Retirement savings: Withdraw more early on without running dry

November 10, 2011: 4:29 PM ET

NEW YORK (CNNMoney) -- I'm thinking of retiring this summer. Ideally, I'd like to withdraw a higher percentage of my savings the first 10 years or so of retirement and then step it down as my wife and I become less active. Are there any rules of thumb or planning tools that could help me out? -- Craig R.

As far as I know, there are no rules of thumb that allow you to spend more early in retirement and then scale back later on without the risk of running out of money too soon.

But then again, sometimes rules of thumb can get you in trouble. For example, even though following the oft-cited "4% rule" can help assure your money will last at least 30 years, this benchmark also has some serious drawbacks.

There are a few planning tools that can help guide you however, provided you use them with good judgment -- and that you're willing to monitor the size of your nest egg and remain flexible about how much you withdraw.

With those caveats in mind, here are some tools that can help you:

Go to T. Rowe Price's Retirement Income Calculator, and plug in your financial information, including the amount you have saved, how it's invested and how long you want your money to last. (The calculator defaults to age 95, which I think is prudent, but you can change that if you wish.)

The calculator is designed to give you an estimate of the chances of your nest egg lasting throughout retirement based on how much you tell it you intend to withdraw from your savings each month.

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But rather than just plugging in the higher amount you wish to spend, start by determining how much you can withdraw while still maintaining a reasonably high probability (let's say, 80%) of your money lasting throughout retirement.

This figure will likely be close to 4% of your current savings balance, but you can arrive at the actual amount by plugging in different spending figures until the calculator shows you odds at or close to 80%.

Let's call this amount, whatever it turns out to be, your "sustainable lifetime withdrawal."

Once you have that sustainable lifetime withdrawal figure, you can then plug in the higher amount that you would like to spend. Let's say, for argument's sake, that your sustainable withdrawal is $2,000 a month, or $24,000 a year, but you want to pull out $2,500 a month, or $30,000 a year.

If you go back to the calculator and plug in that $2,500 a month, you'll see that the odds of your money lasting have declined sharply. But that lower probability assumes you'll spend $2,500 adjusted for inflation throughout retirement, which you don't intend to do. Still, you'll at least have an idea of the potential downside awaiting you if you don't make good on your plan to reduce withdrawals later on.

So now the question is how long can you continue spending at that higher level without running too large a risk of going through your savings too soon?

That's where some flexibility and monitoring come in.

If you go ahead and draw $30,000 from your savings the first year of retirement, you'll have a new balance at the end of the year that reflects the combined effect of your nest egg's investment performance, minus the $30,000 you withdrew.

At that point, you want to plug this new balance into the calculator and go through the trial-and-error process I mentioned earlier to arrive at an updated sustainable withdrawal -- that is, the amount you can now withdraw based on your new savings balance and remaining years of retirement that still gives you an 80% chance your money will last for life.

The new sustainable figure you'll get will depend on how your investments performed over the course of the year. If the markets and your portfolio fared well, the sustainable amount could rise. If your portfolio takes a beating, then the sustainable amount will likely drop.

By comparing your new sustainable withdrawal figure to your $30,000 planned withdrawal, you can see what you would have to do right now to get back on track to an 80% chance of not running out of dough.

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So, for example, if your portfolio suffered a loss and your new sustainable withdrawal figure dropped, say, from $24,000 to $20,000, you would have to cut back your withdrawal from $30,000 to $20,000 maintain those 80% odds. If, on the other hand, your investments grew in value and your new sustainable amount rose from $24,000 to $26,000, then you would need to cut back only to $26,000 if you wanted to stay on track with an 80% probability of your money lasting throughout retirement.

This doesn't mean you necessarily have to reduce your withdrawals immediately. After all, you're looking only at a snapshot of your situation one year into retirement. You've got plenty of years to go, and your sustainable withdrawal amount can rise or fall depending on how your retirement portfolio performs.

But if you go through this process year after year, you can get a sense of how things are going, and whether you can afford to continue withdrawing money at the higher rate or whether you ought to think about scaling back.

That's a subjective judgment, of course. But if you find after several years that your sustainable withdrawal rate continues to fall, that's an indication that your portfolio is probably deteriorating. That could mean two things: If you continue to pull out large sums, the value of your nest egg could drop even more precipitously, raising the possibility of your savings running dry more quickly than you'd hoped.

Second, the more your sustainable withdrawal amount drops, the bigger the cutback you'll eventually have to make if you want your portfolio to support you the rest of your life. Depending on how much wiggle room you have in your expenses, you could find it very uncomfortable to make the necessary cuts.

I've focused on the T. Rowe Price calculator in this example, but there are other tools that can also help you manage your withdrawals, including Vanguard's Nest Egg calculator and Fidelity's Retirement Income Planner.

Whichever you use, however, it's important to remember that there is no free lunch here. The more you withdraw from your portfolio early on, the more you'll likely have to dial back later, especially if the markets turn against you.

So if you're going to take the spend-now-economize-later route, I recommend that you proceed slowly, and be ready to make adjustments as you go. To top of page

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