Cracking your nest egg

Kiplinger's Personal Finance Magazine, Oct, 1998 by Ronaleen R. Roha

Bengen's formula means that the percentage of a portfolio that a conservative retiree should have invested in stocks is 115 minus his or her age. That would mean 50% if you were age 65, for example, falling to 35% 15 years later, when you hit 80. For an aggressive investor, the percentage should be 140 minus age--or 75% at age 65 and 60% at 80.

Based on historical market performance, Bengen's research shows that a 65-year-old invested 50% in stocks can withdraw between 4% and 5% of a tax-deferred portfolio (slightly less for a taxable portfolio) in the first year of retirement (and the same amount increased by inflation in each of the succeeding 30 years) and not run out of money even during market downturns. This means that if you have a $700,000 portfolio, at 4% you can withdraw $28,000 in the first year. Applying a 3% inflation rate, in year two you could take out $28,840, in year three $29,705, and so on throughout the 30 years.

When setting your own allocation, keep in mind that at least part of your money at 65 will be invested for ten years or more. That makes you a long-term investor. For that reason, planner Slafsky aggressively invests funds earmarked for use when people are in their eighties and beyond. "The greatest tools for reducing risk are time and diversification," he says. "That part of the portfolio has the most time."

But what if having 50% or more of your portfolio in stocks still gives you the jitters? Then just say no. Any allocation has to take your risk tolerance into account. You can invest more conservatively--but you may be cutting short the life of your assets.

Which money to spend first?

Tax planning in retirement is a complicated business, so you may need expert help. If you don't have to take minimum required distributions from your IRA or 401(k) plan yet, it makes sense to leave that money tucked in its tax shelter as long as possible. Rely on social security, pension benefits and money produced by taxable accounts before invading tax-sheltered accounts.

Remember that when you draw money out of a taxable account, it goes much further then when you pull cash out of a tax-deferred account. Why? Because you've already paid at least part of the taxes on assets stashed in a taxable account. Everything coming out of an IRA or company plan is taxable (unless you made nondeductible contributions).

Say you need $10,000 for a long-planned European vacation. If you tap a taxable mutual fund account in which shares have appreciated an average of 20%, you'd need to withdraw just $10,415 to have your $10,000 after taxes. Dip into an IRA, though, and you'd have to pull out almost $14,000 to have the same amount left after Uncle Sam claims his share (assuming you're in the 28% bracket). If you take state taxes into account, the gap grows wider.

And don't assume you'll drop to a lower marginal tax bracket in retirement. While that may happen, required withdrawals from large 401(k) plans and other tax-deferred accounts may push you into a higher bracket than before.