How to Survive Retirement -- Even if You Are Short on Savings

Over the past decade, financial experts have been busy figuring out how much retirees can safely spend each year without running out of money. The result? We now have a better grasp of the risks involved -- and a pretty good idea of what a sensible strategy looks like.

There's just one problem: Sensible won't cut it for most Americans.

Wrong answers. Spending down a portfolio in retirement is a treacherous business, because you don't know how long you will live, what the inflation rate will be or how financial markets will fare.

Faced with all this uncertainty, experts typically suggest two solutions. First, you might limit your initial portfolio withdrawal rate to just 3% or 4%, equal to $3,000 or $4,000 for every $100,000 saved. This is well below the 5% and 6% withdrawal rates that used to be advocated and reflects, in part, a concern about today's lofty stock valuations and low after-inflation bond yields.

More from The Wall Street Journal Online: • Retired Executive Revamps Lifestyle • Smart Retirement Shopping • Making Your House Pay in Retirement

"Two percent is bullet-proof, 3% is probably safe, 4% is pushing it and, at 5%, you're eating Alpo in your old age," reckons William Bernstein, an investment adviser in North Bend, Ore. "If you take out 5% and you live into your 90s, there's a 50% chance you will run out of money."

These withdrawal rates represent the percentage of your savings that you would pull out in the first year of retirement. Thereafter, you would step up the dollar amount withdrawn each year along with inflation. Sorry, the sums withdrawn would include any dividends and interest you receive, and a portion would have to go toward paying taxes.

Seem reasonable? Trouble is, the typical household headed by a 55- to 64-year-old has less than $90,000 in savings, so a 3% or 4% withdrawal rate would mean scant income. To make matters worse, if markets are kind, these folks may look back later in retirement and find they had pinched pennies unnecessarily.

That brings us to the second solution that's often advocated. Retirees with modest savings are frequently advised to buy income annuities. This involves handing over a wad of money to an insurer, in return for a healthy-sized check every month for life.

Retirees could also snag a handsome stream of lifetime income by delaying Social Security until their late 60s, while using savings to pay for their early retirement years. Prudent? I think so. But the fact is, most seniors balk at the idea of delaying Social Security and buying income annuities, because they fear they won't live long enough to reap the benefits.

Splitting up. What to do? Clearly, we need to come up with strategies that retirees can both afford and find palatable. My suggestion: Think about your retirement in two acts, the period until age 85 and the period after.

Suppose you retire at age 65. Plan on spending down 85% of your portfolio over the next 20 years. You might withdraw 1/20th in your first year of retirement, 1/19th in the second year and so on.

With this strategy, your initial annual withdrawal would be equal to 4.25% of your total savings. But if your investments perform well, your subsequent withdrawals would soar and you would end up with far more income than with a traditional approach, where you start at 3% or 4% and increase for inflation.

In case you live beyond age 85, you need a financial backstop. To that end, invest the other 15% of your savings in a mix of stocks and 20-year inflation-indexed Treasury bonds. If you are still alive at age 85, you can spend down this money gradually or use it to buy an income annuity. To supplement this income, plan on tapping your home's equity at age 85 by taking out a conventional or reverse mortgage.

I am not claiming the two-act retirement plan is ideal. But if you're short on savings, it will give you a fair amount of income, your heirs will inherit a decent sum if you die before age 85 and, if you live longer than that, you should be comfortable enough.