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IRA and 401(k) retirement drawdown: Just tell me what to do!

How can you generate income from your retirement savings that lasts the rest of your life, no matter how long you live and no matter what happens in the economy? This is one of the most difficult retirement planning challenges facing boomers, and you'd get lots of different answers if you were to ask financial planners or analysts that question.

But many people don't have enough retirement savings to have access to planners who are qualified to make effective recommendations, or who are unbiased by financial incentives and truly have your best interests at heart. So this post -- and my next two -- continues the spirit of my last post, where I'll offer some simple solutions that will be effective in most circumstances and will help you get a fair shake from the financial institutions you deal with. While I prefer you take the time to learn about the various strategies and approaches so you can make informed choices, if you don't have the time or inclination to make that effort, this series of posts describes the next best thing.

The overall strategy

Don't spend your retirement savings willy nilly to meet your living expenses. That's a recipe for failure because you'll most likely outlive your retirement savings. Instead, use your retirement savings to generate a monthly paycheck that will last for the rest of your life. Then cover your day-to-day expenses by living "paycheck to paycheck." Most likely this financial discipline worked while you were employed, so let's not change things up during your retirement years.

The rest of this post and my next two posts provide the necessary "just tell me what to do" advice for generating that retirement paycheck. To keep things simple, I'll assume that all your retirement savings are in tax-advantaged accounts, such as an IRA, or 401(k), 403(b), or 457 accounts at your employer. If you work for a large employer -- say, one with 1,000 employees or more -- your plan is most likely managed by professionals who've shopped around for low-cost, high performing investment funds. Your savings plan at work may be the best place to keep most of your retirement savings.

Step 1: Set aside a reserve for emergencies.

First, set aside an amount that's reasonable for your circumstances that could cover emergencies or unforeseen expenses. You might need this money to cover large deductibles for medical expenses, home or car repairs, and so on. This is an arbitrary number, but I'll suggest $20,000 for this purpose. Invest this money in accounts that are liquid and can be tapped without penalty, such as CDs or money market funds. Your savings plan at work may have stable value funds or mutual funds that invest in Treasury Inflation-Protected Securities (TIPS) -- these would also be good choices for your emergency fund.

Step 2: Split the remainder of your retirement savings between two income generators.

Take the rest of your retirement savings, and divide it equally between an inflation-adjusted immediate annuity and an investment that provides managed payouts. This combination provides the best features of each retirement income-generating solution while mitigating the disadvantages of each approach.

The advantage of the annuity is that it eliminates two significant retirement risks -- the risk of outliving your savings and the risk of inflation. The disadvantages are that once you buy the immediate annuity, your money is locked up and you can't access it. Also, after you and your beneficiary pass away, no money is available to pass on for a legacy to children or charities. But that's the price you pay for the valuable guarantees of the annuity.

You'll invest the portion of your retirement savings devoted to managed payouts and make monthly withdrawals that are intended to last for the rest of your life. However, one disadvantage is that there's a chance you could outlive your savings if you live a long time or your investments perform poorly. The advantages of managed payouts are that you have access to your retirement savings, and any unused money after your death is available for you to leave a legacy to children or charities. 

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Stay tuned for my next two posts, which will describe the best ways to buy an inflation-adjusted immediate annuity and how to arrange for managed payouts.