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Figuring retirement savings spend-down rate

Could your nest egg be too much of a good thing?

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As retirement looms, our focus naturally shifts from acquiring the assets required to maintain our lifestyle once we turn off the income spigot to budgeting ourselves accordingly in retirement so our funds won't expire before we do.

If you've given any thought to post-retirement spending strategies, you may have heard the term "spend-down rate" bandied about by a financial adviser or investment Web site. The term refers to how much of your portfolio you might safely tap on an annual basis without unduly jeopardizing your nest egg.

The so-called "4 percent solution" is the most traditional approach. It starts with a 4 percent dip into your portfolio in the year you retire, then increases annually only by the rate of inflation. If your portfolio totals $800,000, your first-year withdrawal would be $32,000 (4 percent of $800,000); year two would be $32,960 ($32,000 plus inflation), given an inflation rate of 3 percent.

Challenging traditional thinking
But over the past couple years, the "4 percent solution" has come under attack by economists and financial advisers alike who regard it as little more than a thinly veiled scare tactic to sell nervous baby boomers more investment products.

Simply put, you may actually be saving too much -- and needlessly paying off the Mercedes of a financial professional who earns fees for managing that money.

In an article published in the Journal of Financial Planning in June 2005, Ty Bernicke, a certified financial planner in Eau Claire, Wis., threw down the gauntlet. Bernicke pointed out that data from the Bureau of Labor Statistics Consumer Expenditure Survey clearly shows that as retirees age, household expenditures actually decline in every consumer category except health care.

"Most people have heard, as a rule of thumb, that for their initial starting withdrawal rate from their portfolio, they have to stay around the 3 to 4 percent mark," says Bernicke. "It's my opinion that a person could actually start off closer to 5 or 6 percent, assuming that they're not going to be ratcheting up their income for inflation every year, which, guess what, statistics show they're not going to do anyway."

Using his own "reality retirement planning" method, which alters only the spending component to bring it in line with actual BLS survey results, Bernicke calculated the annual post-retirement spending needs for a 55-year-old couple beginning at $60,000 a year. In addition to income, the couple has $800,000 in a 401(k) earning 8 percent annually.

Under traditional retirement planning, which factors in an additional 3 percent in spending each year for inflation, the couple would need $125,626 at age 80, at which point their 401(k) would be completely depleted. Under his reality retirement method however, the couple's spending would be a mere $58,625 at age 80 and the balance in their relatively untapped 401(k) would be $1.8 million.

 
 
Next: "Any of these rules of thumb are really 'rules of dumb.'"
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