How much should you spend during retirement?

It seems entire libraries could be filled with the magazines, newspapers, books and DVDs devoted to saving for retirement.

But much less has been written about spending in retirement. That leaves lots of older Americans worried about outliving their savings. In the absence of a proven formula for spending down their nest eggs, they are afraid to spend.

In fact, experts have advanced several strategies exploring how to "decumulate," a term referring to the slow, careful spending of assets over the course of a retirement. Some are simple, others more complex. Grasping how comparatively effective each is was the goal of a recent study by researcher Anthony Webb at the Center for Retirement Research at Boston College.

He studied the well-known approach called the four-percent rule, which holds retirees can spend four percent of principal each year. Another strategy studied involved spending only interest and dividends yearly, but not principal.

Still another was a withdrawal timetable tied to the IRS Required Minimum Distribution (RMD) schedules, which mandate folks begin withdrawing money from IRAs after reaching 70½. The final strategies studied were one tied to retirees' life expectancies, and another based on buying an annuity product.

Flaws in each

No approach is perfect. The four-percent rule is an excellent example of that imperfection, Webb says. "The four-percent rule should really be taken out behind the woodshed," he asserts. "It's a very foolish rule."

Say a household has $1 million at retirement, and withdraws four percent, or $40,000 annually, for living expenses. Assuming the household is keeping a percentage of assets in stocks, as retirement planning experts urge, a 2008-09-style stock market meltdown could result in the remaining assets being reduced by hundreds of thousands of dollars until the market rebounds.

Continuing to withdraw $40,000 each year will soon deplete the lower net assets remaining after the crash. "If you're investing some of your retirement in assets that have risk, you really have to allow your consumption to fluctuate with market returns," Webb says. "If you're not willing to do that, you might consider basing your retirement income on treasury inflation-protected securities" or TIPS.

Jean Setzfand, vice president for financial security at AARP, agrees with the flaws in the four-percent rule. 

Given the stock market's volatility, she says, even a modest distribution rate of four percent can impact asset preservation. "A more conservative asset preservation approach is to modify your withdrawal rate in keeping with actual portfolio returns and not use a static withdrawal rate," she adds.

"In tougher times, even negative return years, you should not withdraw any amount and consider putting additional capital into your account to again preserve your total portfolio's nest egg assets," she says.

In any case, the four-percent rule has another severe shortcoming, says Greg McBride, chief financial analyst for "The reality is that many people have not saved nearly enough for a four-percent withdrawal rate to give them enough to live on," he says.

Quest for simplicity

The four-percent rule is flawed, but does have the benefit of simplicity, Webb says. And retirees' love of simplicity led him to try another approach.

"I said what would happen if instead of following the four-percent rule, households draw out amounts equal to the IRS's Required Minimum Distribution rules," he says. The IRS's RMD exists to ensure the government can tax the money that wasn't taxed when the earners deposited the money in the account.

"The RMD tables do have attractive characteristics," Webb continues. "One is that the sum you draw out is a percentage of the current market value of your investment. In other words, the sum drawn out automatically responds to market returns and is built into the system. 

"In addition, the percentage withdrawal rate increases with age, and this is another attractive characteristic. If people get to age 100, they will be spending a large percentage of what is left. That is exactly what should be happening, because of the much shorter life expectancy at age 100."

Under the RMD's schedule, retirees withdraw 3.13 percent of assets at 65. That number rises to 3.65 percent at 70, 4.37 percent at 75, 5.35 percent at 80, 6.76 percent at 85 and all the way to 15.78 percent at the century mark.

Test results

The approach that worked best for those concerned with outliving their funds was a strategy of drawing out amounts equivalent to RMD tables, plus the interest and dividends on investments.

McBride addes these caveats:

"The RMD approach is great for someone who has saved enough, and who doesn't need to begin taking those withdrawals right away," he says.

An important lesson to be drawn is that retirees shouldn't be afraid of spending down their savings. "One thing that should be in capital letters is that it really is okay to spend it; that's what it's there for," Webb advises.

"The only real question is, how rapidly?"

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