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3%? 4%? 5%? How much to take for retirement

Kristian Sekulic | E+ | Getty Images

When you have retired, your goal is to expire before your bank account does. The easiest way, of course, is to take up juggling hatchets.

A more moderate solution, however, is to try and figure out how much you can withdraw each year—a tricky calculation at best, since you know neither what you'll earn in any given year, nor what the rate of inflation will be, nor how long you'll live.

Financial planners have long recommended that your initial withdrawal be 4% of your savings, which you then adjust each year for inflation. Recently, however, others have suggested that 3% is a more reasonable alternative, given that savings rates are virtually zero.

But don't get out the hatchets yet. Being too conservative in your assumptions will rob you of retirement joy. You can probably take out more than 4% a year and be reasonably assured of not running out of money.

Most people figure that you can just take your earnings any given year, and live off those. For example, suppose you have $250,000 in retirement savings.

If you have a bond or other income investment that throws off 5% income a year, you could take 5%—$12,500 a year—without fears of running out of money or dipping into your principal, for that matter.

There are two problems with that. The first is that in these days of low interest rates, a 5% return is edging into high-yield category, which means high risk. The average exchange traded junk-bond fund in Morningstar's database has a current yield of 5.38%. If you crave safety, a one-year Treasury bill yields just 0.1%, or $21 a year. You'd be able to afford a peeled lima bean every other Friday.

The second is inflation. Even modest inflation will erode your buying power over time. Suppose you withdraw $500 every month from your retirement kitty. After 10 years of 3% inflation, $500 will have the purchasing power of $380.

Several academic studies have shown that if you start with a 4% initial withdrawal and adjust it each year for inflation, you have a good chance of never running out of money. The rule of thumb assumes a relatively conservative portfolio, typically 50% or 60% stocks, with the balance in cash or bonds.

(Read more: Three ways baby boomers are redefining retirement)

Given a $250,000 retirement portfolio, your withdrawal in the first year would be $10,000, or a monthly income of $833 a month. The next year, you'd boost your withdrawal by the rate of inflation, and so on.

Had you followed this plan in 1960 using a balanced fund, which is typically a mix of 60% stocks and 40% bonds, you would not have run out of money until 2002, 41 years later. And this in a period that featured soaring inflation, several wretched bear markets, and disco.

Given the low returns from bonds—the 10-year T-note yields a miserly 2.5%—some academics have suggested lowering the initial withdrawal rate to 3%. There are two problems with that. The first is that rates probably won't stay this low forever. The 10-year T-note has had an average yield of 6.6% since its inception in 1962, and 4.6% the past 20 years.

The second is that a 3% withdrawal rate is pretty tough to live off, unless you have a great deal of money, and most people don't. If you have $250,000 saved for retirement, your initial withdrawal would be $7,500, or $625 a month.

Depending on your circumstances—how much you pay for rent or mortgage, how much Social Security you get, your overall health, and the taxes on your withdrawals—a 3% withdrawal rate could mean pretty a pretty tight budget.

And, says Michael Finke, professor of retirement planning and living at Texas Tech, you could be living a lean retirement for no reason, even if you stick with an initial 4% withdrawal rate.

"The 4% rule assumes you're going to live to age 95, and most of us are going to be dead by then," he says. "If you're really conservative, you didn't run out of money, but you left a lot of retirement joy in the bank." Among couples age 65, just 18% will have one person who hits 95.

The other flaw with the 4% (or 3%) rule: It assumes that each year, you blindly withdraw according to the formula, and increase your budget for inflation. Most people, if they're having a rough couple of years in the market, will ratchet down spending or not take the inflation increase, Finke says.

Read more from USA TODAY:
At risk of outliving your retirement savings?
Retirement and health care: Concerns are off the charts
At what age should you start claiming Social Security?

What's a retiree to do? Finke has two suggestions. If you're concerned about outliving your money, try to put some of your retirement kitty into a fixed annuity, which guarantees lifetime income.

You'll still be vulnerable to inflation, but you'll at least know that you'll get a certain level of income every year. Currently, a $75,000 immediate annuity will get a 65-year-old man about $430 a month, according to immediateannuities.com.

The drawback: If are struck by lightning the day after you buy the annuity, the insurance company keeps your money, and you'll have nothing to spend in your coffin. You can buy annuities that protect your spouse or leave money to your heirs, but they will reduce your monthly payout.

Social Security is, of course, a form of annuity, and one that rises with inflation. "It's a huge benefit for a married couple," Finke says. If you can continue working until 70, you'll be able to collect your maximum benefit.

Another way to calculate your withdrawal rate comes courtesy of the Internal Revenue Service. When you reach age 70½, you have to start taking money from traditional IRAs. Just how much is based on the IRS required minimum distribution tables, which are based on your life expectancy at that age.

(Read more: For part-time workers, here's a financial toolkit)

For example, if you have a $250,000 IRA and you're 70½, you'll have to withdraw $9,124 this year, according to Fidelity Investment's RMD calculator. Typically, the withdrawals will increase every year until you're 100, and at that age, you probably won't be playing quite as much golf anyway.

The 4% rule is a decent starting point for retirement planning. But it's a highly conservative one. If you take up cobra farming in retirement, you can certainly take more. And if you're willing to cut your budget in the market's lean years, you can probably start with more than 4%, too.

—By John Waggoner, USA TODAY.

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