Have a Retirement Account? Why the "Withdrawing Interest Only" Strategy May Not Work for You.

To determine how long a retirement account is likely to last, a retiree must estimate the average rate of return on their portfolio. For those who are nervous about running out of money in retirement, estimation may not be enough.

Instead, some retirees have decided to withdraw only the interest earned on their retirement accounts each year, leaving the principal untouched. That means withdrawing more in years their portfolio is doing well and scaling back when the market is down. The goal for many is to die with the same amount of principal they started with.

For the truly risk-averse, this withdrawal strategy seems sound. However, there are several reasons it may not work for you.

Image source: Getty Images.

For most, the math doesn't add up

Let's say you've done everything within your power to maximize your Social Security benefits but need an additional $25,000 annually to provide you with the life you want in retirement. If your portfolio earns an average of 6% annually (before taxes), that means you'd need a portfolio size of $535,000. However, that calculation leaves no room to increase your annual withdrawals to keep up with inflation.

If you need an extra $50,000 annually to lead your best retirement life, an account earning an average annual return of 6% before taxes would need to be worth roughly $1.1 million. Again, that doesn't account for inflation.

Given that the median retirement savings for adults aged 65 to 74 is $200,000, most people can't afford to draw interest only.

The guessing game sticks with you

Withdrawing interest alone doesn't eliminate the guesswork from retirement planning. The interest rates and returns you'll earn are unpredictable. Due to market volatility, some years will deliver strong gains while others may produce depressing losses. When interest rates are low, it becomes more difficult to generate the income you need to live well.

There's also the matter of inflation. At an average inflation rate of 3%, your purchasing power would be cut by approximately 50% over 24 years. Your retirement account absolutely must account for inflation, particularly given the higher healthcare costs you're likely to face as you grow older.

Opportunity cost

An interest-only strategy may require you to unnecessarily sacrifice quality of life. If limiting yourself to interest only means missing out on travel, helping family, or other experiences that enrich your life, it may not be worth the trade-off.

A financial or retirement advisor's input could be invaluable here, helping you create a personalized withdrawal plan that addresses any concerns about outliving your money while providing enough income to live comfortably.

The Motley Fool has a disclosure policy.