MONEY

How to salvage your retirement

The good news and bad news about your nest egg: You can find ways to make it last, but it’s not going to be pretty.

I’m retired and have lost a third of my savings and a third of my monthly income. I don’t have earnings, so I can’t add new money to my retirement portfolio. I also don’t have enough time to wait for a market recovery to recoup my losses. What can a retiree in my position do? - B.P. Ocala, Fla.

I’m not going to sugarcoat my answer. Fact is, you and other retirees who have seen the value of their retirement portfolios decline substantially over the past year are in a tough position.

The problem comes down to this: The double-whammy of investment losses and withdrawals from your nest egg to pay living expenses dramatically increase your chances of running through your retirement savings prematurely, which is something you obviously want to avoid.

The good news is that there are some moves you can take to reduce your odds of outliving your savings. The bad news is that those moves aren’t very appealing.

To put it bluntly, to assure that you don’t run out of money before you run out of time, you may very well have to scale back the retirement lifestyle you had envisioned, at least temporarily.

In this column, I’ll explain what retirees and people on the verge of retirement who have suffered sizable losses in their portfolios need to do to salvage their retirement. Indeed, even people who haven’t incurred big losses may also want to read on so they’ll know what to do should they find themselves in that position later on.

But before I get to what you should do, I want to point out that many people facing this problem may be focusing their attention in the wrong place. Since it was the huge drop in stock prices that decimated their portfolios and put them into this financial bind in the first place, many retirees have naturally assumed that the answer to their problems lies in changing their investing strategy.

Toward that end, many people have moved much, if not all, of their investment stash to “safe” alternatives such as stable-value funds, money-market accounts and CDs in an attempt to staunch the bleeding in their retirement portfolios.

Revisiting your investing strategy is certainly appropriate given what’s been going on in the financial markets lately ( although as I’ve noted before, plowing all or nearly all of your retirement savings into low-yielding secure options can backfire over the long run.)

But you really need to concentrate your attention on withdrawals. Specifically, you must figure out how much you can reasonably pull from your retirement accounts each year given their current value without draining them prematurely.

And as unpleasant as the prospect may be, you may very well have to withdraw less than you had planned – perhaps much less – in order to have a realistic shot at making your savings last throughout retirement.

Here’s why.

A variety of studies have demonstrated that if you limit the amount you withdraw in the first year of retirement to 4% or so of your portfolio’s value and then increase that amount each year for inflation to maintain your purchasing power, you’ll have roughly a 90% chance of your money lasting at least 30 years.

But those odds decline dramatically if you sustain big investment losses early in retirement. For example, recent research by investment firm T. Rowe Price shows that if a retirement portfolio invested 55% in stocks and 45% in bonds looses 20% the first year of retirement, your odds of being able to pull an inflation-adjusted 4% of the portfolio’s original value each year drop from 90% to about 60%.

And if the portfolio takes a 30% hit, the odds drop to about 40%. The reason is that the combination of steep losses and withdrawals so depletes your capital that your portfolio can’t fully recover even after the market rebounds.

Which means that if you want to reduce the odds of your savings running dry too soon after a major setback, you really have little choice other than to reduce the amount you withdraw from your savings.

The question is how much should you cut back?

It’s hard to give a definitive answer because the right withdrawal amount depends on a variety of factors, including how large a loss you’ve experienced, how quickly you expect the market to recover, how many years you want your money to last and how much assurance you need that it will last that long.

But T. Rowe’s research suggests that the cutbacks may have to be substantial. Indeed, if your portfolio’s balance has dropped by 20% to 30% and you want a 90% chance that your savings will support you for at least another 30 years, you should probably scale back your withdrawals to about 4% of your portfolio’s new reduced balance – that is, it’s value after the losses.

Let’s say, for example, that going into retirement you had a portfolio worth $1 million from which you had planned to withdraw 4%, or $40,000. But if your portfolio declined in value by 20% to $800,000, instead of withdrawing $40,000, you would instead withdraw $32,000, or 4% of your portfolio’s reduced balance of $800,000. And if your portfolio dropped 30% to $700,000, you would withdraw just $28,000.

You could pull out a bit more – $35,000 and $30,000, respectively in the example above – but then you would have to forego increasing your withdrawal for inflation the first five or six years of retirement. Either way, we’re talking a big reduction from your planned $40,000 initial withdrawal.

Of course, you don’t want to be making cutbacks for your situation based on one hypothetical scenario. If you’re well into retirement, for example, you don’t need your savings to last 30 years. So you may not have to reduce your withdrawals nearly as much. The same goes if your retirement investments haven’t taken a very big hit.

So how can you tell out how much you may need to trim withdrawals given your age, the beating your portfolio has taken and the level of assurance you want that you won’t outlive your savings?

One option is to go to an online tool like T. Rowe Price’s Retirement Income Calculator. You plug in such information as the current value of your savings, how your money is invested and the amount you plan to withdraw, and you’ll get an instant evaluation of whether your savings will last as long as you’d like. You can then see how your prospects change by lowering your withdrawals.

Or you can have a financial adviser run the numbers for you. Any competent adviser should be able to do that, but you want to be careful you don’t end up with someone who sees this analysis as an opportunity to sell you high-priced investments you don’t need. (For the names of reputable advisers, you can click here and here.)

Of course, determining how much you can reasonably withdraw from your savings is one thing. Living on that amount is another. I’m sure that to do so many retirees will have to make painful adjustments to their lifestyles. And some people may simply may not be able to get by on significantly smaller withdrawals.

So I’m not suggesting this will be easy. But whether it’s cutting discretionary spending whenever possible, working part-time, downsizing or taking out a reverse mortgage or even reducing withdrawals by a smaller amount than suggested, you do what people have always done in difficult situations: you make the compromises you can.

It’s possible this retrenchment will be only temporary. Depending on the losses you sustained, how quickly the economy and the financial markets recover and how robust that recovery is, you may be able to boost withdrawals later on so that you can once again live the retirement you envisioned.

For now, though, it’s crucial that retirees and near-retirees do the sort of analysis I’ve described ASAP. Because if you simply pull money from your savings based on the income you would like to have versus the withdrawals your portfolio can actually support over the long term, you may find yourself in even bigger hole later on, recovery or no.

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