Avoiding the nightmare financial scenario in retirement _ running out of money _ is getting trickier.
Rising life expectancy means having to pay for a longer retirement. The lack of a pension or frozen benefits translate to fewer, smaller checks from ex-employers. And the days of being able to count on averaging 10 percent annual returns from the stock market are over.
All that makes it even more important for retirees to know just how much they can take out of their portfolios every year without drawing them down too fast.
There isn't one model that fits all. It depends on individual circumstances, best reviewed with a financial adviser.
But the classic guideline long followed by many, and still respected, is widely known as the 4 percent rule. It holds that if you withdraw no more than 4 percent from your savings the first year of retirement and adjust the amount upward for inflation every year, you can be confident you won't run out of money during a 30-year retirement.
The strategy is credited to financial planner William Bengen, who published his research in the Journal of Financial Planning in 1994.
The twist is this: The father of the 4 percent rule says the complete number is actually 4.5 percent.
"A 4 percent rule is just so easy to think about. People just kind of ignore the extra half," chuckles Bengen, 64, who operates Bengen Financial Services in La Quinta, Calif.
Bengen spoke about his rule and the proper approach to withdrawals in a recent interview. Edited excerpts follow:
Q: How did the rule come about?
A: I started getting clients who were thinking seriously about retirement. They asked me, `How much can I take out of my portfolio when I retire?' I really hadn't a clue. So I started looking and I found no substantial information anywhere. I looked at data on investments and inflation going back to 1926 and reconstructed the investment experience of retirees over the decades.
Q: The Wall Street Journal characterized your findings at the time as "scary for retirees and depressing for everybody else" because they suggested you can't squeeze nearly as much income out of retirement savings as had been thought. Did financial planners resist the new number?
A: It met a lot of resistance initially. I was surprised, too. People were assuming it was 6 percent, 7 percent. But they were using average rates of return, which is very dangerous.
It's like the guy who drowned in a lake with an average depth of 3 feet. You go out to the middle of the lake and it's 10 feet. So that doesn't help you to know what the average depth is. You have to be able to survive worst-case scenarios.
Q: What has changed, if anything, since you did your research?
A: Not much. I still think the rule is valid, although we're in a period of time which may challenge it.
People who retired in 2000 are of the greatest concern. They're the ones who started and had two major bear markets, which is unprecedented _ two big 50 percent drops in the market. A lot of it depends on what happens to stock market returns and inflation over the next five years. The real problem will come about if we get a big boost of inflation (well above its historical average of 3 percent), in that retirees are required to increase their withdrawals. That may make it hard for the 4 1/2 percent rule to fly.
Q: What about the outlook for those retiring now?
A: If you're retiring today, you probably can't expect much more than 5 percent a year from U.S. stocks over the next five to seven years. That's a pretty bad start to your retirement. Bonds also don't look very good.
People retiring today have to be very careful. They may be better off not retiring for a couple of years. The greatest asset you have in an environment like this is a good-paying job so you're not dependent on the stock market or the bond market to support you.
Q: You mentioned having enough money in your scenarios for a 30-year retirement. With lifespans lengthening, is that a long enough period to use as a base?
A: If you feel you could live for 40 years in retirement, either because you're retiring early or you have an exceptional genetic predisposition, you wouldn't want to take 4.5 percent, you'd want to take 4.1 or 4.2 percent. If on the other hand you expect a very short retirement _ you have bad health _ you could think about taking out 6 percent or 7 percent.
Q: What else can retirees do to help their savings last besides sticking to the withdrawal strategy?
A: Besides cutting back on expenses, there's a couple of things they can look at.
One is to utilize the equity in their home and consider a reverse mortgage. That could take the pressure off their withdrawals. If they can get some money out of their house, they can take less out of their investment portfolio.
The other is maybe convert a portion of their portfolio to a fixed annuity. If you're age 80, you can get a fixed annuity paying you 8 percent, and if you're 85, almost 10 percent. So you could take 10 or 20 percent of your investment portfolio and convert it to a fixed annuity and get a very high payout.
Q: Do you have any other financial advice for retirees?
A: Be conservative in both your living expenses and your investments.
It's also a good time to actively manage your portfolio. Buy and hold in this environment probably is counterproductive. It worked in the `80s and `90s and I think it'll work again someday, but not in this environment, where there are so many risks and threats to capital.
Protect your nest egg. Don't let anyone step on it.
AP Personal Finance Writer Dave Carpenter can be reached at http://www.twitter.com/ScribblerDave.