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Avoid this critical retirement planning mistake

(MoneyWatch) I was at a holiday party recently when a friend started talking to me about her retirement plans, hoping to get some free advice. I'm always glad to help out my friends, but my advice wasn't exactly what she was expecting to hear.

Helen, a single nurse in her mid-60s, said to me, "I've got $300,000 in my 403(b) retirement savings, and I need an annual income of about $25,000 per year in addition to Social Security. I should be OK if I take out this amount each year, right?"

I did the mental arithmetic in my head and realized that she'd be withdrawing from her retirement savings at a rate of more than eight percent per year. My response? "At that rate, you'll probably run out of money while you're still alive, most likely in your 80s. I know you're healthy, and there's a very good chance you'll live into your 90s. You'd be better off by starting with a withdrawal rate of four percent per year, and then if your investments do well you could increase your withdrawals down the road. This means you should start out by withdrawing just $12,000 per year."

Her response? "But I can't live on $12,000 per year!"

I continued by saying, "If you reach your 80s and exhaust your retirement savings, then you'll need to live on just Social Security. So consider your retirement savings as a generator of a lifetime retirement income and figure out how much income is reasonable to expect from your savings." (I encouraged her to learn more and told her I'd give her a copy of my new book, "Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck.")

Unfortunately, Helen's story is typical of the type of financial "planning" many people do for their retirement. They roughly estimate how much money they need each year for living expenses above and beyond their Social Security income. If their retirement savings are somewhat bigger than this annual amount, then they think they'll be OK.

Even surveys are showing that many people expect to withdraw from their savings at a rate of eight percent per year or higher, with the unfortunate result that most of them will likely run out of money before they die.

People who "plan" in this manner are hoping that their money will last for a lifetime without really doing any planning. Well, hope is not a good strategy. Instead, they should be learning about the different ways they can generate a lifetime retirement income and choose the method or methods that best meet their goals and circumstances.

Not only will this planning give them a better chance of having enough money no matter how long they live, it will also make them more confident about their retirement. The annual Retirement Confidence Surveys from the Employee Benefit Research Institute consistently show that people are less anxious about their retirement if they do the math to estimate how much savings they'll need to cover their wants and needs.

But back to Helen. Since she's a nurse, she can easily find part-time work after she retires from her full-time job to help her delay drawing down her retirement savings and postpone starting her Social Security benefits, both good moves to improve her retirement security. Meanwhile, she'll still be able to enjoy some free time because she'll only be working part time. With just a bit of planning, she can start making smart decisions about the rest of her life!

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