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In 1994, financial planner William P. Bengen analyzed different withdrawal rates and asset allocations to determine the optimum rate which could be sustained over a 30 year retirement period beginning every year from 1926. Using a portfolio split evenly between stocks and bonds, he determined that an initial withdrawal of 4% adjusted annually for inflation could allow the retiree to continue withdrawals for up to 30 years without exhausting his funds. In the years since Mr. Bengen published his results, the 4% rule has become the generally accepted "rule of thumb" for retirement planning.

The 4% rule has been analyzed, modeled, modified, praised and debunked. It's been modeled with various asset allocations and today we can find results that show recommended initial withdrawals rates ranging from 1.7% to 7.5%. But the basic and generally accepted model is that you can begin with a first year withdrawal of 4% and increase the withdrawal amount annually by 3% to account for inflation. Financial planners will happily "plug your numbers" into their simulation software and tell you that you have a 93% chance of not outliving your money. Is that good news? I guess it is, unless you fall into the 7% chasm.

Make no mistake; retirement planning has many more moving parts than the 4% rule. Perhaps you are fortunate to qualify for a company pension. Most of us can expect to collect a modest stipend from Social Security. In the context of this article, I'm not going to try to address the full spectrum of retirement planning. But most of us also have some combination of taxable savings and tax deferred savings: 401k and/or IRA's. For these accounts we will have to figure out how to turn them into an income stream in order to purchase food and clothing and maybe an occasional vacation or golf outing. This is where the 4% rule comes into play.

Let's turn from the generally accepted rule of thumb to a look at the practical implementation. For simplicity, we'll assume that you have a $1 million account from which you want to extract an income stream. The 4% rule tells us that your first year withdrawal is $40,000. In order to insulate yourself from the ups and downs of the financial markets, you're supposed to set aside enough money in your account to cover 5 years' worth of withdrawals. This will serve to keep you from the situation in which you have to liquidate assets at a time when prices are at their lows. Presumably you will accumulate this near term reserve gradually in the years leading up to the point when you want to begin withdrawals. This reserve should be kept liquid and safe, perhaps a 5 year CD ladder. In our example, you would need to set aside $200,000 for this purpose. Going forward, each year you would add another year's income to this reserve. So you are gradually liquidating your investment account. In effect, you are being asked to construct your own income annuity. This can be very tricky and the price for not getting right could be quite high.

My preference is to look at this from a different perspective. I retired near the end of 2010. In the time leading up to that point, I began to construct a retirement budget in order to arrive at an income number I would need. So rather than focus on attaining the magic number (total retirement assets) this allowed me to plan for a particular income that I would need in order to stop working. Here I did not use the "income rule of thumb", ie. plan for 80% of your pre-retirement income. I would suggest that you start with a blank page and construct a bottom up budget. Once I arrived at a workable spending budget, my objective was to extract the income needed to support that spending from my taxable account.

A little more background is in order. When I retired, I was much too young to qualify for Social Security and even too young to allow penalty-free distributions from my IRA, which is a traditional IRA. Therefore, all of my income must come from the investments in my taxable account. Further, I wanted all of the income as dividends and other distributions from these investments, not requiring liquidation or other sales of assets. This is what I'm calling my "0% withdrawal plan." Why 0%, you ask? Because all of the assets will remain invested. Only the income derived from them will be used. As these investments pay dividends, the available cash is swept into a checking account for spending. To the extent that these dividend paying stocks periodically bump their payouts, then my spending can keep pace with inflation providing a theoretically perpetual income generating machine.

Now let's look at specifics. Below is a listing of the assets I currently hold in this taxable account. Disclaimer: The specific stocks listed in the table below are in no way to be viewed as recommendations for your account. I am not suggesting that this portfolio is appropriate for anyone else. These are merely the choices I have made. You may view this portfolio as very poor from an asset allocation perspective; however, I also have an IRA which has different assets that provide balance for this portfolio.

% of port

Yield

MO

ALTRIA GROUP INC

4.57%

5.71%

ATAX

AMER 1ST TX EX INVTRS LP

2.29%

9.71%

NLY

ANNALY CAPITAL MGMT REIT

2.87%

13.79%

BWP

BOARDWALK PIPELINE PTNRS

4.19%

7.67%

CTL

CENTURYLINK INC

6.48%

7.64%

EXC

EXELON CORPORATION

4.61%

5.34%

JPM+C

JP MORGAN CHASE 6.70% Pref

3.77%

6.45%

MWE

MARKWEST ENERGY PTNR LP

4.57%

5.15%

MCD

MC DONALDS CORP

15.35%

2.50%

NRP

NATURAL RESOURCE PTNR LP

3.93%

7.83%

OKS

ONEOK PARTNERS LP

8.49%

4.37%

PM

PHILIP MORRIS INTL INC

4.94%

4.13%

PGN

PROGRESS ENERGY INC

5.67%

4.57%

SDT

SANDRIDGE MISSISSIPPIAN

3.76%

10.08%

SDRL

SEADRILL LTD F

5.18%

8.52%

TOT

TOTAL S A ADR F1 ADR REP 1 ORD

5.27%

5.72%

CH

ABERDEEN CHILE FD INC

2.91%

12.34%

GGN

GAMCO GLOBAL GLD NATURALRES&INCOME

2.24%

10.86%

PFF

ISHARES S&P U S PFD

4.45%

6.99%

JNK

SPDR BARCLAYS HIGH YIELD

3.03%

7.73%

GM

GENL MOTORS ACC 7.25%

1.44%

7.25%

100.00%

6.37%

As you can see, the blended current yield is 6.37%, however, my yield on cost is 8.42%. The difference is primarily due to the McDonald's holding which I've had for over 8 years. During our first year of retirement (2011) we came in slightly under budget for our spending and slightly over budget on our income, due to dividend increases during the year and some unexpected distributions.

My objective here is to show a real-world working example of an alternative to the 4% withdrawal rate retirement income plan. This concept can be applied to any retirement savings to generate an income stream. You will need to incorporate selections which have a history of increasing their distributions so that your spending can keep pace with inflation. You can find many articles within Seeking Alpha that address that particular topic.

Source: Zero Percent Withdrawal Retirement Plan