3 Approaches to Retirement Cash Flow

By Justin Pritchard, CFP®

When you leave your job, you’re off the payroll system, and you no longer get a steady income. But you may have retirement savings, and you might get income from sources like Social Security or a pension. Managing cash flow in retirement is a new skill for retirees (and those planning for retirement), and there are several strategies for getting the income you want.

On this page, we’ll review two strategies (plus a combination of strategies) that you might use to spend from your retirement savings.

  • Withdrawal strategies
  • Guaranteed income products
  • Combining strategies

We’ll cover the pros and cons of each approach, as well as tips for customizing those strategies to meet your needs. Finally, we’ll touch on any pensions and Social Security that form a base of income in retirement.

Withdrawal Strategies

One way to get cash flow from your retirement savings is to simply withdraw funds from your retirement accounts. With that method, you take what you need (whenever you need it), and you might continue to use an investment approach similar to the one you used in your “accumulation” years. But it’s smart to review your investment strategy and set guardrails on your spending. If you withdraw too much, you may run out of money during retirement.

Two strategies that might reduce the chances of exhausting your funds include withdrawal rates and time segmentation.

Withdrawal Rates

A withdrawal rate is an amount (typically a percentage) that you pull from your retirement savings each year. 

One historically popular strategy is the 4% rule, which is designed to provide a “safe” withdrawal rate that ideally prevents you from running out of money in retirement. But there are no guarantees—and you could still come up short with the 4% rule—so it’s best to be flexible when applying these rules.

As an overview, with the 4% rule, you withdraw 4% of your retirement savings each year. For example, if you have $1 million of retirement assets, you’d take out $40,000, which is 4% of $1 million. 

In the following year, you adjust your withdrawal for inflation. If inflation is 2%, you add that to your second year’s withdrawal. In our example, $40,000 plus 2% inflation is $40,800 of cash flow. You can learn more about the 4% rule and some pros and cons of using this strategy.

Some argue that 4% is too high, and you should use a lower withdrawal rate—3%, for example. With low interest rates and uncertain market returns, the most conservative approach is to start small. That said, 4%—or some other number—might be appropriate. An even better idea is to run detailed numbers to estimate how much you’ll really need, and don’t just assume you’ll want the same amount (with an inflation adjustment) each year.

Modifications: To reduce the risk of running out of money, you can modify the standard 4% rule. Obviously, a lower withdrawal rate is one solution. But you can also consider a flexible or dynamic withdrawal strategy: When markets go down, you withdraw less. You might take a smaller percentage in those years or eliminate the inflation adjustment, for example. You can also reset the withdrawal amount each year (based on each year’s account balance) to see if it results in a smaller withdrawal amount.

Potential benefits:

  • Relatively easy to manage: Just withdraw from your portfolio as needed, and consider opportunistic selling.
  • Potential for increasing income and assets if markets perform reasonably well.
  • Ability to change course and use a different strategy down the road.

Potential Pitfalls:

  • You may run out of money during your life.
  • You may need to adjust spending in response to weak markets (sometimes dramatically, sometimes not).
  • Picking the right withdrawal rate is a challenge.

Time Segmentation (Bucketing)

A “bucketing” strategy, also known as time segmentation, is a system of categorizing funds for short-term and longer-term cash flow needs. 

Bucket #1: The first bucket is money you’ll spend in the next few years. For example, you might set aside enough cash to cover your spending (after Social Security or pension income) for the next four years. You can choose a longer or shorter period if you prefer to be more or less conservative.

Bucket #2: Next, you have funds that you’ll use to replenish your cash bucket. This bucket might be a portfolio of relatively low-risk investments. For example, it might hold 30% in stocks, with the remainder in high-quality (and possibly short-term) fixed income. You’ll sell holdings from this bucket and shift the cash to your “safe” bucket.

Bucket #3: Your next bucket contains long-term investments that will hopefully grow over time. You’ll likely lose money in this portfolio—at least temporarily—occasionally, and you might have significant exposure to stock markets in this bucket. But the idea here is to avoid touching the funds in this bucket for at least 10 years. There’s no guarantee that you’ll earn money over that time (it’s even possible to lose money), but the hope is that you’ll get growth that can replenish Bucket #2.

The bucketing strategy can offer peace of mind because you know that your next several years are taken care of. You also know that you don’t need to touch your risky investments for at least 10 years. But the strategy can result in relatively high levels of cash holdings, and that might cause you to miss out on some growth if the markets go up.

Modifications: You can customize your bucket strategy in numerous ways. You might extend (or shorten) the timeframes, or you can add more buckets. Be wary of overcomplicating things, as you’ll need to manage the strategy over time. Finally, you can add a guaranteed income source like an annuity to satisfy some basic spending needs, which may reduce the need for a cash-like bucket.

