Keep The Money Flowing

It's okay to dig deep -- but not too deep -- into your retirement stash.

By Mary Beth Franklin, Senior Editor

From Kiplinger's Personal Finance magazine, October 2004

How much can you withdraw from your retirement portfolio each year and not have to worry about running out of money before you die? It's a blunt question -- one of the toughest facing current retirees and the rest of us still trying to build up nest eggs sufficient to support us once the paychecks stop.

Unfortunately, you're probably not going to like the answer. In the shadow of the 2000-02 bear market, an increasing number of financial planners and leading mutual fund companies set the sleep-at-night number at a miserly 4%. For example, if you have a million bucks, you can withdraw $40,000 in your first year of retirement. You can bump up the withdrawal each subsequent year, but only enough to keep up with inflation. Follow that payout scheme, and it's all but guaranteed that your money will last for 30 years. Dig deeper into your stash, however, and the odds increase that you'll run out of money before three decades pass.

Seems downright parsimonious, doesn't it? Why limit yourself to 4% when, over the long term, stocks have returned an average of better than 10% a year? Since 1926, even a portfolio equally split between stocks and U.S. Treasury bills returned an average of better than 7% a year. Is the 4% rule a sneaky way to get us to scrimp in retirement just to leave inheritances for our kids?

Forget the conspiracy theories. The 4% solution is solidly grounded in research based not on average returns, but on the market's ups and downs. To determine the odds of a certain withdrawal rate's being sustainable, planners run hundreds of scenarios based both on historical data (retiring at the beginning of a bear market à la 2000 is a bad thing, for example) and on various portfolio allocations. This research shows that there's about an 85% chance that a portfolio split evenly between stocks and bonds will support a 4% withdrawal rate -- adjusted each year for inflation -- over a 30-year retirement. If you want better odds, you could tilt more heavily toward stocks or trim the withdrawal rate below 4%. If you're willing to take more risk, you can take more money each year.

Just because there's sound research behind that 4% figure doesn't mean you're stuck with it, though. Some critics complain that it unnecessarily restricts spending in the early years when retirees are more likely to want to travel and indulge in expensive hobbies. And, 85% of the time, the 4% system means most retirees will unintentionally wind up leaving estates -- often large ones -- to their heirs.

"If I had $1 million, and my financial adviser told me I could only afford to withdraw $40,000, I'd fire him," says Philip Cooley, a professor at Trinity University in San Antonio who has spent years researching how much money retirees can safely withdraw without fear of outliving their money. "It's true that 4% or 4.5%, adjusted for inflation, is a reasonable, sustainable withdrawal rate," he says, "but it's way too conservative."

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