How Much Does the Frequency of Retirement Withdrawals Matter?

Analysis November 05, 2024 at 10:58 AM
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What You Need To Know

  • A paper by the editor of the CFP Board Financial Planning Review examines monthly, quarterly, semi-annual and annual withdrawals.
  • Intuition suggests that smaller amounts taken more frequently should help control key risks, but the findings show otherwise.
  • Assuming similar investment timelines, the more important factors in positive outcomes are withdrawal rates, volatility and taxes.
Upside-down piggy bank with dollars bills falling out

A sizable and growing amount of academic research has sought to identify the best ways to structure sustainable withdrawals from retirement accounts, with many authors concluding that flexibility is a key element in maximizing outcomes and preventing late-in-life insolvency.

Less attention has been paid, however, to the question of withdrawal frequency, which is why a recent paper authored by Stephen Horan tackles the issue head on. Is it better to take withdrawals monthly? Semi-annually? Once per year?

Horan, an associate professor at the University of North Carolina Wilmington and the executive editor of the CFP Board's Financial Planning Review, uses Monte Carlo simulations to test the question — and his results are likely to be surprising to some financial planners.

As Horan writes, there are intuitive reasons to believe that dividing retirement withdrawals into smaller amounts over more frequent intervals might help control volatility or sequence of return risk. After all, dollar-cost averaging is seen as an important tool during the accumulation effort, so why wouldn't a similar principal apply to retirement income?

Yet, the results of Horan's analysis actually show that withdrawal frequency has essentially no effect on retirement withdrawal sustainability — provided the withdrawal patterns allow money to be invested for roughly equivalent periods of time. Notably, the result holds whether one uses simulated or historical returns.

Despite the "negative result," Horan says, the paper offers up some important implications.

"First, financial planners may mistakenly believe that increasing or decreasing the frequency of withdrawals may improve a retirement portfolio's probability of success," Horan writes. "This is false. They should instead focus their attention on withdrawal rates, volatility and taxes."

Second, Horan finds, financial planners and retirees should focus on matching retirement withdrawal frequency to cash flow patterns. This can help to decrease transaction or financing costs, among other benefits.

"In fact, policymakers and financial specialists may revisit the wisdom of retirement account-linked debit cards to facilitate this cash flow matching principle," Horan argues.

Finally, the results also have important implications for common beliefs about dollar-cost averaging, Horan says. Namely, it is less useful in the withdrawal phase than many financial planners might expect.

Time in Market Matters More

At the heart of Horan's analysis is a review of retiree cash flow patterns that seeks to compare different withdrawal frequencies in a way that holds the retirees' "time in market" closer to equal relative to less sophisticated analyses of withdrawal patterns.

Applying this standardization method to different frequencies suggests that dollar-cost averaging frequency is essentially irrelevant in the context of retirement withdrawal optimization. That is, portfolio depletion does not seem to be correlated with either a faster or slower frequency of withdrawals, assuming that the underlying assets have been invested for roughly equal amounts of time.

"We put withdrawal programs of different frequencies on an equal footing by standardizing the amount of time funds are invested in the portfolio," Horan explains.

He then chooses withdrawal patterns of approximately equivalent in-market duration across four frequencies using a series of beginning-of-month withdrawal patterns, including monthly, quarterly, semi-annually and annually.

"These beginning-of-month withdrawals allow withdrawal durations of various frequencies to align more closely with each other than end-of-month withdrawals," Horan adds.

Ultimately, when thus controlling for the duration of withdrawals to equalize the amount of time capital is invested, withdrawal frequency is shown to do "little or nothing" to control the risk of portfolio failure.

The Bottom Line

Horan concludes that maximizing the duration of time over which capital is invested (not the frequency with which it is liquidated) is the determining factor for withdrawal sustainability.

"This intuitive result is important because one might otherwise mistakenly conclude that withdrawal frequency can magically preserve retirement portfolio value even when investment duration is held constant," Horan says.

Another notable finding is that the "time in market principle" — i.e., the amount of time retirement assets are invested in positive expected return assets — seems to be even more important when the retirement investment account is a tax-deferred account.

For financial planners, the key insight is that retirement spending patterns should influence or even dictate the retirement withdrawal pattern in a way to maximize "time in market."

"Pre-emptively making retirement withdrawals in advance of spending needs is sub-optimal," Horan concludes. "Rather, withdrawal frequency should match spending frequency. If retirement expenses occur at more frequent intervals, then retirement withdrawals should, as well. This practice is likely to enhance retiree utility and decrease transaction or financing costs from cash flow mismatches."

For policymakers, the key insight is that proposals to link debit cards to retirement accounts (which have been met with some derision) probably deserve a closer look.

"Although 401(k)-linked debit cards may promote poor spending or borrowing behavior for investors in the accumulation phase, a similar product for retirees in the decumulation phase may allow retirees to align their retirement spending more closely with their retirement withdrawals and hence maximize the time their funds are invested and increase their utility," Horan says.

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