Potential benefits:

  • Ensure that you satisfy cash needs for several years
  • May enable you to ignore fluctuations in your long-term bucket

Potential pitfalls:

  • Requires ongoing management and bucket replenishment
  • Can lead to high cash levels

Guaranteed Income Products

Private annuities can provide guaranteed cash flow in retirement, and some people find that to be comforting. The simplest form of an annuity is an immediate annuity, which provides income for your life—and the life of a beneficiary (like your spouse), if you choose.

When buying an annuity, you give an insurance company a lump sum of cash. In return, you get a stream of monthly or annual payments that are guaranteed to last for the rest of your life. Remember that any annuity guarantee is not a government guarantee—it’s only as strong as the insurance company behind it, so choose strong insurers with the highest ratings.

Immediate annuities can be intimidating. If you die shortly after buying one, you “lose” because the insurance company keeps your money. You can manage that risk with a joint life annuitant, adding a “period certain,” and other strategies, but you get the biggest payments by taking the biggest risk. For some, that’s just not appealing.

Plus, an annuity can be inflexible. Once you convert your savings to income, it’s difficult or impossible to get your money back. If things change, you may be in a challenging position.

Modification: Annuities with lifetime income riders, also known as “living benefits,” can address the risk of dying early and needing your money. They offer lifetime income guarantees, but you can also withdraw any remaining savings at any time (you may face surrender charges or taxes, but the funds are available).

There are always tradeoffs with financial products, and income riders are no exception. Those strategies can have high fees and confusing features, and you might not be able to walk away with as much as you’d like if life takes an unexpected turn.

Potential benefits:

  • Lifetime income guarantee from an insurance company
  • Ensure that a spouse or others receive income after your death
  • Potentially eliminate worries about stock market performance

Potential pitfalls:

  • Must commit a significant amount to get a meaningful cash flow
  • May be difficult, impossible, or unappealing to change course after you start
  • No exposure to long-term market growth, in many cases

A Combination of Strategies

Remember that few things in personal finance are either-or. If you want the best of both worlds, you can always draw on the strengths of each strategy. 

For example, you might use guaranteed income products to cover your essential spending needs, helping to reduce the chances of coming up short. But you can also keep funds invested for long term growth and take withdrawals for discretionary spending. That way, if your investments do well, you have more to spend, and if they don’t, you can still meet your basic needs.

For that strategy, you might estimate how much you need for critical expenses like healthcare, housing, food, and regular bills. Figure out how much of that you get from Social Security or a pension, and then determine if there’s a gap you want to fill with annuity income.

You typically don’t put all of your retirement savings into an annuity. With this combination strategy, you would only use enough to meet your basic needs. You might invest the rest of your money in a way that will hopefully grow over the long term, and you can take withdrawals at a rate you’re comfortable with.

Potential benefits:

  • Get a “floor” of guaranteed income
  • Participate in long-term market growth (if any)
  • Maintain flexibility

Potential pitfalls:

  • With one foot in both camps, you might not maximize the benefits of the “best” one (which you’ll never be able to identify in advance)

Pensions and Social Security

Social Security and pension are relatively straightforward. The rules and options available to you are set by Social Security (or your employer, in the case of pensions), so you just need to choose the option that works best for you. Once you do that, it’s a hands-off affair, and you simply receive payments that you can use for anything.

Two of the most important decisions to make with Social Security and your pension include:

  1. When to take benefits
  2. Whether or not to use a survivor benefit

When to Begin?

The longer you wait to begin your retirement income benefits, the more cash flow you generally get. That’s true for both pensions and Social Security. The reason? The older you are when you start taking income, the fewer years you have of life expectancy. While that may seem morbid, the fact is that retirement income often depends on how many years of income you receive. With fewer years, you get bigger monthly or annual payments.

Social Security is available to most people as early as age 62. But your benefits are reduced at that point, and delaying claiming results in higher payments. At age 70, those increases stop, so it doesn’t make sense to delay after that. If you can wait to claim, you might substantially increase your income, and it might even make sense to spend down your assets for a few years while you delay.

Pensions also typically reward you for starting your income later. Contact your benefits department or your pension administrator to learn about the details. If you don’t need the income immediately and you can get a meaningful raise by waiting, it may be worth it. 

Another factor that affects your pension income in retirement is the survivor option. If you choose to get income for your life alone, you generally get the biggest monthly payment available. But if you want payments to continue to a spouse, for example, you can often arrange that. The tradeoff is that you’ll get a smaller monthly payment while you’re both alive, but that may be well worth it to ensure that your beneficiary gets your income if you die first.