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The RetireMentors

Retirement advice from experts in the business

March 9, 2016, 10:11 a.m. EST

The ultimate retirement-distribution strategy is here

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By Paul A. Merriman

About Paul

Paul Merriman is committed to educating people of all ages to get the most from their retirement investments. Founder of Merriman Wealth Management, a Seattle-based investment advisory firm, he is the author of numerous books on investing: "Financial Fitness Forever," "Live It Up Without Outliving Your Money," and the new "How To Invest" series, free at his website:  "How To Invest" series: "First Time Investor," "Get Smart or Get Screwed: How to Select the Best and Get the Most from Your Financial Advisor" and "101 Investment Decisions Guaranteed to Change Your Financial Future." In his retirement, Paul writes a weekly column at MarketWatch and continues his weekly podcast, Sound Investing, which was recognized by Money magazine as "the best Money Podcast in 2008". He is president of The Merriman Financial Education Foundation and all profits from the sale of his books are used to advance financial literacy. His recommendations for portfolios of Vanguard funds, Fidelity funds and ETFs, podcasts, articles and books are available at paulmerriman.com. Follow Paul on Twitter @SavvyInvestorPM.

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With several years of retirement under my belt, I'm more confident than ever about the truth of something I wrote some time ago: The ultimate financial luxury for a retiree is simple: Having more than enough money to meet your needs.

It's not necessarily easy to achieve, but when you're retired, having a comfortable margin of extra savings is about as good as it gets. Let's look at some numbers to see what I mean.

Last week, I wrote about taking fixed distributions in retirement, a discussion built on the assumption that you will need all the retirement income you can get without taking the risk that you could run out of money.

Today I want to explore a variation on that theme: How much can you take out if you start your retirement with significantly more savings than you really need?

Making it work

If you have more than you need, I believe you should be able to function comfortably with retirement distributions that go up and down to reflect the returns on your investments.

I'm going to show you a flexible distribution plan that adjusts your cash flow from year to year as the value of your portfolio goes up and down. In doing that, this plan automatically does something that most smart retirees would naturally want to do if they could: Take out more money after good years and scale back their spending when their investments are struggling.

When your investments are doing well, this is a wonderful plan. But in bad times, it can be tough.

The ups and downs of investing

The very first column I wrote here at MarketWatch was called "How to double your retirement income in five years.” It had a very high readership, and it's very relevant to the current discussion.

As we go through this topic, it will help if you follow along while looking at some tables of historical returns and hypothetical flexible withdrawals.

These tables show what could have happened to somebody who retired in 1970 with a $1 million portfolio. I'd like to start with Table 7 , which is based on the assumption that at the start of every year, a retiree takes out 5% of the portfolio's value from the end of the prior year.

This table shows several investment allocations, varying from 40% stocks and 60% bonds up to 100% global stocks. For comparison, I've also included the S&P 500 Index.

You will see that, after 46 years, none of these portfolios was anywhere near the danger zone of running out of money as 2015 came to a close.

The true cost

But our imaginary investor paid a price for this. If you study the top figures in the distribution column for the 60% equity portfolio, you'll see that the newly minted retiree had to get by with sharply fluctuating income for a few years.

The low point, 1975, provided only $43,461 that year, a significant drop from the initial $50,000. If you really needed $50,000 to cover your cost of living, this had to hurt.

With the benefit of hindsight, we can see that everything worked out well after 1975. But back then, our hypothetical retiree had no way to know that. Would any intelligent retiree knowingly embark on a withdrawal plan like this?

In fact, this plan could make a lot of sense to a retiree who had over-saved. Imagine that you had $1.5 million in your portfolio (instead of "only" $1 million) and your needs did not exceed $50,000. You could then multiply each of the withdrawals in the table by 1.5. In 1970 you would take out $75,000 instead of $50,000. What a nice kickoff.

At the low point (1975), you would have withdrawn $65,191 instead of only $43,461. Assuming you kept your cost of living under control, that would be well above your basic needs.

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