How Much of Their Nest Egg Should Retirees Spend a Year?

large golden egg nest
John Kuczala
If you're among those fortunate enough to have saved enough to retire comfortably, you'll still face this annual dilemma: How much of that stash can you spend each year?

There are more than 76 million baby boomers in the United States, and they'll be retiring at a rate of about 3 million a year. That makes the hopes, dreams and fears about retirement a top-of-mind issue for about a quarter of the U.S. population.

The average life expectancy for someone turning 65 this year is an additional 20.4 years. Now, those life expectancy tables can tell you how long the average person will live, but they don't speak to the downsides of living an unusually long life. While it's a blessing to live into your 90s or even longer, it also means there's a greater chance that you will outlive your savings. And that great unknown -- how long will you live? -- is at the root of our fears when it comes to planning how to spend money in retirement.

Let's examine some of the most-discussed strategies for calculating a spending plan that won't have you outliving your next egg, including the 4 percent rule, annuities, required minimum distributions and living only on dividends and interest.

The 4 Percent Rule

The 4 percent rule is one of the most commonly recommended approaches: The idea is to spend 4 percent of your assets each year, adjusted for inflation.

That's a "safe withdrawal rate [that] actually has a 96 percent probability of leaving more than 100 percent of the original starting principal," according to Michael Kitces, publisher of the Kitces Report blog and partner at Pinnacle Advisory Group in Columbia, Maryland.

The 4 percent formula is based on an allocation of 60 percent stocks and 40 percent bonds. But with bond interest rates near all-time lows, does this still hold up? Kitces says it does "because historical safe withdrawal rates aren't based on historical averages. They're based on historical worst-case scenarios."

In fact, he says that if you could be sure that markets would produce "average" returns over the course of your retirement, the safe withdrawal rate would be closer to 6.5 percent.

This strategy requires you to rebalance your portfolio each year to maintain the 60/40 balance. Kitces says this will help you avoid selling stocks in a down market. If stocks declined, you would raise the necessary cash distribution by selling bonds instead, which would also bring your portfolio back into balance.

Annuities as an Alternative

But the 4 percent rule has plenty of critics. Part of the problem is that its success hinges on the timing of when you retire. If you leave the job market just before the stock market goes into a tailspin, you could be in trouble, argues Anthony Webb, research economist at Boston College's Center for Retirement Research. He calls the rule "a foolish thing" that gives its adherents a "very high probability of running out of money."

Webb says people need to tailor their withdrawals to market returns, cutting back on spending when the market does poorly. He says stocks have a higher expected return over the long term, but with considerably higher risk -- "and you really have to build that risk into your plan."

Webb suggests that inflation-adjusted annuities will take the longevity risk off the table for most people. However, annuities require a significant up-front investment that could limit your financial flexibility, and they could reduce the inheritance you intend to leave, because most annuities expire upon your death. "I know people will say you're gambling with death, but the fact remains that unless you're super-rich, that's the only way to insure against longevity risk," asserts Webb.

Required Minimum Distributions and Other Ideas

Another strategy is based on the required minimum distributions set by the Internal Revenue Service. The IRS rules require that those of us with 401(k)s or other retirement accounts to begin to draw down those assets starting no later than age 70½. The percentage of mandatory withdrawals starts low and increases as you age. Some financial advisers say sticking to those minimums can be an effective strategy for many retirees.

Some retirees want to live only on the dividends and interest earned by their investments, and keep their principal intact. This strategy can work for people with substantial nest eggs, but experts warn that it could prompt some people to make poor investment choices in the name of boosting their dividend and interest income, at the detriment of their portfolios' long-term growth.

Other factors to consider in deciding what strategy to use include when you decide to start collecting Social Security (most advisers suggest delaying as long as you can to get the biggest monthly benefit), your health, and your tolerance for risk. And then there's the psychology of spending the money you've worked so hard to save. "Savers who have accumulated wealth have to get themselves out of the savings mode and into the spending mode," said Webb. "It really is OK. It's not morally wrong. It's what you saved for in the first place."

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August 26 2014 at 10:34 AM Report abuse rate up rate down Reply

This baby boomer worked his whole life while the good paying jobs were available in this country. With my social security and pension I am still saving money and have plenty of toys to fill my life. You working people today do not have the same advantages. The loss of manufacturing jobs and turning into a service industry is not a lifestyle to save lots of cash. The republicans want individual accounts, that is what they say, what they really mean is they want to stop the taxes on companies for social security and medicare. Now do you think walmart or mcdonalds will contribute to your retirement. Nope.

