Planning for retirement is no walk in the park: You have pick a smart investment strategy, search out all the employer matches and other goodies that can boost your savings, and—lest you forget—squirrel away a good chunk of your income.
But building up a solid nest egg is only half the battle. Equally important, and perhaps even more complicated, is figuring out how to safely withdraw money from those savings.
Decisions on when to start taking Social Security, what to do with any defined benefit pensions, and how and when to draw down savings will all have a dramatic effect on the quality of your retirement life. And while almost all experts urge you to sock away as much as possible while you are working, there is no unanimity when it comes to your best plan for using that money in retirement.
"When you are saving for retirement, general guidelines can work pretty well. When you are heading into retirement, you want something specific to your situation," said Judith Ward, a senior financial planner with T. Rowe Price. "There isn't really a good place to go for guidance around this issue."
You may also be confronting a savings gap as your retirement draws near, making your drawdown strategy that much more important. A 2014 Employee Benefit Research Institute survey found that just 55 percent of respondents were somewhat or very confident that they would save enough for a comfortable retirement. And new data from EBRI found that among early boomers facing a retirement savings shortfall, the figure for each individual in a married household averaged $71,299, while for unmarried men it came to $93,576, and unmarried women faced a retirement savings shortfall of $104,821.
The 4 percent rule
So how can you best use the savings you do have in retirement?
One approach is the 4 percent rule: you calculate 4 percent of your retirement savings in the first year, and then draw down that amount every year. This approach was first broadly proposed by William Bengen, a former financial advisor, in 1994, and it has been applied often enough to be called the Bengen rule. It provides you with both defined income and an easy plan to follow.
But a number of experts take issue with the Bengen rule. "Four percent is a conservative starting point, but people need to every year come back and look at what's going on," said T. Rowe Price's Ward. "If the markets are doing great, you might want to take a little more. If they're not great, tighten the belt."
Ward also believes that retirees should take tax considerations into account. Taxable savings will only be subject to capital gains taxes when retirees draw them down, and that may be a lower tax rate than their income tax rate. Drawdowns from IRAs will be taxed like ordinary income, so they should come second, she said.
The last bucket of savings to draw on is any tax-free savings, she said, like assets in a Roth IRA. They can continue to grow the most efficiently, and if retirees don't need them during their lifetime, they are "a great vehicle to pass on to your heirs."
Another consideration is when you will need to withdraw any savings in retirement.
"Almost everybody has Social Security, and a lot of people retiring today have some kind of pension," said Luke Delorme, a research fellow at the American Institute for Economic Research. Social Security Administration calculations show that 86 percent of people 65 and over receive Social Security, and 41 percent receive government or private pension income.
A 2014 T. Rowe Price survey found that among recent retirees with 401(k) or rollover IRA accounts, 43 percent of their income came from Social Security, and 19 percent from defined benefit pension plans. Almost half had a retirement withdrawal plan and were withdrawing a median of 4 percent annually, but more than a quarter of that group were withdrawing 1 percent or less.
Jack VanDerhei of EBRI said he has seen similar behavior in his research. The vast majority wait until age 70 1/2 and then take the minimum required distribution, he said. But that approach may endure, because people retiring now are among the last wave of employees who have built up sizable defined benefit pensions. "I would be shocked if the percentage of people getting annuities from their defined benefit plans in five years is anywhere close to what it is now."
VanDerhei also pointed to a relatively new option for retirees who are trying to organize their retirement income: qualified longevity annuity contracts, or QLACs. These are annuities that start paying out at some point in the future, like age 80 or 85, and they cost less up front. Retirees are allowed to put 25 percent of their retirement assets, up to $125,000, in these contracts, thereby obtaining income protection for the end of their lives and clarifying how long other assets have to last.
Of course, you do run the risk of not living long enough to receive those deferred payments, or seeing inflation erode their real value. While you can pay for options that eliminate those risks, indexing the payments to some benchmark or assigning payments to your heirs, they will cost you.
Still, many experts argue that these annuities at least provide some insurance against outliving your assets.
At the end of the day, there is no one right answer for all retirees, Delorme said. Everyone's financial situation is different, and may vary widely from the models experts use to make recommendations. It's important to have a plan, and not to be swayed by emotional decisions or the market's ups and downs. But "ultimately, you should do what you're comfortable with," he said. And rest assured that the retirement landscape will probably be very different for the people coming after you.