Use our template to document your retirement assets, strategy, and spending system.
By Christine Benz | 06-15-17 | 05:00 AM | Email Article

If you start reasonably early, set aside adequate savings, and invest in a semi-sane manner, it's hard to go terribly off track with investments in the years leading up to retirement. But decumulation--the process of figuring out how to position your portfolio to deliver desired cash flows in retirement--is another ballgame. 

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

In retirement, a separate set of variables comes into play. Issues like asset allocation and the quality of the investments you choose are still important (which is why you still need an investment policy statement) but so are factors such as how--and how much--you'll spend from your portfolio on an ongoing basis.

If you're close to retirement or already retired, creating a retirement policy statement is your June task on my 2017 financial to-do list. With an RPS, you're effectively committing yourself to abiding by a given system. That's not to say your system won't evolve as the years go by, but having an RPS makes it much less likely that you'll ratchet your planned 4% spending rate up to 10% in a given year.

We've created a template to help. You can append pages to address topics not covered in the template.

While your RPS isn't likely to contain as much personally identifying information as a master directory, it's still valuable to protect these documents. Note that our RPS template is designed for users with access to Adobe Acrobat, which enables password-protection. If you are opening this template with Adobe Reader (rather than Acrobat), print the document and write in your answers. Store the document in a safe location, such as a locked file drawer or safe deposit box. Alternatively, customize the document by setting up a file with similar fields in Microsoft Excel or Microsoft Word. Both programs enable password-protection.

No matter what format you use for your RPS, be sure to follow these steps.

Step 1: Specify retirement details.
In this section, lay out the basic details of your retirement program. As you may have guessed, "anticipated retirement duration" requires you to break out a crystal ball and forecast your own life expectancy. This article helps you make a realistic assessment on that front.

Step 2: Outline your retirement portfolio strategy.
Simple and to the point is the name of the game here. For example, a retiree employing the bucket system might write: "To maintain a portfolio that consists 60% of high-quality, dividend-paying stocks and 40% high-quality bonds, along with a cash component consisting of two years worth of living expenses. Spend from cash bucket and periodically refill using rebalancing proceeds. Use 4% guideline for spending."

Step 3: Document retirement assets.
Use this space to note your accounts and the amount of assets in each. As with the investment policy statement, this template requires you to amalgamate multiple accounts of the same type into a single line entry, but you can append pages enumerating each distinct account. Calculate a total dollar amount for all of your retirement accounts.

Step 4: Specify your spending plan.
In this section, document the key components of your retirement spending plan: your spending needs and the extent to which they'll be supplied by nonportfolio income sources (Social Security, pensions, and income annuity) and the extent to which that desired cash flow will come from your portfolio. If you're a few years from retirement and aren't sure what your spending needs will be, this article can help.

Armed with your planned annual portfolio withdrawal and the total dollar value of your portfolio (total retirement assets, from the preceding step), divide the former by the latter to arrive at current annual spending rate. (We've included the term "withdrawal rate" on our worksheet because it's more familiar to investors, but I prefer the term "spending rate" because it’s more encompassing.)

Step 5: Detail how you'll address inflation.
Drawing a fixed dollar amount from your portfolio will help ensure that your standard of living declines as the years go by. That's not what most retirees want. Thus, it's wise to factor your approach to inflation into your spending plan, to allow for higher withdrawals in years in which your cost of living is on the move. The "4% guideline," for example, assumes that a retiree takes 4% of his or her portfolio in year one of retirement, then inflation-adjusts the dollar amount as the years go by.

In this section, write in what inflation level you're assuming will prevail over your retirement years--2%-3% is in line with historic norms. Also include when you'll forego giving yourself a raise from your portfolio. It's only sensible to skip an inflation adjustment in those years when you're not feeling any inflation, for example, and T. Rowe Price research following the financial crisis demonstrated that forgoing an inflation adjustment in the wake of a bear market also helped improve a portfolio's sustainability.

Step 6: Document your cash-flow generating system.
This is the meat of the statement: Where will you go for cash from your portfolio on an ongoing basis?

Option 1, living on income distributions alone, is the old-school way to do it, but it might not be practical given today's low yields; nor will an income-centric portfolio necessarily be optimal from a risk/return standpoint. 

Option 2, using rebalancing (selling highly appreciated portions of the portfolio) to fund living expenses certainly receives more support in the academic community; it's the way noted financial planner Harold Evensky says he creates cash flow in retired clients' accounts. 

Option 3 blends the two strategies: The retiree uses income distributions to provide a baseline of living expenses but doesn't stretch for yield; he or she then periodically rebalances to shake out additional living expenses.

There's no single "right" way to do it, but this article details the pros and cons of various approaches. 

Step 7: Document your approach to withdrawals.
Like the previous step, this step requires careful consideration, because it can have a big impact on the viability of your plan as well as the variability of your cash flows during retirement. Here you're documenting not just your withdrawal rate--though that's in the mix, too--but also your approach to withdrawals.

Option 1, withdrawing, say, 4% of the portfolio and then inflation-adjusting the dollar amounts annually, will deliver a fairly stable in-retirement cash flow. 

Option 2, spending a fixed percentage of the portfolio year in and year out, helps tether withdrawals to the portfolio's performance, but will lead to significant variability in cash flows. 

Option 3 is a hybrid of the two methods. It entails using a fixed percentage withdrawal as the baseline, but employs "guardrails" to ensure that spending never goes above or below certain levels. (Financial planner Jonathan Guyton initially wrote about the guardrails system in this research paper; this Vanguard research explores a similar methodology.) Under Option 4, a retiree is spending just a portfolio's income distributions, whatever they might be.

This article explores the pros and cons of each of these approaches.

Step 8: Specify whether and when RMDs apply.
This section is straightforward: Document which of your accounts are subject to required minimum distributions--mandatory withdrawals once you pass age 70 1/2. Required minimum distributions apply to traditional IRAs and 401(k)s, as well as Roth 401(k)s and other company retirement plans. They do not apply to Roth IRAs.

Also document when RMDs must commence, for both you and your spouse, based on your birthdays. You must take your first RMD by April 1 following the year in which you turn 70 1/2. So if you turned 70 in February 2017 and will turn 70 1/2 in August 2017, your first RMDs would be due on April 1, 2018.

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