5 strategies to make retirement savings last

When it first emerged nearly three decades ago, the 4% rule captured the minds of financial advisors as a one-size-fits-all solution. Created in 1994, the same year that Ace of Base's "The Sign" ruled the airwaves, as Kiplinger's recently put it, the rule of thumb holds the following: If you have $1 million in retirement savings and want to cover your expected costs over the three decades you will live, draw down 4% of your holdings in the first year you're no longer working. 

For each subsequent year's withdrawal, tack on extra dollars equal to inflation. So a retiree with $1 million and 2.84% inflation, in a Morningstar example, would pull out $40,000 in the first year, $41,136 in the next year, $42,304 in Year 3 and so on.

The rule is the brainchild of a now-retired financial advisor, William Bengen, a solo practitioner who took his bachelor's degree in aeronautical engineering at the Massachusetts Institute of Technology. Over roughly the past decade, his theory, published in a widely-read article in the Journal of Financial Planning, has taken a bruising. 

"The 4% rule is a common rule of thumb, but we think you can do better by finding your personalized spending rate," Schwab says. "The biggest mistake you can make with the 4% rule is thinking you have to follow it to the letter."

The rule assumes a split evenly between stocks and Treasury bonds. It also hinges on an average 10.3% annual return for equities, 5.2% for bonds and 3% annual inflation. The posit doesn't account for market downturns early in retirement that can reduce available money in later years, a factor known as "sequence risk." 

The 4% rule covers all retirement assets, from tax-deferred accounts like 401(k)s and IRAs to brokerage accounts and cash. That means a retiree and her financial advisor must do the math to compute how much must be taken out in required minimum distributions from tax-deferred accounts at age 73, then backfill discretionary dollar amounts from the other sources.

The rule is easy to digest, formulaic — and rigid.

A different spend-down strategy known as the "guardrails" approach, pioneered by planner Jonathan Guyton of Cornerstone Wealth Advisors in Edina, Minnesota, and William J. Klinger, a financial and software engineer, says retirees shouldn't make fixed withdrawals. Instead, they should toggle drawdowns based on how the market is doing in a given year. When stocks and/or bonds are down, trim pullouts; when they're up, increase them.

Last year socked many investors with paper and actual losses as the volatile S&P 500 fell nearly 20%, its worst performance since the financial crisis of 2008. While bonds are usually a safe haven during equities turmoil, 2022 flipped the script as the Bloomberg U.S. Aggregate Bond Index, a widely used barometer, slumped 13% — what one financial historian called their  worst year in history.

What does Wall Street's horrible 2022 mean? That people who will retire this year can withdraw more money than they safely could have last year.

That's the surprising and counterintuitive finding of a Morningstar report last December. The reasoning: Lower stock and bond values now create more room for upside in the future. That in turn leaves more money to be withdrawn this year without damaging a nest egg's growth potential.

An initial withdrawal percentage of 3.8% is safe in 2023, according to Morningstar director of personal finance and retirement planning Christine Benz, research director John Rekenthaler and Morningstar Research Services chief ratings officer Jeff Ptak. A year ago, they recommended 3.3% for 2022.

Like the author of the 4% rule, Morningstar assumed a new retiree's portfolio holds $1 million, 50% in stocks, 50% in bonds, and has a 30-year time horizon. 

Because bonds are less volatile than stocks and expectations for their returns have improved, more conservative investors can have the same outcome: Morningstar found that "a retiree could dial equity exposure all the way down to 30% and still employ that same starting withdrawal percentage of 3.8%. Likewise, retirees who only plan to use their savings over 10-15 years can take less equity exposure. For those savers, "portfolios with equity weightings of less than 40% generally supported higher withdrawal rates than more aggressively positioned portfolios would," Morningstar wrote.

The Chicago-based investment research and financial services company said its model had a
90% chance of being successful, meaning savers who follow the strategy will avoid running out of money in nine out of 10 cases.

"New retirees don't need to stick their necks out with higher equity weightings in order to obtain higher starting paydays," it wrote.

Roth accounts are funded with dollars on which taxes have already been paid, and their withdrawals are tax-free once a saver is at least age 59 ½ and has held the account for 5 years. Again, they have no RMDs, so a saver who has multiple retirement buckets, such as a 401(k) and individual retirement plan, can use a Roth to cushion the tax hit that materializes when making withdrawals from those tax-advantaged accounts.

Taxes are often the single largest expense for retirees. So planning strategies that lower outlays to the IRS in old age, when you're no longer earning income, are particularly valuable.

Affluent people on the cusp of retirement who are in their 60s and still working, earning good income, have their living costs under control and own pre-tax accounts like an employer-sponsored retirement plan can set themselves up now to blunt taxes in the future, said James Bremis, a certified financial planner with Sentinel Group in New York.

By converting a tax-deferred account to a Roth now, they pay taxes up front, at ordinary rates, on the switch. But they also shift money out of a 401(k) or traditional IRA from which they'll have to take required minimum distributions, starting at age 73 in 2023, up one year from last year's age 72. 

Such savers can be well-heeled enough, with significant assets held in a taxable brokerage account, that they won't need to access their pre-tax retirement accounts in retirement, Bremis said. But once the RMD requirement starts, it can create big tax bills from the distributions, so moving money out of accounts with required RMDs makes economic sense, he said.

"You can intelligently structure a Roth conversion strategy, even over multiple years" by converting portions of a tax-deferred account, thus lowering the amount of upfront tax owed, Bremis added.

Read more: This Roth IRA conversion trick can save investors big money