Tips on Shifting to Retirement Spending Mode

Uneasy about the future, many new or prospective retirees figure it's time to purge their portfolio of risk (translation: growth stocks) and shift the money into conservative, income-producing investments such as bonds, dividend-paying stocks, and bank certificates of deposit.

But such a seemingly sensible course of action is reckless in today's world. The concept of an income-only portfolio that earlier generations might have sailed by on is no longer viable. That is, unless you are one of a small cadre of well-heeled retirees with assets substantial enough to produce hefty cash flow.

Managing your retirement portfolio requires a new financial mind-set but not a whole new investing strategy. "It is more a behavioral shift than a financial one," says Tom Orecchio, a financial planner at Greenbaum & Orecchio in Old Tappan, N.J. For people who have spent 30 years steadily hoarding savings, the idea of spending that retirement cache on daily living while also trying to make it last for the rest of their days can be hard to grasp.

"What's our new plan?" clients on the cusp of retirement anxiously ask. Orecchio gently explains that there is a plan, and nothing is going to change radically overnight, or even in the near future. Simply put, the client's portfolio will slowly shift away from stocks into more conservative allocations as the years tick by.

The bottom line is that if, like many people, you are facing two or three decades of retirement living, even modest inflation will surely chew away at your portfolio's purchasing power. And unplanned expenses will crop up. It could be out-of-pocket nursing home care for a parent with dementia, soaring unreimbursed medical bills of your own, or even spur-of-the-moment fun, like a sailing trip with your sister in the British Virgin Islands. For financial fitness in retirement, you'll need long-term growth for years to come from your existing stock holdings.

So, plan to sit tight. There are, however, other transitions you can make to ease your way into a comfortable retirement. Here are five moves to consider as you prepare to shift from saving and building up to spending and drawing down.

1. Set aside cash: If you're nearing retirement, set aside cash in accounts such as money market mutual funds, short-term bond funds, or certificates of deposit, says Christine Fahlund, a senior financial planner at T. Rowe Price Group. Ideally, you should sock away enough to cover expenses for about three to six months so you're not forced to sell stock or bond holdings in a down market. As contrarian as it may sound, you might even consider starting a "phased-in" retirement by diverting money from funding a 401(k) plan in your last year of working, she advises.

Next, look for holes in your overall finances and plug cracks with your cash reserves. For example, use the cash to pay down debts with variable interest rates that are about to rise. Review your insurance needs. Securing a long-term-care policy while you are still in good health and premiums are low is worth considering. You might ensure a lifetime stream of income by converting part of your nest egg to an annuity.

2. Get organized: Take stock of your retirement assets. Your money is strewn in different accounts, including tax-deferred savings (such as IRAs, 401(k) plans, annuities, and Social Security) and taxable investment accounts (such as CDs, short-term bonds, and other securities). Perhaps you have a Roth IRA in your mix.

Quite possibly, you own several IRAs, in addition to 401(k) and 403(b) funds, from multiple employers both past and present. Roll all of them into an existing IRA, or open a new one if you don't have one already, suggests Fahlund. This eases bookkeeping when age 70½ rolls around and, by law, you must draw down some of the money from these tax-protected accounts. Plus, an IRA will generally have a greater choice of investments than your 401(k) offers.

3. Set a withdrawal strategy: Overzealous spending early in retirement trips a lot of people up. It's the most common cause of running out of money, Fahlund says.

As a general rule, if retirees limit their initial withdrawal to 4 percent of their investment portfolios—and then increase that dollar amount by 3 percent a year for inflation—they should stand a 9-in-10 chance of being able to sustain that income stream over 30 years, according to Fahlund. Individual situations vary, of course; you may want to consult your financial adviser.