Retirement income for the everyday investor

NEW YORK (Money) -- Question: I'm looking to retire in the near future and want to know how an "everyday" investor like me can develop a good strategy for taking income from my savings. Any advice? --Nate, Carbondale, Illinois

Answer: This is the single biggest issue facing soon-to-be retirees like yourself. How do you make that transition from building a nest egg for retirement to cracking that nest egg for everyday living expenses - and do it in a way that doesn't deplete your savings too soon?

I'm sure I'm not revealing any secret when I say that there's no single correct answer to this question. The strategy you develop should be tailored as much as possible to your specific circumstances - how much income you need, how long you think you will need it, the amount of savings and other resources at your disposal and how much risk you're willing to take that you could outlive those resources.

So I can't give you a customized plan. But if you follow these three steps - and then monitor your progress throughout retirement - you should be able to develop a retirement income strategy that works for you.

1. Estimate how much income you'll need: Relying on a rule of thumb like assuming you'll need 70% to 90% of your pre-retirement salary to live comfortably after you retire may be okay when retirement is still a far-off mirage. But once you're within five or so years of calling it a career - or if you've already done so - you should have a much more realistic idea of how much money you'll need in retirement for everything from basic living expenses to discretionary items like travel and entertainment. You can create a retirement budget with a pencil and paper, but you'll have much more flexibility in tracking your outlays and updating your spending habits if you do it online or use software.

Remember to factor in inflation. Even if the cost of living rises at a tame 2% a year, your spending would have to increase nearly 50% over 20 years just to give you the same purchasing power you have today. Keep in mind that you may also need a reserve to fund the occasional splurge, unexpected expenses and higher health-care costs later in retirement.

2. Figure out where you'll get that income: Start with assured sources of income such as Social Security and a traditional company pension if you're fortunate enough to have worked for a company that still offers one. You can get an estimate of how large a monthly Social Security check you'll qualify for by clicking here. If you'll receive a company pension, your HR department can tell you how much it pays and give you details on various options you may have for collecting it.

I doubt that Social Security alone will allow you to maintain your pre-retirement living standard. Throw in a company pension and that may still be the case. But that's where all that money that you've been socking away in 401(k)s, IRAs and other retirement accounts comes in.

Here, the challenge is to pull enough from your investments so that, combined with Social Security and pensions, you have enough income to enjoy your retirement, but not so much that you jeopardize your financial security later on.

If you want a high level of assurance that your savings will support you for 30 or more years, you should generally limit your withdrawal in the first year of retirement to 4% to 5% of the value of your retirement investments. You would then increase this amount each year for inflation to keep your purchasing power in line with rising prices.

So if you have retirement savings of $500,000, you might withdraw $20,000 the first year of retirement. If inflation were running at, say, 3% a year, you would increase that amount to $20,600 the next year, $21,200 the next, and so on.

As I've noted before, this doesn't mean you have to stick to the same withdrawal rate religiously throughout retirement. Indeed, you should re-evaluate your withdrawals at least every couple of years. If your portfolio has been racking up gangbuster returns for several years, you might want to give yourself a raise. After all, you don't want to live like a pauper and die with a huge bank account. On the other hand, if you run into a series of lousy returns or outright losses, you might want to scale back your withdrawals for a bit to give your investments a chance to recover.

3. Deal with the shortfall, if you have one: If Social Security, a pension and reasonable withdrawals provide enough cash for you to live the way you want, congratulations. Enjoy retirement.

But it wouldn't surprise me if you find that you're coming up a little short, in which case you can consider any number of adjustments. One possibility is to put off retiring a few years. The extra time in the workforce will allow your nest egg to grow, allowing for bigger withdrawals, while postponing Social Security can significantly boost the size of the monthly check you'll collect.

Other options include downsizing to a smaller home or taking out a reverse mortgage and finding part-time or consulting work (as I pointed out in Money Magazine, you need to be realistic about what sorts of jobs are available and how much you can earn).

You might want to compare the cost of living in different cities and think about relocating to an area with lower living expenses.

Of course, doing all this requires a bit of number crunching. You do that on your own with the help of some online tools. For example, Fidelity's Retirement Income Planner can help you create a detailed retirement budget and estimate the odds that your savings and other resources will be able to support you throughout retirement. (The calculator is free to non-Fido customers, but you must register at the site.) And T. Rowe Price's Retirement Income Calculator can show you how long your savings are likely to last given different withdrawal rates and investment strategies.

If you don't have the time or inclination to rev up a calculator, you can always hire an adviser to run the numbers for you. You can get the names of financial planners in your area by clicking here and here.

But whether you do it on your own or hire someone to help you, the important thing is that you develop some reasonable strategy for creating regular income in retirement. Fail to do that, and your retirement could be adventurous, but not in the way you hoped.