How to make the 4 percent withdrawal rule work for you-By Kira Brecht

Thinkstock

The so-called "4 percent rule," long considered a safe amount one should withdraw each year in retirement, is now the subject of much debate. Some experts argue that it is too high, while others say it is too low. Still, many financial advisors say it is a good starting point for retirees to determine how much of their nest egg to spend on an annual basis.

Here's how the 4 percent rule works : "One could withdraw 4 percent of his or her retirement-date portfolio value, adjust this amount for inflation in subsequent years and sustain withdrawals over 30 years using a diversified portfolio with 50 percent to 75 percent stocks," says Peter Mallouk, president and chief investment officer of Leawood, Kansas-based Creative Planning, an independent wealth management firm.

Financial advisors say the rule can be a good starting point. "Just like an airline pilot has a flight plan that he or she is to follow when starting out, retirees need a retirement cash-flow plan for their future when embarking on the next phase of their lives," says Joe Franklin, president of Franklin Wealth Management, a financial services firm based in Hixson, Tennessee. "In both cases, course corrections are going to be needed based upon turbulence, storms, unforeseen emergencies and many other factors. A plan that factors in these types of issues is going to work better over time."

There are several important variables retirees need to understand about the 4 percent rule, and a few adjustments they can make to meet their needs, experts say.

Don't convert savings to all bonds and CDs. As you hit retirement age and begin taking withdrawals, it is important to maintain a diversified portfolio and keep some of your assets in stocks to generate enough gains to keep your assets growing. "If you have a well-diversified portfolio with a heavy equity exposure, you should see annual returns of 6 percent, 7 percent or more," says Travis Sollinger, director of financial planning at Fort Pitt Capital Group, a Pittsburgh-based investment management firm. "The reason the 4 percent rule can work is if you average 6 percent on your money and are only taking out 4 percent, you still should see modest growth in your portfolio."

If you have a 60-40 split between stocks and bonds in your portfolio, he advises maintaining that allocation because "your years in retirement will still be significant."

Diversify internationally to boost returns and decrease risk. Many advisors suggest maintaining an allocation to international stocks to add diversification and potentially boost returns. "The [4 percent] rule assumes only a few asset classes are used in a client portfolio ... we believe using a globally diversified portfolio can potentially produce a return and risk characteristics that support a higher withdrawal rate," Mallouk says.

Don't overspend in good years. Stock market cycles mean some years produce outsized returns, while other years yield paltry gains. In the years when the market posts significant returns, retirees should stick to their plan and try not to splurge. "If your account is up 20 percent, the tendency is to say, 'I don't want to limit myself to 4 percent. I can take 10 percent.' You have to maintain discipline," Sollinger says.

Stay the course in bad years. Consider using a "bucket" approach to investing, and set aside enough cash to cover your bills for one and a half to two years. Keeping some money in safe investments such as short-term CDs can help you manage your fears about losing too much in bear markets. "Put these assets into something where there is no risk at all. These are short-term investments to get you through the rough times. Don't freak out, don't change your allocation, don't move away from your plan," Sollinger says.

Consider additional retirement income strategies. Future health care costs are a big unknown in retirement, which means retirees should add other income streams to the mix. A 65-year-old couple may need an average of $220,000 to cover medical expenses throughout retirement, according to a 2014 estimate from Fidelity Benefits Consulting.

"Medicare supplements and long-term care insurance can help those that have not saved as much as others," Franklin says, adding that Social Security income can help provide "more certainty to the retirement income picture."

"Many who want additional certainty look to private pensions or retirement income strategies where some of the income is guaranteed over their lifetime by insurance companies. Many of these currently guarantee lifetime income over 4 percent," he says.

Tap a financial advisor for guidance. A financial advisor can assist you through this process and help determine a withdrawal strategy that works for you. "A financial planner is going to know the questions you should be asking but don't know to ask. He or she is likely to have seen retirees make many mistakes in the past and can help guide you away from making these mistakes yourself," Franklin says.

He adds: "A good financial planner knows the common pitfalls to avoid and can help guide clients toward the correct path, even if it is not a popular one."

Culled from US News