August 21 2014 at 10:10 PM Report abuse +4 rate up rate down Reply

the 4% rule is stupid.....I have 1 million in 3 Ira's....Invested in funds..preferred stock..MLP's...REITS....and 50k in cash.....The 950k that is invested generates 41k in dividends and interest which is just over 4%. If I have no growth and just withdraw this 41k , or 4%, in theory my 1 million will be there when I die. I would be very comfortable drawing more then 4% and not worrying about outliving my money although at this point I just take the 41k to go along with my SSI.....There is no one % that works for everyone and every situation.

August 21 2014 at 10:01 PM Report abuse +2 rate up rate down Reply

Your article may be correct when it comes to the number of boomers now retiring each year. They are ,in fact ,leaving the workforce in droves and virtually every one I know is saying good riddance. The long hours, excess stress, downsizing, no pay raises, few days off, and the creeping replacement of people by computers and doing business by spreadsheet analysis rather than customer service is taking its toll. What I must take issue with though is that tired, old figure of 76 million boomers born between 1946 and 1964. That figure has been quoted since marketing peole were tryingg to predict "record sales" for the next year. The sad fact is that boomers have been dying since the late sixties. It began with car accidents, then Vietnam, then drugs and suicides, then diseases started ot emerge. Now, in 2014 the number of boomers who have already perished has certainly reached nearly 20 percent . The death rate will increase faster soon for both older and yougner boomers. For older boomers father time is right around the corner.For a huge number of younger boomers,Gen Xer's and Millenials, poor phsical condition and obesity is going to take a very large toll before these folks turn medicare age (65 ) or full retirement age for social security (67) . I find the forty year long reference to 76 million boomers to be annoying and an indicative of laziness among writers.

August 21 2014 at 8:33 PM Report abuse +1 rate up rate down Reply

The mentality of the working classes is that of a brain dead slug... Dependent babies from day 1.

Dependent on mommy and daddy, then dependent on an employer, then finally dependent on social security...

How much of your savings should you spend in retirement ?... HOW ABOUT ZERO ??

Live off of your dividends and other forms of income that your investments produce.... DUH !!

August 21 2014 at 6:23 PM Report abuse rate up rate down Reply

People who write or talk about money, don't actually have any wealth of their own. I am willing to give odds of 20 to 1 on that.

August 21 2014 at 5:17 PM Report abuse +3 rate up rate down Reply
1 reply to Michael's comment

gamblers are the ones who don't have any cash....

August 21 2014 at 6:20 PM Report abuse -2 rate up rate down Reply

Retired in 2010 at age 66, luckily with a regular pension and some investments and savings. Not easy to do but worth the effort. We are just taking the required minimum distribution to satisfy the IRS. Life is good for now. Hope to fall over dead before a nursing home is required. I have seen some of that in my family and it's not living. Merely existing.

August 21 2014 at 2:21 PM Report abuse +12 rate up rate down Reply
1 reply to Dan's comment

do some parachuting and test the heart if you don't want to be crapping yourself in a wheel chair.

August 21 2014 at 6:36 PM Report abuse -6 rate up rate down Reply
2 replies to socioeconomist1's comment

Don't take this the wrong way socio, but you really ought to do something about all that anger. Keep saying, "Serenity now. Serenity now". Might help.

August 21 2014 at 7:42 PM Report abuse +4 rate up rate down

"Keep saying, "Serenity now. Serenity now". Might help..." by Dan.

Does that mean 'clearness of thought' or just taking another mini-vacation?

August 21 2014 at 10:54 PM Report abuse -1 rate up rate down
Robert Fugate

Their's so many variables, and every time you ask someone else they have a different opinion! The one sure thing work as long as you can stand it. If you've saved too much you can always spend it!

August 21 2014 at 1:49 PM Report abuse +5 rate up rate down Reply
1 reply to Robert Fugate's comment

that was 54 for me. i couldn't take it any more. retired in 2000 , perfect timing for two huge down turns in the market, right! lol

August 21 2014 at 3:41 PM Report abuse rate up rate down Reply

It's encouraging to know that if we can stay alive until 65th birthday, then we can kind of expect to live another ~20 years~. It's sad that we'll have to go...sooner or later.

I'm really not keen on living beyond about 87 because the 'odds are' - at that age, life is no longer a bed of least that's the way I see it in this fambly's history. ( ; > !

August 21 2014 at 1:42 PM Report abuse +4 rate up rate down Reply