These days, protecting your savings as you approach retirement -- with the goal of making it last as long as you do -- is like navigating between a rock and a hard place. Now in its seventh year, the bull market is one of the longest on record. That means by most standards that a bear market is overdue. Interest rates are almost certain to go up in the coming years, and bond prices fall when interest rates rise. "I see risk at both ends of the spectrum," says
The more distant future looks dicey, too. Over the next 10 to 30 years, we think stocks will deliver average annual returns of 6% to 8%, rather than the annualized return of 10.1% they have produced since 1926. If you buy a 10-year Treasury bond today, you know that you'll earn roughly 2.2% a year over the next decade. Expect a little more if you invest in individual high-grade corporate bonds. (Funds will be hard-pressed to match the return of investors who buy individual bonds and hold to maturity.) Inflation is projected to stay low, at 2%, but cash will earn less than that, with money market mutual funds yielding maybe 1.5% over the next five to 10 years.
In this low-growth world, calculating how much money you need in retirement and at what rate you can safely draw it down is challenging. Longer life spans further complicate such estimates. A 65-year-old man can now expect to live another 18 years, on average; a 65-year-old woman can expect to live another 21. "Longevity is a two-sided coin," says
Whether you're a few years away from retirement or a few years into it, you still have the ability to adjust your plan. The key is to be flexible and willing to rethink some of the old rules.
Invest for the long haul
Traditional wisdom has it that you invest heavily in stocks while you're young and scale back that part of your portfolio to, say, 50% as you approach retirement, keeping the rest in bonds and other fixed-income investments. Near-retirees who are still shell-shocked by the bear market of
That means entering retirement with a healthy portion invested in stocks for growth and gradually reducing that side of your portfolio to lower your risk as you age. "A portfolio of 40% to 60% in equities is a good starting point," says Bruno. The
Which strategy you choose depends on your circumstances and risk tolerance, says Bruno. If you have a large portfolio and plan to leave money to your heirs, "a more aggressive allocation later can make sense for those who are comfortable with the additional market risk," she says. If, however, heavy losses in the stock market could affect your ability to cover living expenses, you may not be able to stomach that volatility as an 85-year-old.
No matter what, aim for a portfolio that includes foreign stocks, including those from emerging markets, as well as large and small U.S. companies. Round it out with international bonds, real estate and some alternative investments, such as commodities and managed futures.
To take advantage of rising yields, consider building a ladder of bonds that start to mature five years from now, says Pfau. According to this strategy, you buy a five-year bond now, then invest a like amount in new bonds in each of the next four years. If rates rise as expected, you'll earn more interest with each new purchase. When a bond matures, you can use that money for retirement expenses. If you invest in bond funds, it's the manager's job to make the most of rising rates while minimizing the negative impact on bond prices. (
Set your spending rate
Five years out is not too soon to calÂculate how much you'll need to live comfortably in retirement and how much you can withdraw from your accounts without running out of money. On the savings side, one formula is to multiply your last year of preretirement expenses, minus
One problem: Those formulas rely on historical market returns and don't reflect future returns, which are likely to be lower. To avoid lowering your living standard and to keep from running out of money, you'd have to save 33 times preretirement expenses (rather than 25) and drop your initial withdrawal rate to 3% or less, according to a 2013 study by Blanchett, Pfau, and
For most people, upping the savings goal dramatically a few years away from retirement probably isn't realistic, says
One certain way to avoid running out of money is to take a percentage -- say, 4% -- from your portfolio each year and forgo the inflation adjustment altogether. Another is to calculate your withdrawals according to the actuarial tables the
Here's another idea: Use the 4% rule as a starting point but adjust it up or down (or skip the inflation adjustment) depending on how your investments do in any given year. In a good year, you can give yourself a bonus, maybe upping the withdrawal to 5%. In a bad year, cut back. "Rather than taking a vacation in the south of
Use the bucket system
This approach combines withdrawal and investing strategies. In one "bucket" you hold enough money in cash and short-term CDs to meet essential and discretionary expenses over three to five years, and you keep the rest in another bucket invested in stocks and bonds. As you spend down the first bucket, you replenish it by taking profits from the second. Some financial planners suggest creating three buckets, the first with cash and CDs, the second with short- and intermediate-term bonds, and the third with stock and bond funds.
The beauty of the bucket system is that you probably won't have to sell stocks in a market downturn to cover expenses. "Even in 2008, if investors had had five years to wait it out, their stock investments would have been in good shape by 2013," says
A fixed annuity, which provides guaranteed income for life, can be a part of the strategy. You use the income from the annuity, along with
Fixed annuities lock up a big chunk of the savings you might need later.
Lower your tax bill
When you take money from savings for retirement, you're generally advised to tap taxable accounts first, then tax-deferred retirement accounts, and finally your Roth IRA. Here's why: If you've held the investment in a taxable account for more than a year, you'll pay the long-term capital-gains rate -- no more than 15% for most people. Plus, tapping taxable accounts first allows your tax-deferred accounts and tax-free accounts to continue to grow.
Once you turn 70 1/2, you're required to start taking distributions from IRAs and other tax-deferred retirement accounts. If you don't take a distribution of at least the required amount, you'll pay a penalty of half of the required amount you failed to withdraw.
Generally, you should save drawing down your Roth IRA for last. You can withdraw your Roth contributions tax-free and penalty-free anytime; the earnings are also tax-free as long as you're 59 1/2 and have held the account for at least five years. Unlike traditional IRAs, Roth IRAs have no annual distribution requirement. So if you don't need the money, you can let it grow and leave it to your heirs, who can take distributions tax-free.
The exceptions. Now consider situations in which you might be better off departing from the standard advice. If you expect your RMDs to kick you into a higher tax bracket when you start taking them, it may make sense to take some distributions from your tax-deferred accounts before you reach 70 1/2 (as long as they don't put you into a higher bracket). That income will be taxed at your lower rate, and you'll lower the amount of future RMDs, says
Add up your other sources of income and withdraw just enough from the tax-deferred account to keep you in the 15% tax bracket. If you need more income to cover expenses, take withdrawals from your taxable accounts first, followed by withdrawals from the Roth.
Comment by clicking here.
Jane Bennett Clark is a Senior Editor at Kiplinger's Personal Finance.