October 2005

You’ve saved for retirement for 40 years. Now comes the fun part: Cracking open that nest egg so you can start spending it.

Not so fast.

Spending your retirement assets responsibly might be even tougher than accumulating them in the first place.

“The focus of most financial education is on how to invest for retirement,” says Kristin Kotsakis, CFP, vice president of Northern Trust Securities, Inc. “But it’s just as important — and no less difficult — to determine how to turn your retirement assets into income that will last the rest of your life.”

Here’s a strategy for replacing your paycheck with your retirement assets — so your nest egg will last as long as you do.

The 5 percent solution
Too many retirees believe they can withdraw 8 percent to 10 percent from their portfolios each year.

After all, they figure, a portfolio of 60 percent stocks, 30 percent bonds and 10 percent cash earned an average annual return of nearly 12 percent between 1969 and 1999. Even if you reinvest 4 percent to cover inflation, that leaves 8 percent a year for the retirement budget.

Not so fast.

A 12 percent average per year isn’t the same as 12 percent each year.

“A portfolio can be wiped out by this approach, depending on when it encounters a bull market and how severe that bull market is,” Kotsakis says.

So what’s safe?

About 5 percent, Kotsakis suggests.

Withdraw that percentage of your portfolio’s total value each year. With this approach, as your portfolio rises and falls, so too does your retirement income.

Since your income fluctuates, you may have to severely cut back your spending during a bear market. However, you can be sure that your portfolio will last your entire lifetime.

“The question is, as the markets ebb and flow, can your retirement budget swing along with the changes?” Kotsakis says. “That’s why asset allocation is so important.”

Asset allocation for retirees
How should you allocate your assets in retirement?

The higher your income needs as a percentage of your portfolio, the more you should hold in income-producing instruments, Kotsakis says. The lower your income needs as a percentage of your portfolio, the more you can allocate to equities.

If you have $1 million and need $50,000 a year, for instance?

Depending on your comfort with risk and other personal considerations, Kotsakis might put 40 percent into growth instruments and 60 percent into income-producing instruments. The latter might include laddered CDs, government bonds, preferred stocks and corporate bond funds.

And, to guarantee your income, Kotsakis uses a tool that has been receiving more interest lately: an annuity. As long as investors understand the fees, withdrawal penalties and other options, she says, an annuity can be a good way to secure income for life. Upon annuitization, the income payments provided for under the contract are guaranteed by the insurance company.

In fact, owning an annuity in addition to a conventional portfolio can substantially reduce the odds that you’ll run short of money, according to a study for Money magazine.

“You insure your life, your car and your house, but do you insure your retirement income?” Kotsakis asks. “An annuity is one way to do that.”

Income for life
Will your retirement assets last as long as you do?

With a reasonable withdrawal strategy, a balanced portfolio and good advice from your financial advisor, they should.

As Kotsakis says: “I like to wish new retirees a long, happy life — and the income to support it.”

How to Tap Your Assets Some 51 percent of retirees surveyed by Fidelity said they didn’t know which assets to tap first for retirement income. But deciding what to sell when can help you make the most of your nest egg. The best withdrawal strategy is to tap accounts in this order: 1 Withdraw for asset allocation. First, sell to keep your portfolio diversified. Say your target asset allocation is 60 percent stocks and 40 percent bonds. Sell stocks if your portfolio has become lopsided — 70 percent growth vs. 30 percent income, for instance. If your allocation is overweighted toward income-producing instruments, sell them instead. “Fluctuating markets mean your portfolio will always be a little out-of-whack,” says Kristin Kotsakis, CFP, vice president of Northern Trust Securities, Inc. “Use your withdrawals to rebalance it.” 2 Withdraw to reduce taxes. Tap your taxable accounts first. That way you can leave money to grow in your tax-deferred funds. 3 Withdraw because you have to Uncle Sam insists that you begin drawing down your 401(k)s and IRAs the April after you turn 70 1/2. You can set a withdrawal rate from these accounts using your own life expectancy or a combination of yours and a spouse’s or another beneficiary’s. Combine your life expectancy with a younger person’s if you want to minimize your distributions, making your money last longer. Each year, you’ll reset your life expectancy using the IRS’s Uniform Lifetime Tables. These three techniques will help you withdraw wisely — and allow you to make the most of your retirement assets.