Retirees: Are you spending too much?-By Christine Benz

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How much can you spend in retirement without outliving your money? It's one of the most fundamental questions confronting anyone who's retired--or getting ready to.

But it's a head-scratcher for many, according to a survey from the American College of Financial Services. Seven in 10 individuals between the ages of 60 and 75 with at least $100,000 said they were unfamiliar with the oft-cited 4% withdrawal-rate guideline. Meanwhile, 16% of survey respondents pegged 6% to 8% as a safe withdrawal rate.
That's a problem. Because setting a sustainable withdrawal rate--or spending rate, as I prefer--is such an important part of retirement planning, pre-retirees and retirees who need guidance should seek the help of a financial advisor for this part of the planning process.
And at a bare minimum, anyone embarking on retirement should understand the basics of spending rates: how to calculate them, how to make sure their spending passes the sniff test of sustainability given their time horizon and asset allocation, and why it can be valuable to adjust spending rates over time.
How to Calculate It
To determine your own spending rate, simply tally up your expenses--either real or projected--in a given year. Subtract from that amount any nonportfolio income that you're receiving in retirement: Social Security, pension, rental, or annuity income, to name a few key examples. The amount that you're left over with is the amount of income you'll need to draw from your portfolio. Divide that dollar amount by your total portfolio value to arrive at your spending rate.
Say, for example, a retiree has $60,000 in annual income needs, $28,000 of which is coming from Social Security and the remainder of which--$32,000--she will need to draw from her portfolio. If she has an $800,000 portfolio, her $32,000 annual portfolio spending is precisely 4%. But if she needs to draw $50,000 from her portfolio, her spending rate is 6.25%.
The 4% Rule, Unpacked
The notion that 4% is generally a safe withdrawal rate was originally advanced by financial planner William Bengen; it has subsequently been refined--but generally corroborated--by several academic studies, including the so-called Trinity study. Before retirees take the 4% guideline and run with it, however, it's important to understand the assumptions that underpinned it.
First, the research assumed that retirees would wish to maintain a consistent standard of living, drawing a steady stream of income--in dollars and cents--from their portfolios each year. Thus, the 4% guideline assumes that the retiree spends 4% of his or her initial balance in year one of retirement, then subsequently nudges the amount up in subsequent years to keep pace with inflation. He or she doesn't take 4% of the balance year in and year out, though that's a viable spending-rate method, too (more on this in a moment).
Additionally, the 4% guideline assumes a 60% equity/40% bond asset allocation and a 30-year time horizon, and that the 4%, whether it comes from income and dividend distributions or from selling securities, is the total withdrawal. Thus, a retiree whose portfolio was generating 4% in income distributions couldn't take an additional 4% from her principal. This article discusses the 4% guideline research in greater detail.
Swing Factors
Because not every retiree's profile matches those parameters, not every retiree should take the 4% guideline and run with it. Indeed, much of the recent research on spending rates has suggested that rather than take 4% of a portfolio per year and simply inflation-adjust that dollar value, retirees should be prepared to adjust their spending rates up or down based on the following factors.
Time Horizon: Retirees with time horizons that are longer than 30 years should plan to take well less than 4% of their portfolios in year one of retirement. On the flip side, older retirees--those 75 or older, for example--might consider taking a higher withdrawal rate. David Blanchett, head of retirement research for Morningstar Investment Management, has suggested that retirees consider their life expectancies when determining their spending rates. The life-expectancy factors used to calculate required minimum distributions from IRAs and company retirement plans could be helpful in doing so, as Blanchett discussed in this video.
Asset Allocation: A retiree's asset allocation should also be in the mix when calibrating sustainable spending rates. The 4% guideline, as noted above, is centered around a 60% equity/40% bond mix. But investors who want to employ a portfolio that includes more bonds and cash should be more conservative in their spending rates, as Blanchett discussed in this video. The reason is that bond yields have historically been a reasonable predictor of bond performance in subsequent years, and bond payouts are ultralow right now. Thus, the bond-heavy investor can expect less help from the market in the years ahead.
Market Performance: The bear market of 2008 illustrated so-called sequencing risk: Retirees greatly reduce their portfolio's sustainability potential when they encounter a lousy market early on in their retirements and don't take steps to reduce their spending. That's because if they overspend during those lean years, they leave less of their portfolios in place to recover when the market does.
The Right Spending Strategy for You
Indeed, much of the recent research on sustainable withdrawal rates supports the idea of tying in withdrawal rates with portfolio performance. The retiree takes less out in down-market years and can potentially take more out in years when the market performs well, such as in 2013.
The purest way to tie in spending with portfolio performance is simply to take a fixed percentage of that portfolio--say, 4%--year in and year out. Under this method, the retiree could take $32,000 from her portfolio when its value is $800,000, but would be forced to live on $24,000 if her portfolio dropped to $600,000 in value. Using the fixed-percentage method, the retiree would never run out of money, but she might not be able to make do on the smaller amount.
For retirees who aren't comfortable with such dramatic fluctuations in their standards of living, it's possible to employ a hybrid approach: tying in spending with market movements while also ensuring a basic standard of living. One such strategy, discussed here, blends fixed-percentage withdrawals with a ceiling and floor. A simpler strategy, advanced by T. Rowe Price and discussed in this article, allows the retiree to spend a fixed dollar amount, adjusted upward for inflation, as in the 4% guideline. But the retiree simply forgoes the inflation adjustment in lean market years. T. Rowe's research found that even this simple step helped improve portfolios' sustainability.

 Culled from Morning star