Personal Finance: Looking at the 4% rule for retirees

If you retire, how much money can you remove each year from your savings and make sure you don't rob your golden years of the gold you will need to put food on the table?

In the last couple of decades, many financial planners had their clients live by what's called the 4 percent solution. Backed by research done in the 1990s, the solution enables a retiree in the first year of retirement to take 4 percent out of his or her total retirement savings and use it for living expenses. Then, each year the person can increase the amount just a tad to cover inflation.

So if someone retired with $500,000 in savings, the person could use $20,000 of it for living expenses in year one of retirement. The next year, the sum would be tweaked to cover the cost of inflation. With inflation running at 3 percent, the tweak would be $600. In other words, for year two of retirement the person would have $20,600 in spending money from the nest egg, plus whatever comes in from Social Security, pensions, or part-time work.

According to research conducted by financial planners such as William Bengen in the 1990s, a person who removes more than 4 percent is taking a relatively large risk of running out of money prematurely in retirement. He came to that conclusion after examining numerous market conditions from the past and applying them to today's long life spans. Often people retire in their 60s and live into their 90s. The 4 percent solution assumes people are retired for 30 years.

But the traumatic experience of two horrendous bear markets since 2000 has caused financial planners to reexamine old assumptions.

The realities have been tough on seniors, and especially on those who have never heard of the 4 percent rule and simply removed the money they wanted or needed for retirement expenses. If a person spends too freely early in retirement and then sees the well going dry at 75, it's tough to find a job.

While research conducted before the 2000s skirted over periods of huge losses and especially the Great Depression, there is renewed interest in peering at brutal times as well as benevolent times in the stock market.

So new research by Chris O'Flinn, president of Elm Income Group, garnered attention at the annual conference of the Society of Actuaries last week.

O'Flinn wondered if people could still feel safe removing 4 percent from their savings and whether they could dare push the limits a little and remove 5 percent.

He went through history from 1926 through 2009, examining what a typical retirement portfolio of half stocks and half bonds would do.

The conclusion: A person who removes 5 percent the first year of retirement and then tweaks it each year to cover inflation stands a 51 percent chance of running out of money in a 35-year retirement. In a 30-year retirement, the danger of running out is 36 percent. In 25 years of retirement, there's a 20 percent chance of outliving your money.

The 1960s were also tough on retirees. A nasty combination of high inflation and bad returns on investments conspired to erode people's savings faster than usual, O'Flinn said.

Some people feel comfortable with a 15 percent risk. But if you want certainty that you won't exhaust your savings, history suggests you should be fine if you remove no more than 3.5 percent of your savings in the first year of a 30-year retirement.

Of course, that's getting pretty lean on spending money. O'Flinn notes that another way to handle a period like we've encountered in the last few years is to stop taking any inflation adjustment for a year or more. The idea is to take as little as possible out of your savings so that you give the stocks time to make gains again. If you've removed money, it will never have a chance to heal and prop up your savings again.