Viewpoint December 17, 2010, 5:40PM EST

No Rest for Retirees

Retirees need to lower their savings withdrawal rates to adjust to new global realities, research suggests. The bottom line: Save more, or spend less

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The economic news has been bleak for retirees and near-retirees over the past decade: Two recessions and two bear markets. The Standard & Poor's 500 index sporting an average annual return of 0.81 percent over those 10 years. A one-third decline in home values since the market peaked in 2006. Near-zero yields on safe savings.

So shouldn't anyone retired, or soon about to say goodbye to their workmates for the last time, be heartened by the recent uptick in stocks and the economy? Sure—but not too much. In fact, there's an argument to be made that hunkered down is exactly the right stance for retirees, not so much because of the recent financial crisis as the realities of the new global economy.

It all has to do with the question of how much retirees should withdraw from their long-term savings. It's a calculation that gets a lot less attention than how much they save but is just as important in determining a retiree's lifestyle. Some research shows that the common assumptions about withdrawal rates are out of whack and need to be adjusted downward. "People will have to be much more conservative with their assumptions," says Henry "Bud" Hebeler, the former president of Boeing Aerospace and author of Getting Started in a Financially Secure Retirement.

Spend Neither Too Much Nor Too Little

Here's the classic dilemma: Everyone wants to maintain the highest possible standard of living throughout their lives, including old age. Live too high on the hog off accumulated savings early in retirement, spending with abandon, and you might have a lot of fun, but the risk is you'll be forced to make drastic cuts in lifestyle later on. Spend too little, hoarding savings, and the danger is you'll die with plenty of money and a long list of regrets. "How much to withdraw is one of the biggest decisions anyone will ever make," says Ross Levin, a certified financial planner and head of a planning company called Accredited Investors.

The standard solution: the 4 percent rule. In essence, a retiree adds up all the components of her long-term savings, such as 401(k), the stub of a 403(b) from a previous employer, the two IRAs set up years ago, the mutual fund accounts that have been bulked up over the years, and so on. The typical portfolio is assumed to be 60 percent in stocks and 40 percent in bonds at retirement. The first withdrawal is equal to 4 percent of the overall portfolio's value. (The 4 percent figure depends on 60 percent to 65 percent in stock.) The next year the retiree takes out another 4 percent plus the rate of consumer price inflation, and so it goes for the rest of life.

The 4 percent-plus-inflation rule got its power from a series of studies over the past two decades. They mostly relied on Monte Carlo simulations—computer-generated models for calculating the odds or probability of an outcome. The conclusion of the studies in the aggregate was that the maximum initial withdrawal rate with 100 percent confidence of not running out of money over 30 years ranged between 4.1 percent and 4.58 percent, according to a 2006 Journal of Financial Planning article by Jonathan Guyton, a certified financial planner with Cornerstone Financial Advisors, and William Klinger, a software developer. (Their study came up with a figure about a percentage point higher under certain conditions.) The heuristic examples in the studies had portfolios worth $400,000, $1 million, and so forth.

When the Future Isn't Like the Past

Problem is, what if the 4 percent past isn't prologue? What if the simulations and experience behind the withdrawal rule-of-thumb largely reflects an unusually generous period of U.S. equity returns and the damage from the last decade lingers? That's the risk contemplated by three scholarly articles by Wade Pfau, associate professor at Japan's National Graduate Institute for Policy Studies. He too assumes a retiree has a 60/40 portfolio.