Make your money last in retirement; 5 keys

By Liz Pulliam Weston

Phil Horstman retired at 55 with a nest egg of $1.5 million and a lot of confidence his best years were ahead.

Seven years later, the Murrieta, Calif., resident is down to $300,000 and is, as he puts it, "running out of money and options."

Horstman takes $28,800 a year from his retirement accounts for living expenses, a withdrawal rate that once seemed paltry but that now will have him broke in about 12 years -- far short of the 25 or 30 years he's expected to live.

Horstman is a poster boy for almost everything that can go wrong in retirement, from a bear market early on, to a withdrawal rate that proved unsustainable, to questionable financial advice that kept him invested in risky assets even as his portfolio plunged.

"My financial adviser didn't deliver in providing me with a secure retirement income," Horstman wrote me in an e-mail. "He kept telling me that the market would come back. Well, it hasn't in my case."

Hard-learned lessons

Horstman's situation, unfortunately, is "far too typical," said financial planner Bob Frey, a fee-only advisor in Bozeman, Mont. Retirees are often overconfident about how long their money will last and may fail to adapt quickly enough to changing circumstances. Horstman's goals now -- to grow his portfolio and get more income -- aren't realistic, Frey said.

"He seems to need a lot more income than the portfolio can supply under any reasonable assumptions and using any strategies at his age," Frey said. "His biggest worry should be the portfolio going to zero long before he runs out of time."

Horstman does have some options, and I'll detail those in a minute. But for right now, we'll use his situation for some object lessons in what retirees and near-retirees need to know to make sure they don't run out of money.

Lesson No. 1: Your withdrawal rate is key

How much you take out in the early years of your retirement matters more than other factors, including your asset allocation, in determining the odds that you'll run out of money. That's according to studies by influential financial planner Bill Bengen and by mutual fund giant T. Rowe Price.

The safe withdrawal rate is probably less than you think. Those facing a 20- to 25-year retirement should keep their initial withdrawal in the 4% to 5% range, while those expecting to spend 30 years or more not working need to ratchet back to 3%-4%.

This initial withdrawal amount can be increased by the rate of inflation each year, so that a $12,000-a-year withdrawal from a $300,000 portfolio could be increased to $12,360 the next year (assuming 3% inflation). You can play with various withdrawal rates using fund company T. Rowe Price's Retirement Income Calculator.

Retirees also need to consider cutting back further if their assets plunge, as Horstman's did. A big drop early in retirement is especially dangerous, since you would be drawing from a much smaller pool of assets, making it far more likely you'll run out of cash.

Right now, Horstman shouldn't be withdrawing more than about $1,000 a month if he wants an 80% chance of not outliving his money, according to the calculator (and to Frey). He could boost that withdrawal to $1,200 if he were willing to let his chances of running out of cash drop to 50% -- or if he were willing to put a lot more of his retirement fund, which he switched to cash, back into stocks. Which leads to:

Lesson No. 2: Your asset allocation matters

Those who take out just 3% a year can be pretty conservative with their investments, leaving most of their money in cash and bonds, according to T. Rowe Price. But you'll need a significant amount of stocks if you want to use a greater withdrawal rate, or have some money left over to pass on to heirs or to use in an emergency.

T. Rowe Price found that with a 4% withdrawal rate, a $500,000 initial nest egg likely would still be worth a median $395,000 after 30 years if the portfolio was invested 60% in equities, 30% in bonds and 10% in cash. By contrast, when the stock investments were reduced to 20% of the portfolio, the median value was just $180,000. (T. Rowe used Monte Carlo analysis, which simulates thousands of possible future rates of return for stocks, bonds and cash over time. The "median" portfolio value is the one that marks the halfway point, with half the simulations ending in a higher balance and half ending lower.)

Financial planner Bengen believes most retirees need at least 50% of their portfolio in stocks to generate returns that are substantial enough to offset the corrosive power of inflation. T. Rowe says the proportion is at least 20% to 40%.

Lesson No. 3: Use extreme care in tapping assets early

You can get around the tax penalty for early withdrawals from a retirement account by arranging to take "substantially equal periodic payments," or a series of payments based on your life expectancy. That's what Horstman did.

But doing so can lock you into years of withdrawals that may turn out to be too great if your portfolio shrinks dramatically in the meantime.

Frey usually advises his clients to use non-retirement assets to live on, letting their IRAs and 401(k)s continue to grow until mandatory distributions are required after age 70 1/2.

If you decide to go the early withdrawal route anyway, consult an experienced tax pro or financial planner about how to calculate your withdrawals and the best method to use. If you make a mistake, you may not be able to correct it. IRS rules on these withdrawals are pretty strict.

Lesson No. 4: Get good, objective advice -- and checkups

Even if you're a diehard do-it-yourselfer, you should get a second opinion about your portfolio and retirement plans from an objective, experienced planner.

Simply put, the stakes are too high to leave your retirement to an amateur or a professional adviser who might not have your best interests at heart. You might not have the time or cash to recover from a bad move.

"Talk to someone before you resign," says financial planner Christine Fahlund, a vice president at T. Rowe. "More than one person has been surprised by how quickly they ran through their money" when an objective evaluation could have alerted them to flaws in their retirement plan.

You can get a referral to a fee-only financial planner from the National Association of Personal Financial Advisors. The Garrett Planning Network also has a roster of fee-only planners who charge by the hour.

At the very least, you should be testing your plan on the T. Rowe Price calculator to see your odds of success and returning each year to make sure you're still on track.

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