Fund Mechanics: Investing & Redeeming

Step 5: Are There Any Special Issues I Should Keep in Mind When Setting Up a Withdrawal Plan?

While withdrawal plans are a useful service, they can lead to certain problems. Here are some to ponder.

• Recordkeeping for tax purposes can be a headache, especially with more frequent redemptions. Each time you make a withdrawal you're selling shares, which results in a taxable event. You need to adopt a systematic procedure for calculating gains and losses on each withdrawal.
• Volatile stock and sector stock funds are generally poor candidates for withdrawal plans. These funds can plunge as fast as they can surge. Withdrawing money when the value of your account has taken a steep decline can lead to problems if it doesn't rebound quickly.
• It's best to be conservative. Too high a withdrawal rate can deplete your capital too soon. Be sure to compare your withdrawal rate with the rate at which you expect your fund to compound, after inflation. If the former exceeds the latter by too many percentage points, your capital might not last as long as you'd like. The numbers in Table 1 are useful in this regard.
• Make sure you consider the impact of taxes on your investment earnings and withdrawals. Of course, the effect of taxes varies depending upon your circumstances, and tax rates are subject to change, but the tax factor is too important to overlook.

It's a good idea to reevaluate your situation every year or so. Do some revised number crunching to see if you need to make any adjustments in your withdrawals.