What Is Systematic Withdrawal Plan (SWP) And How Does It Work?
A systematic withdrawal plan (SWP) is a retirement savings strategy that allows you to withdraw a fixed amount of money from your account at regular intervals with less risk of outliving your money since withdrawals are done systematically. SWP also allows you to customize the cash flow from your account over your lifetime. You can choose to make larger withdrawals in the early years of your retirement life and smaller withdrawals later. You can also delay withdrawing money from your account if you want to withdraw smaller amounts during the early years and then increase the amount as you begin living on a fixed income. This makes it easier for retirees to manage their personal finances since there is no need to worry about market conditions and their account balance can last longer.
Why Do I Need a Systematic Withdrawal Plan?
An SWP can help retirees maintain a steady stream of cash flow during their retirement years. This is important since retirees may need to pay for medical expenses, household expenses, and other costs. It is also important to have a SWP because you don’t want to outlive your money in retirement. An SWP helps ensure that you don’t run out of money early in your golden years.
How Does the SWP Work?
There are a few things you need to do in order to set up an SWP:
- Choose the account you want to use for your withdrawals, such as an IRA or 401(k).
- Decide on the amount of money you want to withdraw each month. This amount should be based on your retirement goals and income needs.
- Choose the date you want your withdrawals to start. This could be the day you retire or a later date.
- Choose the number of years you want your withdrawals to last. This could be for the rest of your life or a specific number of years.
- Decide on the frequency of your withdrawals. For instance, you can choose to make monthly withdrawals or withdraw quarterly.
- Decide on an inflation factor that will be applied to your account each year before making any withdrawals. This will help keep pace with the rate of inflation.
It is recommended that retirees use 3 percent for their SWP calculations since this is considered a conservative rate of inflation. Once you have set up your SWP, the withdrawals will be automatically made on the chosen date each month or quarter. You can also change your withdrawal amount or frequency if your needs change.
SWP Calculation Example
Here is an example of how an SWP would work: A retiree has a 401k with $100,000 and decides to withdraw $2,500 per month. This amounts to a total withdrawal of $300,000 over 10 years. If the retiree chooses to make withdrawals monthly, they will receive a total of $36,389 annually after taxes and an inflation rate of 3 percent. If the retiree decides to make withdrawals quarterly, they will receive a total of $11,722 annually after taxes and an inflation rate of 3% per year. The monthly withdrawals are larger than the quarterly ones so retirees get more spending money each month compared to making withdrawals quarterly. However, the total amount received over 10 years is the same for both withdrawal options.
There are three types of SWP: fixed percentage, fixed dollar amount, and sliding scale.
With this option, an amount equal to a percentage of the balance is withdrawn using a fixed date. The percentage can either be a fixed percentage or a fixed fraction of the account value. For example, you can withdraw 1 percent of the account value and make this withdrawal every quarter.
Fixed Dollar Amount
With this option, a fixed dollar amount is withdrawn using a fixed date. The dollar amount can either be a fixed dollar amount or it can be based on the value of your account at the time of withdrawal. For example, if the withdrawal is $40,000 and the value of your account is $800,000 at the time of withdrawal, then 8.0% of your account will be withdrawn.
Using a fixed date in this method, you have two options for how withdrawals are calculated: You can either withdraw an amount that is a fixed percentage of the account balance or you can withdraw an amount that is a fixed dollar amount. The withdrawal amount will be based on the account balance at the time of withdrawal. For example, if the withdrawal amount is $1,000 and your account balance is $10,000, then 10% of your account will be withdrawn.
Systematic withdrawals are considered taxable income by the Internal Revenue Service (IRS). This means that you will need to pay taxes on these withdrawals no matter what type of account you choose to use for your SWP. However, the withdrawals will be taxed in a lower tax bracket than your primary income. For instance, if you have a primary income of $100,000 each year and withdraw $10,000 from your retirement account each year, this amount will be taxed at a lower tax bracket. This is because the IRS considers the systematic withdrawals to be a form of pension income.
Systematic Withdrawal Plan Benefits
There are a few benefits of using a systematic withdrawal plan:
- You can’t outlive your money – This is one of the biggest benefits of using an SWP. The withdrawals will last as long as you live.
- You don’t have to worry about market fluctuations – With a SWP, you will receive a steady stream of income for as long as the money is available.
Since market fluctuations do not impact withdrawals, you don’t have to worry about your account balance decreasing or increasing significantly at any time.
- You can be more flexible with your investments – As retirement accounts typically offer a wider range of investment options than taxable accounts, you can be more flexible with the investments you choose for your SWP.
- You can minimize taxes – Withdrawals will be taxed in a lower tax bracket than your primary income.
- You can maintain control of your money – Unlike pensions, you are in control of the amount and frequency of your withdrawals.
Systematic Withdrawal Plan Drawbacks
While there are many benefits to using a SWP, there are also a few drawbacks:
- Fees may reduce your account balance – Some retirement accounts charge withdrawal fees, which will reduce the amount of money you have available for withdrawals.
- You may not have enough money to cover all of your expenses – Since systematic withdrawals are designed to last as long as you live, they are based on your life expectancy.
If you have a shorter life expectancy than the withdrawal rate, you may not have enough money available each year to cover all of your expenses.
- Unforeseen circumstances – Although rare, it’s possible that there can be an unforeseen circumstance that will reduce or stop your withdrawals. If this happens, you may not have enough money to cover all of your expenses in retirement.
- Withdrawal options may be limited – Some retirement accounts, such as 401(k)s, don’t offer the same withdrawal options that traditional IRAs and Roth IRAs do.
For example, you may have the option to receive a lump sum or set monthly payments, but your employer-sponsored plan may only offer a lump sum payment at retirement.
- You may not want withdrawals – There are some people who don’t want their money to run out. If this is the case, creating a SWP may not be the right decision.
This is because you can potentially outlive your savings if withdrawals are made each year based on an estimate of how long you will live.
The Bottom Line
Overall, a systematic withdrawal plan is a great way to ensure a steady stream of income during retirement. While there are some drawbacks to consider, the benefits usually outweigh them. If you are looking for a way to ensure your money will last throughout retirement, then a SWP may be the right option for you.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.