Retirement savings: How to draw the max (safely)

(MONEY Magazine) -- "What's the most I can pull from savings each year without running short of money later in life?" It's the single most frequent question I get from retirees and near retirees.

A formidable challenge anytime, turning one's savings into lasting income is especially daunting today. Slowing growth and high levels of government debt make it unlikely we'll soon see a bull market delivering '90s-style returns. Add in the fact that many nest eggs are still recovering from the 2008 meltdown, and it's no surprise that folks are eager to squeeze more from less.

Alas, there's no magic formula that will allow you to draw outsize sums risk-free. However, I'll lay out four options to help you get the most out of your money, starting with the conventional 4% drawdown, then moving to methods that can provide a bit more spending cash if you make certain accommodations.

No matter which you choose, you'll need to stay flexible. "You can't just set a withdrawal rate and leave it on autopilot," says T. Rowe Price senior financial planner Christine Fahlund. Depending on the market and your needs, you may have to make midcourse corrections.

But adjusting our living standard to our income is the sort of fine-tuning we routinely do during our careers. Why should retirement be any different?

How it works: Separate studies conducted in the early 1990s used historical stock and bond market returns to try to determine the most retirees could safely pull from savings each year.

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The research showed that if people limited themselves to an initial draw of roughly 4% ($20,000 on a $500,000 portfolio), then adjusted that annually for inflation (assuming it's 3% a year, you'd take $20,600 in year two, $21,218 year three, and so on), they'd have a high level of assurance of their assets lasting at least 30 years.

Using Monte Carlo software, which accounts for thousands of market scenarios, investment firms have since come to similar conclusions. Today the "4% rule" is the most frequently cited retirement income strategy.

Pros: T. Rowe Price estimates that by following this rule you'd have an 88% chance of your money lasting 30 years.

Cons: Those with small nest eggs and without pensions may find it hard to get by on 4%. Another concern: If the markets do well over time and you only adjust withdrawals for inflation, you could end up with heaps of savings (and regrets) later.

Right for you if ... Your nest egg is large enough that you can live comfortably on the amount this strategy provides, or you're willing to accept a tighter budget in exchange for extra security.

How it works: The premise is the same as that of the 4% rule, except that you start with a higher initial withdrawal rate. So instead of pulling $20,000 from a $500,000 savings stash, you might start by drawing, say, 5% ($25,000).

Pros: A higher withdrawal rate gives you more spending money, making it easier to afford the lifestyle you want.

Cons: The more you pull from your portfolio, the greater your risk of running out of money. Going from an initial 4% withdrawal rate to 5% reduces the chances that a 65-year-old's stash will last to age 95 from 88% to 64%. The likelihood drops even more dramatically if your portfolio suffers a big loss early on. The combination of the hit and higher withdrawals so weakens your portfolio that it would have difficulty recovering even when the markets revive.

All that said, there may be times when new retirees can take higher draws and have a greater degree of security than Monte Carlo analyses suggest. Research by financial planner Michael Kitces suggests that a portfolio of 60% equities and 40% bonds can sustain a withdrawal rate as high as 5.5% for 30 years if the stock market is undervalued -- and thus more likely to generate lofty returns -- at the time of the initial distribution.

Unfortunately the market doesn't appear to be priced to support bigger withdrawal rates right now. To judge value, Kitces uses Yale professor Robert Shiller's 10-year average price/earnings ratio, calculated using inflation-adjusted stock prices and average earnings. By that metric, stocks have been selling at a P/E over 20, well above the historical average of 16 or so.

Right for you if... You're willing to accept a higher risk of running short of money in return for being able to spend more freely, or you don't think you'll need to draw on your savings for a full 30 years. You might also go with a higher withdrawal rate if you have other assets to fall back on like a big pension or substantial home equity.

How it works: You start with a higher withdrawal rate -- say, 6% instead of 4% -- at the beginning of retirement. Then instead of sticking to that higher rate, you dial back after the first five or so years to a lower level of withdrawals that are more likely to be sustained for the remainder of retirement.

Pros: You have more spending money in the early stage of retirement when you're more active and probably better able to enjoy the extra cash. And by having a plan in place ahead of time to cut back, you have a better chance of your portfolio supporting you for 30 or more years than if you just opt for a higher withdrawal rate indefinitely.

Cons: There's no free lunch here. In return for living larger early on, you'll likely have to cut back your withdrawals pretty significantly to avoid the possibility of not having enough for regular living expenses later in life. If your period of freer spending coincides with a market setback, the budget cuts you would need to make could be especially painful -- and difficult to pull off. The amount you'd have to dial back to would be well below what you had been drawing, and even well below what you would have drawn at that time if you followed the 4% rule.

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The other challenge is that as you age, you're likely to face rising health care costs. So while you might figure you can handle a big spending cut later on, you may end up with less wiggle room than you think.

Right for you if... You're financially and emotionally prepared to make cuts in your expenditures, perhaps even draconian ones, later in retirement for the chance to spend more right after you call it a career. This strategy could work for you if a sizable percentage of your budget goes toward discretionary items, like travel and entertainment -- expenses that could be trimmed fairly easily.

How it works: Instead of leaving the workforce on your original timetable, you put your departure off for a few years and continue to contribute to your retirement accounts during that time.

Pros: Additional contributions and compounding time should allow you to pull out more income from your savings without boosting the risk of your money running out. Even if the market were to drop during your last few years of work, your nest egg would be larger than it would have been had you been withdrawing money rather than putting more in.

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With a larger nest egg, that safe 4% withdrawal rate provides more income. And with a shorter time horizon, you may be able to increase your initial withdrawal to something slightly above 4% while maintaining low chances of running out of money. The graphic below shows you just how much putting off your goodbye party by a few years can increase your income.

This strategy has another benefit: Working longer will help you delay claiming Social Security, which can significantly boost the size of that payment. Hanging on just three years more than you'd planned can increase your monthly check from the government by upwards of 30%.

Cons: You'll have to stay tethered to the 9-to-5 ball-and-chain when you might rather be getting a start on retirement.

Right for you if... Your nest egg at its current size can't provide enough money for a comfortable retirement at a reasonably safe withdrawal rate, or you're willing to work a few extra years in return for a shot at more spending money with more security when you do finally retire.