Develop A Contingency Plan For Retirement

February 27, 2008

A fixed rate of withdrawal is fine for starters, but have a backup to mitigate risk.

Most retirees are probably familiar with the generally accepted starting withdrawal rate of 4% a year.

In a rising or even flat market, that will probably work fine. After all, as those retirement assets grow, the actual withdrawal rate will start to decrease, providing an extra cushion for unfavorable markets.

But a starting withdrawal rate of 4% could be very dicey entering a major bear market as the 30-year success rate drops dramatically.

Critical First Few Years

The idea behind starting at the 4% level is to enable a portfolio to last 30 years without depletion. The Trinity Study, which determined this rate, also allows for an annual inflation increase to the original 4% amount.

Another key element to the study is that an asset allocation of 50% to 75% stocks is optimal to support the 4% withdrawal rate.

Well, maybe it's optimal for the study, but it may not be for the retiree.

A 75% stock allocation is pretty aggressive for most retirees. They need to consider that in the bad bear market of 1973-74, a portfolio containing 75% stock lost about 33% of its value. That is a drop of $330,000 in a $1 million portfolio-not an easy loss to simply attribute to bad luck. And it's not an easy amount to make up by any measure.

So, as you can see, there are risks on both ends. If a retiree sustains a drop of 33%, the withdrawal rate would rise to an alarming 6.0%, assuming the dollar amount withdrawn remains the same.

Retirees Need A Contingency Plan

Investors planning on starting their retirement with a withdrawal rate of 4% need to be prepared in the case of near future adverse market conditions. They need to begin this preparation by carefully evaluating their situation and making a "what-if" contingency plan.

Such academic studies, while issuing a serious warning, thankfully do not factor in an investor's ability to use some plain old common sense. Common sense and a fallback plan can certainly make the difference between success and failure.

As long as retirees are aware of the higher risk of retiring in a bad market, steps can be taken to reduce the risk. The overall goal, not just in the first years of retirement, but throughout retirement, is to control risk and smooth withdrawals.

Review Plans At Retirement

An investor's personal assessment should begin with their retirement age. Many workers are now retiring in their 40s and 50s. For these retirees, the time span is longer than 30 years and a starting withdrawal rate of 4% might be a little high-even in good market conditions.

On the other hand, for someone retiring in their 70s, a 4% withdrawal rate already has a built-in safety factor.

Other factors to consider that might smooth things out are dependable income streams, such as a pension or social security. Are other reliable sources for additional funds obtainable if needed? Retirees might even consider delaying retirement for a year or two if they have the option. But that assumes they have a clear idea of the problem. That clarity is likely to be rare in most situations, which makes the backup plan necessary.

A small, part-time job doing something enjoyable will easily fill the gap and can provide some stress-free social interaction. Options like a Single Payment Immediate Annuity (SPIA) will add a pension-like reliable income stream and help smooth the rough patches. However, SPIAs may not be optimal for retirees under 65.

And finally, just cutting back on spending or delaying that cruise might be all that's needed.

One last, but important factor is how retirees construct their portfolios. A general guideline for risk management based on historical data is that a portfolio has the potential to drop about half the allocation to equities. A 50/50 portfolio would then have a potential loss of roughly 25% in a bear market that equaled the one of 1973-74. Investors should calculate this impact on their personal circumstances.

For more information on withdrawal studies, try this excellent website:

Paul Keck is a retired engineer and an investor advocate for retirees. His column on investing in retirement is a regular feature of

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