'Does the 4% rule for retirement withdrawals make sense?'

(Money magazine) -- I hear a lot about the 4% rule for withdrawing money from your retirement savings, but nothing about the "unexpecteds" that can create havoc with that plan. Can you explain some of the things that can go wrong if you follow the 4% rule - and suggest ways retirees can protect themselves? -- Cecilia K. Blue Ash, Ohio

The 4% rule is often presented as a near fail-safe strategy. Just withdraw 4% of your nest egg the first year of retirement, increase that dollar amount each year by the rate of inflation to maintain your purchasing power, and you have 90% assurance that your savings will last at least 30 years.

It all seems so simple and so certain. And it would be, if life unfolded with the predictability of a spreadsheet. Alas, that's not the case. As you note, there are many "unexpecteds" that can cause even the best-laid retirement income plans to go awry.

Let's start with subpar investment returns. The high probability that your savings will last 30 or more years if you stick to the 4% rule hinges on your investments earning a decent rate of return.

Assuming you invest in a diversified portfolio with a reasonable balance of stocks and bonds -- say, 50-50 -- history shows you've got a good shot at getting the returns you'll need. But the stock market can take some frightening dives that may lead to decade-long periods of mediocre returns or worse. And recent research shows downturns may be more common than we used to think.

If you're unlucky enough to experience a large loss or period of paltry gains, especially early in retirement, the odds of your nest egg surviving three decades can easily drop from 90% to 60% or lower.

Paradoxically enough, following the 4% rule could also be problematic if the financial markets thrive. If your investments earn outsize returns and you limit increases in your withdrawals to the inflation rate, you could end up with a big pile of cash late in life.

That might not seem like much of a drawback, particularly for your heirs. But think of it this way: If you're still sitting on a huge nest egg in your dotage, it could mean you lived a lot more more frugally than you actually had to earlier in retirement.

There are plenty of other potential hitches. You may periodically find yourself forced to spend more than the 4% rule dictates in order to meet unforeseen or higher-than-anticipated expenses -- health-care costs only partially covered by Medicare, the roof that had to be replaced after a freak storm, the money you shelled out to help a relative through a financial crisis.

Even in the absence of spending surprises, your money could run out sooner than projected. If inflation heats up in the future and investment returns cool, as was the case for parts of the 1970s, just maintaining your purchasing power could drain your retirement accounts prematurely.

You can't eliminate uncertainty from your life in retirement. Nor can you control the economy, the markets or, in some cases, even your spending. But there are steps you can take to at least minimize the chance of an unforeseen event derailing your retirement plans.

Start by thinking of the 4% rule as a guideline rather than a hard-and-fast formula to be followed slavishly. Depending on market conditions and how comfortable you are with the possibility of depleting your savings sooner, you may be able to start with a somewhat higher withdrawal rate.

Whatever your starting point, stay flexible. If your investments go through a rough patch, you may want to forego an inflation increase or even scale back your withdrawal. Conversely, if the financial markets go on a tear and your retirement account balances climb, you might splurge a bit.

By going every year or so to an online tool like T. Rowe Price's Retirement Income Calculator, you can see whether the odds of your money running out are going up or down, and then boost or pare your withdrawals accordingly.

Recognize too that while you don't know exactly what additional costs might wreak havoc with your budget, you do know something is likely to pop up. So you may want to set aside a reserve to handle future unknown expenses or informally earmark a small percentage of your nest egg for that purpose. That way, when unexpected demands arise -- as they inevitably will -- you'll be better prepared to meet them.

Bottom line: No spending system can accommodate all the twists and turns you'll experience in retirement. But if you think of the 4% rule as a guideline and stand ready to adjust your spending and withdrawals to changing conditions, you should be able to handle those unexpected events and still enjoy retirement.

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