Retiring When the Bear Growls

09/02/2009 12:00 pm EST

Focus: MARKETS

Liz Pulliam Weston

Personal Finance Columnist, MSN Money

Liz Pulliam Weston, columnist for MSN Money, gives some suggestions on what retirees and near-retirees should do if their portfolios were hit hard in the bear market.

Big drops in the stock market obviously can devastate retirement accounts. But the people most at risk are those who have just retired or who are about to retire.

That's because dipping into a shriveled nest egg can dramatically increase your chances of running out of money. The cash you take out won't be there to earn future returns when the market recovers; what's left would have to earn extraordinary gains to make up for the double-whammy of market losses and your withdrawals.

Studies by mutual fund giant T. Rowe Price found that people who tap the recommended 4% of their nest eggs in the first year of retirement and who increase that withdrawal amount by 3% each year to compensate for inflation stand only an 11% chance of running out of cash before they die—if they retire in a normal market.

If they retire in a bear market, however, and do the same thing, their risk of running out of money can shoot to more than 50%.

The first five years in retirement are critical, said Christine Fahlund, a senior financial planner for T. Rowe Price, because the average retiree has many years ahead.  If a bear market occurs in the second five-year period, "it isn't quite as bad," Fahlund says.

Here's your game plan if you're in the retirement danger zone

Don't bail on the stock market. Typical retirees need to keep at least half of their portfolios in stocks or stock mutual funds to offset inflation's effects. Hiding in cash "is not going to work, not when you have so many years ahead of you," Fahlund says.

Consider putting off retirement. The simplest solution may be waiting to retire until the market is firmly back in positive territory. "Our advice right now is that if you don't have to retire, don't," Fahlund says.

If [you don't have a choice]:

Consider part-time work. Whatever you can do to reduce your initial withdrawals will help stretch your nest egg. "A part-time job that pays $20,000 . . . is the equivalent of having saved an extra $500,000," Fahlund says, because a 4% withdrawal of $500,000 would produce $20,000.

Trim withdrawals in bad markets. An alternative is to freeze your withdrawal in a bad year, then for one or two years afterward. "When it's time to take that 3% increase, don't take it," Fahlund recommends. "Defer that (increase) for up to three years. You can manage on literally a fixed income for that time."

Set aside a cash cushion. [Keep] at least one year's worth of expenses in cash or cash equivalents, such as short-term-bond funds. A fat cash cushion also can give you the comfort level to ride out market downturns without panicking and selling.

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