How to reset retirement plans to weather a downturn

The older the current bull market gets, the more stories you are likely to read about how this is an awful time to retire.

Yes, we are due for a correction that trims 20 percent or more from stock values. That could be a big problem for people taking withdrawals from investment portfolios, since market losses early in retirement increase the chances of running short of money.

The answer isn't to cower in fear, but to plan for the inevitable downturns. Financial planners said the following actions can help make your money last.

Stocks have quadrupled since March 9, 2009, the beginning of the current bull market. Meanwhile, returns on bonds and cash remain low. Investors who haven't regularly rebalanced back to a target mix of stocks, bonds and cash probably have way too much of their portfolios in stocks.

The time to rebalance is now, before markets start bucking. The right asset allocation depends on your income needs and risk tolerance, among other factors, but many financial planners recommend having a few years' worth of withdrawals in safer investments to mitigate the urge to sell when stocks fall.

Certified financial planner Lawrence Heller of Melville, N.Y., uses the "bucket" strategy to avoid selling in down markets. Heller typically has clients keep one to three years' worth of expenses in cash, plus seven to nine years' worth in bonds, giving them 10 years before they would have to sell any stocks.

"That should be enough time to ride out a correction," Heller said.

Historically, retirees could minimize the risk of running out of money by withdrawing 4 percent of their portfolios in the first year of retirement and increasing the withdrawal amount by the inflation rate each year after that. This approach, pioneered by financial planner and researcher Bill Bengen, became known as the "4 percent rule."

Some researchers said they worry that the rule might not work in extended periods of low returns. One alternative is to start withdrawals at 3 percent.

Another approach is to forgo inflation adjustments in bad years. Derek Tharp, a researcher with financial planning site Kitces.com, found that retirees could start at an initial 4.5 percent withdrawal rate if they were willing to trim their spending by 3 percent — which is equivalent to the average inflation adjustment — after years when their portfolios lose money.

"You don't actually cut your spending. You just don't increase it for inflation," said certified financial planner Michael Kitces.

Reducing expenses trims the amount that retirees must take from their portfolios during bad markets. That's why Melissa Sotudeh, a financial planner in Rockville, Md., said to pay off debt before retirement.

Ideally, retirees would have enough guaranteed income from Social Security and pensions to cover all of their basic expenses, such as housing, food, utilities, transportation, taxes and insurance, said Wade Pfau, professor of retirement income at the American College of Financial Services. If they don't, they may be able to create more guaranteed income using fixed annuities or reverse mortgages, said Pfau, author of "How Much Can I Spend in Retirement?"

Fixed annuities allow buyers to pay a lump sum to an insurance company typically in exchange for monthly payments that can last a lifetime. Reverse mortgages give people 62 and older access to their equity through lump sums, lines of credit or monthly payments, and the borrowed money doesn't have to be paid back until the owner sells, dies or moves out.

Covering expenses with guaranteed income can free retirees to take more risk with their investment portfolios, which over time can give them better returns and more money to spend or leave to their kids, Pfau said.

"They'll be able to invest more aggressively and still sleep at night," he said.