Q: I don't understand why all of the financial experts recommend that retirees withdraw only 4 percent (or less) of their nest egg in retirement. It seems needlessly conservative.

I think of it this way: if you did that, you would be literally guaranteed enough money to make equal withdrawals for 25 years. If you wanted growth to keep up with inflation you could just invest the money in Treasury Inflation-Protected Securities (TIPS), which I know you like.

If you did that, you would be taking the most conservative possible approach, and yet you would be guaranteed enough funds to last for 25 years with inflation protection. If you retire at 65, which most people recommend, you would be guaranteed enough money to last until you're 90. This exceeds typical life expectancy.

Obviously, I wouldn't do this. My point is, if you invest the funds in anything with higher growth than TIPS, such as a 50/50 mix of bonds and stocks, you would definitely be able to make it more than 25 years.

Is it possible that this ultralow withdrawal rate the "experts" recommend is simply a ploy by the investment industry to reduce the amount of money that is drawn out of the system, and therefore out of their reach in fees?


A: I don't think it's a ploy, although industry fees are too high on average. The dilemma is real. You can have fun spending retirement savings early, but you also run the risk of being forced to make drastic cuts in your lifestyle later on. That is an outcome most people don't want. On the other hand, as you note, if you're too conservative with savings the risk is you'll die with a flush portfolio and a trail of regrets. The uncertainty is compounded by the fact that most of us don't know how long we'll live. The rise of 401(k) and similar plans means more retirements are subject to the whims of the market.

For most people it isn't easy to come up with a reasonable withdrawal rate, assuming you don't want to see your living standard fall in your elder years. The decision involves a lot of judgments about health, desires and goals, the importance of leaving an inheritance, and so on. The safe withdrawal rate isn't a static number, either. It changes with time and circumstances.

There are three main approaches for dealing with the uncertainty. In essence, they are all conservative in orientation. With the 4 percent rule you mentioned, the typical portfolio is assumed to be 60 percent in stocks and 40 percent in bonds. The first withdrawal is equal to 4 percent to 5 percent of the portfolio's overall value. The next year the retiree takes out another 4 to 5 percent, plus the rate of inflation. The risk of running out of money is low, but it exists.

Another technique is following the IRS' Required Minimum Distribution rules (RMD) for 401(k)s and IRAs. The RMD is a percentage of assets you're required to withdraw each year starting at age 70½. The RMD is easy to follow and it allows the percentage of remaining wealth consumed to increase with age since you have less time to live. Approach number three, the bucket strategy, emphasizes safety-first. One bucket has enough savings to handle two to three years of spending. The other bucket holds your riskier assets.

You can do any of these financial strategies on your own or with a financial planner. That's your choice. The strategies are really starting points. They should be tailored to your circumstances.