Don't let your retirement well run dry

Everything will work out just fine in retirement if you withdraw only 4% a year, right? Don't be too sure.

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By Walter Updegrave, Money Magazine senior editor

What can go wrong with 4%
If you follow the standard withdrawal rule on a $500,000 portfolio, your success may depend in large part on how well you do in the first five years after retirement. But you face two risks.
Risk no. 1: You deny yourself
If all goes well in the markets over 30 years, you have a 50% chance of having $750,000 or more left.
Risk no. 2: You run out of cash
If you assume less than 2% annual returns for the first five years, there is a 43% chance that your money won't last.
Notes: Assumes a portfolio of 55% stocks and 45% bonds that gradually shifts to 20/80 stocks/bonds; 3% annual inflation; and long-term expected returns after fees of 7.8% for stocks, 5.7% for intermediate-term bonds and 4.1% for short-term bonds.
SOURCE: T. Rowe Price.

(Money Magazine) -- Want to be sure you won't run out of money in retirement? The standard advice that you'll hear from planners (or find on the pages of Money Magazine) is to follow the 4% rule: Withdraw no more than 4% of your portfolio the first year of retirement and then increase that amount for inflation each year. And indeed, if you do this, there will be roughly a 90% chance that your money will last at least 30 years.

But while this rule is a decent guideline for managing your withdrawals, it can't cover all of the surprises that life - and the markets - may have in store for you. Before you adopt this regimen, consider these two rarely discussed risks.

First, if your investments lose money or post subpar gains early in your retirement, those reassuring 90% odds shrink.

Earn less than 2% a year on average in the first five years, for example, and the odds of your money lasting three decades or longer fall to 57%, according to T. Rowe Price. The combination of withdrawals and lousy performance so depletes your portfolio that you can't make it up when the market rebounds.

Earning stellar gains early on doesn't guarantee that your money will last, but it helps. This brings us to another risk: If the markets are kind to you, a good chance exists that your money not only will be there well into your dotage but will grow to more than you had at the beginning. Apply the 4% rule to a $500,000 portfolio and you have a fifty-fifty shot at ending up with at least $750,000 in 30 years.

Granted, that may not sound like a risk. But you wouldn't want to find out late in life that you spent too cautiously and didn't enjoy retirement as much as you could have. To balance the threat of running dry against the possibility of living too frugally, consider these steps.

Delay your departure. If you're retiring when the markets are in turmoil (as they are today), hold off for a year or two. That way you'll avoid pulling money from your savings during a falling market. If waiting isn't an option or you've already retired, consider part-time work or a consulting gig. The more you bring home, the less you have to tap savings.

Rein in withdrawals. You can't control the market. But you can limit the damage of weak returns by holding the line on withdrawals. One relatively painless way to do that is to forgo your annual inflation increase.

"We find that people can usually do this for four to five years before they really feel the hit," says Christine Fahlund, a senior financial planner at T. Rowe Price. You may also want to consider scaling back or putting off larger expenditures such as replacing your car or taking a major trip abroad. Any cutbacks you can make will give your savings a chance to recover.

Stay flexible. It's unrealistic to think that you can set a pace for withdrawals on the day you retire and then follow it like clockwork for 30 years. So every year or two after you retire, rev up an online tool like T. Rowe Price's Retirement Income Calculator or Fidelity's Retirement Income Planner to see how much you can safely pull from your portfolio given its current value and your age (or consult an adviser). If that amount is significantly higher or lower than what you're withdrawing, adjust.

Better to keep fine-tuning than to wake up one day and find that you've got only a few years' worth of expenses left in your account - or to realize that you could have afforded that trek through the Andean foothills after all but you no longer feel up to it. Start with the 4% rule. Then be ready to improvise.

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