Don't run out of retirement money

Turbulent markets are devastating for new retirees, since early losses can cripple the ability of a portfolio to generate enough income in decades to come. But retirees who flee from stocks to the relative safety of bonds and cash risk missing out on the historically higher average returns generated by stocks once they recover.

In most cases, there's a better route for retirees to follow: Give yourself a pay cut by withdrawing a little less today and continuing to take out less over the next several years. According to a new analysis by Baltimore-based financial-services firm T. Rowe Price Group Inc., this approach can help make a damaged portfolio still last a lifetime.

Bruce Hugill, 67, a retired financial planner in Tulsa, Okla., is trimming his withdrawal to 5.5 percent from 6 percent, even though his investments in oil and gas partnerships, and annuities are holding up. “If you continue to take money out of your total portfolio as the balance declines, the account value will go down even faster,” he says.

Typically, retirees are advised to withdraw no more than 4 percent of their portfolios' value in the first year of retirement, and then bump up that sum each year, typically in 3 percent increments, to keep pace with inflation. If you retired with $1 million in savings, you could withdraw $40,000 in year one, $41,200 in year two and so forth, without running much risk of depleting your nest egg in your lifetime. In fact, that approach would provide an 89 percent chance of sustaining an income stream for at least three decades, according to T. Rowe Price research, which simulated 10,000 potential market scenarios.

But what if you retired last year and your investments are suddenly worth $800,000 instead of $1 million? Unless you change your withdrawal strategy, your odds of running out of money rise sharply.

“You have to understand that there are things you can control. You can't go through this in ignorance, and you have to understand that you are now in a high-risk position,” says Christine Fahlund, a senior financial planner for T. Rowe Price.

Even if the market manages a tepid recovery – for example, gaining an average 4 percent to 6 percent a year over the next five years – a retiree with a 20 percent loss would increase the risk of running out of money early by following the traditional withdrawal rate. Doing so would leave the retiree with a 49 percent chance of depleting a portfolio invested 55 percent in stocks and 45 percent in bonds, the T. Rowe Price model finds.

If your portfolio took a 30 percent loss, the news is much more grim: You'd have a 79 percent chance of running out of money prematurely if you continued a traditional withdrawal strategy.

So what can you do to make your savings last when a downturn hits?

The easiest fix is to simply quit giving yourself a cost-of-living raise for the next five years. In other words, if you're on track to take out $41,200 this year, stay at $40,000 instead. This would give you a 75 percent chance of sustaining your savings for 30 years, assuming a 20 percent loss followed by a slow recovery, according to T. Rowe Price.

But a 75 percent chance is not enough assurance for many people. What would you need to do to get back to a 9-in-10 chance of making your money last? Assuming you had experienced a 20 percent loss, you could still take withdrawals of almost 4 percent. But you would need to take them from your new, lower balance – not from the original nest egg. So, rather than taking 4 percent of $1million, you would need to scale back to taking 3.9 percent of $800,000. Doing so would give you only a $31,000 annual income, but would also allow you to increase payments each year by 3 percent.

If you'd rather take a bit more money up front and forgo the inflation adjustment for several years, you could make an annual 4.4 percent withdrawal for each of the next five years, or $35,000 on an $800,000 portfolio.

In Scottsdale, Ariz., Stephen Martin, 63 years old, has decided to shave his retirement withdrawals to 3 percent from the traditional 4 percent after watching his portfolio lose about 15 percent this year through the week of Oct. 3 – the last time he had the courage to check, he says. Now, the former chief financial officer of Xyterra Computing Inc. is cutting back on impulse buys.

Other retirees are forgoing retirement-savings withdrawals altogether. Katherine Sewell, a retired engineer in Edina, Minn., called her financial planner last Wednesday and halted all withdrawals from her retirement savings.

It's the second time she's taken such a drastic step: When her nest egg lost 40 percent in the tech downturn shortly after she retired eight years ago, she froze the account and went to work for a year as a cashier for Target.

“So many of my friends are wringing their hands, worrying themselves into bad health, but not doing anything,” says the 68-year-old Sewell. “Or they're running out and selling everything. Those are bad choices.”

Also stopping withdrawals is William Van Steenburgh, a Bellevue, Wash., resident who retired in 1984. He hopes the move – which has reduced his income to a small pension with no inflation adjustment and Social Security will help to preserve his disabled son's inheritance. “I would guess that we've cut back by close to 40 percent,” says Van Steenburgh, 83, who now takes the bus to save money on gas. “We stay at home and watch TV.”