Be gentle in drawing cash out of a nest egg

October 21, 2001|By EILEEN AMBROSE

IT WOULD be a cinch for retirees to figure out how much money they can spend without running out if they could count on their investments growing at a set rate each year.

But as the past 18 months have reminded investors, the market is not only unpredictable, but can go down, too.

Calculating how much money to draw out of a retirement nest egg each year is complicated. It can even be harder than saving for retirement, experts said.

"You have more variables to contend with," said Christopher L. Jones, executive vice president with Financial Engines. How much to withdraw depends on the amount saved, taxes, life expectancy, what portion is in stocks or bonds, and whether the money is in tax-deferred accounts or not, he said.

And there's timing. Retire just as a bear market hits and your nest egg will shrink a lot faster than the portfolio of someone lucky enough to retire in a bull market.

Financial planners say people often assume that they can safely withdraw 8 percent to 10 percent a year from invested assets throughout retirement, excluding what they receive from pensions and Social Security. That's about twice the rate generally recommended.

Christine Fahlund, a senior financial planner with T. Rowe Price Associates in Baltimore, said she's often greeted with skepticism at seminars when she suggests a 4 percent or 5 percent initial withdrawal rate from a portfolio, with slight increases thereafter to keep up with inflation.

Her audience tends to become more accepting when she explains the huge hit that their portfolios will take if they withdraw 8 percent from a portfolio that's fallen 3 percent. "We are getting a lot of believers now that the market is down," she said.

So, how does a retiree figure a realistic withdrawal rate?

Fortunately, planning in recent years has become more sophisticated than just basing withdrawals on a projected average annual return and average inflation rate.

Computers now run portfolios and withdrawals through hundreds and thousands of economic scenarios and tell retirees the likelihood of their money lasting in retirement.

Price offers its free online version, the Retirement Income Calculator, at Financial Engines next year will launch technology that shows retirees how much to invest, how much to draw down and from what accounts based on assets and income, including Social Security and pensions.

If you are trying to determine a withdrawal rate, here are some factors to consider:

Life expectancy: This depends on a person's health, gender and family history of longevity. Generally, people are living longer and need to plan for that.

Rockville financial planner Marvin Burt said a decade ago that he would use a life expectancy of 85 when developing retirement plans. He later upped that to 90 and recently started using 95. Couples must factor in the life expectancy of each partner, especially if one is much younger than the other, he said.

Asset allocation: Retirees should have at least 25 percent of their portfolio invested in stocks to help keep up with inflation, but probably no more than 70 percent in equities, Fahlund said.

Stocks add volatility to a portfolio, and investing too heavily in them can exacerbate the effects of a down market.

"You'll find the volatility can work against you over time," Fahlund said. "You might have to withdraw a little less than you can if you are well-balanced."

Also, avoid the mistake of trying to make up for a lack of saving by aggressive investing, which can backfire, warned Jack Brod, head of Vanguard Advisory Services in Malvern, Pa.

Some retirees with long life expectancies also may want to consider buying an annuity as part of their portfolio to provide a lifelong income stream, suggested Jones.

Timing: Not only how much you take out each year matters, but whether you start tapping into your nest egg in an up or down market can be critical.

"The worst thing is to have a big market downturn early on in your retirement. That will affect all future years," Jones said.

Take the case of a retiree who assumes an annual return of 9 percent on a $500,000 portfolio and withdraws about 7 percent the first year, increasing that yearly for inflation. Based on a portfolio of 60 percent stocks, 30 percent bonds and 10 percent cash, the retiree would run out of money in 25 years if the market performed according to plan, according to a calculation by Price.

But what if that person retired in 1973, just as the market headed into two years of negative returns? Using actual market returns, Price found that the retiree would run out of money about six years ahead of schedule if no adjustment to withdrawals was made.

However, if the retiree started out with a more conservative withdrawal rate or reduced withdrawals after the bear market, he or she would have wound up with a hefty portfolio balance after 23 years because of the bull market.

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