includes stocks held longer than one year, tax-managed funds, index funds, qualified-dividend-paying stocks and mutual funds, as well as municipal bonds (if they make sense for your tax bracket).
  • Keep tax-inefficient investments in tax-deferred accounts, such as an IRA, Roth IRA, or 401(K). This includes stocks held one year or less, actively managed funds, taxable bonds and real estate investment trusts (REITs).

Determine where the money will come from

Once you’ve figured out how much you need from your portfolio for the year and decided on an appropriate portfolio asset allocation, the next question is: Where should the money come from?

Many retirees say they prefer not to spend “principal.” However, capital gains are an important source of return—and potentially cash flow—so it makes sense to have a broader conception of income. If your annual spending exceeds Social Security, pensions, interest income, dividends and mutual fund distributions, generate additional cash through periodic rebalancing.

  • Dividends and interest versus selling shares. Over time, your annual portfolio withdrawals will likely come from taking a total return approach—that is, a combination of interest, dividends, and proceeds from the sale of appreciated assets. For example, if you have a moderately-conservative target asset allocation (40% stocks, 50% bonds and 10% cash), you might expect an average annual total return of around 5%. As a result, your withdrawal for the year might consist of interest and dividends, as well as capital gains and principal.
  • Which investments should you sell? One reasonable approach is to take care of your cash flow needs a few times a year as you rebalance your portfolio back to your target asset allocation. As you reallocate your assets, you can take out the cash you need. For example, if your target allocation is 40% stocks and 50% bonds—but your portfolio drifted to 45% stocks and 45% bonds—you could sell a portion of your stock allocation, reallocate what was left to bonds until you were back on target, and generate the cash you need.
  • Bonds maturing in the coming year. Consider bonds maturing within the next 12 months as part of your current-year cash flow, before liquidating other assets at a taxable gain. If you’re holding such bonds in a taxable account, you shouldn’t have to worry about unrealized capital gains, as any gains are likely to be relatively small.
  • Taxable versus tax-deferred accounts. In general, it’s typically better to sell long-term investments held in taxable accounts instead of taking money from tax-deferred accounts before you have to. Withdrawals from traditional IRAs and 401(k)s are taxed as ordinary income—typically at a higher rate than the preferential long-term capital gains rate. What’s more, tapping your IRA or 401(K) early means losing opportunities for tax-deferred compound growth. However, there are possible exceptions to this general rule: If your IRA or 401(K) balance is very large, you may want to draw from it before the age of 70½, when the required minimum distributions (RMDs) begin. (More on those below.) A sound tax-management strategy may be to start IRA distributions earlier to smooth out your tax bill.

    For estate-planning purposes, your taxable estate includes your IRA balance and your heirs will owe income tax on any distributions they take from your IRA. Drawing down your IRA during your lifetime and leaving taxable accounts to heirs could be an effective strategy. If you have both a traditional IRA and a Roth IRA, consider drawing from the traditional IRA first. The Roth is still included in your taxable estate, but at least your beneficiaries will be able to take distributions tax-free. Distributions  from a Roth IRA are tax-free if you take them in retirement as well. If you had the foresight to accumulate savings in a Roth, it gives you flexibility to balance withdrawals between traditional brokerage accounts, traditional IRAs and Roth IRAs as needed.


Finding the most tax-efficient withdrawal strategy can be challenging. Work with a tax professional each year to create the most efficient strategy for you.

Other issues

There may be other factors to consider when building your income plan.

  • Required minimum distributions. Once you reach age 70½, the IRS requires you to take money out of your retirement accounts, known as required minimum distributions (RMDs). If you don't, you could face a tax penalty. You can use an RMD calculator to calculate how much you should take. Withdrawals from traditional IRAs and 401(k)s will need to be considered first—at least up to the amount of the RMD—or you will face a 50% penalty on what you should have withdrawn under the RMD formula.
  • Tax bracket ramifications. Consider ways to manage your tax bracket. For example, before you turn 70 ½ and become subject to RMDs, you could consider taking just enough from your traditional IRA or 401(K) to keep you in the 15% tax bracket. That could reduce the potential tax hit of future RMDs. Or it might make sense to convert a traditional IRA to a Roth IRA for income tax and/or estate planning purposes. Finally, you may wish to postpone the sale of low-basis securities in taxable accounts for gift and estate or charitable purposes.
  • Securities held for slightly less than a year. Assuming there’s no undue risk in maintaining the position, try to postpone the sale of taxable-gain securities held 12 months or less in a traditional brokerage (i.e. non-IRA or 401(K)) until you’ve held the position for at least one year and one day from the original date of purchase. Taxes on capital gains apply only in traditional brokerage accounts.
  • Other special situations. You may also have special situations where tax-loss harvesting, matching of gains and losses and other tax issues override the general guidelines outlined below. Talk to your tax advisor to see if any of these circumstances apply.

Next Steps