One thing retirees fear is outliving their money. Since the mid 1990s many of them have relied on a staple of retirement planning known as the 4 percent rule to avoid that. Although the name says 4 percent, the rule states that if retirees withdraw 4.5 percent of their savings every year, adjusted for inflation, their nest egg should last 30 years, the length of time generally used for retirement planning.
That percentage was calculated at a time when portfolios were earning about 8 percent. Not so anymore. Today portfolios generally earn much less, about 3.5 percent to 4 percent, and stocks are high-priced, which is linked historically to below-average future performance.
Michael Finke, a professor at Texas Tech University in Lubbock, says there are many problems with the 4 percent rule, but a big one is that it doesn't acknowledge the new economic reality of prolonged low returns. "There haven't been any historical periods that look like today," Finke said.
Many advisers recommend maximizing earnings by moving away from the 60 percent stocks to 40 percent bonds portfolio allocation on which the 4 percent rule is based, says Jay Wertz, director of wealth advisory management firm. He says that as interest rates have fallen and stayed low, "earning 2 to 3 percent on 40 percent of your assets for the next several decades doesn't really make sense."
Retirees wanting more certainty in the future might consider investing in a deferred income annuity, Finke said. Deferred income annuities pay a yearly income that kicks in later in life — usually starting about age 80 or 85.
Steve Vernon, a retirement consultant advises investing up to half of retirement savings in an immediate fixed annuity, which starts payouts when you retire. The annual income usually ranges from 5 to 6 percent of the amount paid for the annuity, and those payouts, together with Social Security, should be used to cover basic living expenses, says Vernon. "The remainder of savings should be invested and systematically withdrawn to cover everything else," he said.
Another option is a managed payout fund, especially for people who do not want to actively manage their money. These funds invest savings for you and send out a check each month that is a combination of investment income and a return of principal.