It may not seem like the most important subject, but there are in fact few financial matters more critical than your retirement accounts and the rate at which you draw down money from them after you stop working. Actually, it's an issue that can directly bear on the quality of your life in those years.

If you withdraw too much too fast, you run the risk of outliving your nest egg and might later on have to consider options such as taking out reverse mortgages or going into debt to meet expenses. Withdraw too little and you might have to skimp and unnecessarily compromise your lifestyle during the more active early years of your retirement.

It's a balancing act that most people perform without the safety net of a salary. Meanwhile, they worry they'll be shortchanged by Social Security at the same time their employee retirement plans are shifting from precise defined benefits to inadequate defined contributions. A volatile stock market and very low bond yields don't help matters.

Certainly for those who were thrown out of work and forced into early retirement, this could be a particularly brutal time. But on the other hand, should investors constantly be expecting the worst? Should they really be bracing themselves for another crisis like the one we just experienced when they determine their future withdrawal rates? It was a perfect storm, but such storms are rare.

Challenging Convention
The average advisor would suggest a static retirement portfolio withdrawal rate of about 4.5%-based on the investor's assets, growth, annual expenses and longevity. This figure would then adjust annually for inflation. But Jonathan Guyton, a principal at Minneapolis-based Cornerstone Wealth Advisors, says that's rather arbitrary.

According to his own research-based on a portfolio of 65% stocks, 30% bonds and 5% cash-Guyton thinks retirees can enjoy a higher withdrawal rate with a very high degree of certainty that they won't run out of money as long as they properly monitor the assets and annually rebalance, an idea laid out in the article he co-authored with William Klinger, "Decision Rules and Maximum Initial Withdrawal Rates," which appeared in the Journal of Financial Planning in March 2006. Here's how his approach works:

Let's start off at the beginning of 2008 with a $1 million retirement portfolio. Guyton's client is withdrawing at an annual rate of 5%. At first, that amounts to $50,000. But by the end of December of 2008, that portfolio would have fallen to $700,000. A $50,000 withdrawal suddenly amounted to a rate of 7.1%.

"In this scenario," says Guyton, "I would've suggested the retiree reduce his or her effective withdrawal by 10% to $45,000. And for any year that experiences a loss, I would not make an inflation adjustment for the following year." This approach lowers the withdrawal rate to 6.4%.

By the end of December 2009, the portfolio had rebounded to $820,000. Guyton re-evaluated and increased the withdrawal by 2.8% for inflation. This pushed the actual withdrawal amount to $46,260, a rate of 5.6%.

"Folks are prone to making the worst decisions during times of extreme volatility and stress," he observes. "If one doesn't panic and subscribe to a doomsday scenario, then one is likely to see the market stabilize and start moving back up."

Seeing what has since happened to the markets and the economy, Guyton believes this present amount of withdrawal is manageable. And if the rally continues and the withdrawal rate falls to below 4.5%, he would then consider increasing distributions to keep pace with portfolio appreciation.

Unless the bear market continues for the next ten years and inflation soars, Guyton believes advisors should not tell retirees to reduce their withdrawals in the middle of a substantial sell-off. "It may feel like the right thing to do, but it isn't," concludes Guyton.

The only limitation with this thinking: One doesn't know when floods will hit that 100-year high-water mark until the rivers have already crested.

One strategy investors might use to deal with this problem is to leave untouched pretax retirement accounts for as long as possible-for non-Roth accounts, that's until the age of 70 and a half-and instead draw down from personal accounts.

According to Ron Weiner, the head of Connecticut-based RDM Financial Group, "There may be a natural inclination to start accessing money that has been untouchable for a long time. But if you can afford to live off your taxable savings and investments for a while without sacrificing necessary liquidity, it makes all the sense in the world to keep tax-free accounts working for as long as possible." Roth accounts, since their withdrawals are not taxed, should be the last touched.

Cash Crunch
However, not everyone will remain gainfully employed until retirement or have accounts sufficient to live off of when they stop drawing a paycheck. "There are investors that need to tap into their retirement accounts before they reach 59 and a half, the age in which they can start withdrawing from such accounts without restriction," explains J. Graydon Coghlan, who has been running his own shop, Coghlan Financial Group Inc., in San Diego since 2002.

"As a result of massive layoffs, the market collapse and cash accounts that generate very little income," says Coghlan, "we are seeing about twice the number of individuals looking into penalty-free early withdrawals than we saw just five years ago."

Such withdrawals can be done via IRS rule 72(t), which allows early fixed withdrawals from retirement accounts without penalty for five years from the first date of distribution or until the age of 59 and a half, whichever is longer.

It sounds like a promising way for workers who need additional cash to get by. But there are three catches. One is that draining retirement accounts early may be setting up retirees for financial problems later on. Two, investors who begin paying taxes on monies withdrawn from all non-Roth retirement accounts deprive themselves of capital that could be growing tax free. And three, the withdrawal is fixed to the federal mid-term rate, which is currently low and so it limits the amounts an investor can annually withdraw.

But despite the tremendous advantage in keeping tax-free retirements funded and functioning, investors might still consider withdrawing more now because taxes will be higher next year. Leo Marzen, a partner at New York-based Bridgewater Advisors, says, "Advisors may suggest clients [take] out up to two years' amount of withdrawals before the end of this year to avoid getting clipped by substantially higher taxes." If this is done after an investor stops drawing a paycheck, a larger-than-normal withdrawal might not necessarily push an investor into a higher tax bracket.

The unused portions of these funds could then be invested in either tax-efficient securities or Roth IRAs, where they will be exempt from future taxes. It may in fact make financial sense for clients with long life expectancies to consider taking a substantial chunk out of their traditional IRAs and converting them into Roths, especially if one expects marginal tax rates to continue rising.

Portfolio Management
Ron Weiner explains that it requires as much talent to efficiently withdraw money from accounts as it does to maintain them. The impact of market downturns are exaggerated when investors remove money. And because the interest, income and capital gains generated aren't usually enough to cover annual withdrawals, managers need to tap into capital. That means selling securities. The current market offers a good example of the challenges in balancing a portfolio during withdrawals.

Many financial planners, including Michael Kitces, director of research at Columbia, Md.-based Pinnacle Advisory, recommends 60% equity exposure and 40% bond exposure. The equity part of an investor's allocation has likely expanded over the past year as stocks have soared and long bond prices soured. Maintaining the balance might mean that withdrawals should be funded initially from the sale of stocks. Yet the near-term growth prospects of stocks are positive as corporate earnings recover, and meanwhile bonds are likely to fall in value as interest rates increase. So it might be, instead, that investors want to raise cash from the sale of bonds rather than stocks.

Another problem is market volatility, which can play havoc with the accounts investors are trying to draw from. In a study that tracked performance of the S&P 500 over a 40-year period between 1966 and 2005 and then recalculated as if the years were sequentially reversed, the American Funds Company found that annualized returns and volatility were exactly the same. However, a person withdrawing 5% starting in 1966 would have run out of money by 2002. When you work backwards and start in 2005, on the other hand, such a withdrawal rate would have left plenty in the portfolio after the 40th year.

The study suggests that advisors must be collectively mindful of how portfolio management, performance and withdrawals interrelate.

A lesson in effective retirement account management comes from Wisconsin-based Appleton Group Wealth Management. With $144 million in assets under management, the firm has done a decent job sustaining growth and limiting risk when markets turn treacherous. According to senior portfolio manager Mark Scheffler, "We target annualized gains of 7% to 9%, which doesn't require us to make high-stakes bets." As a result, when most accounts were getting slammed in 2008, Appleton's account losses were only between 5.1% and 8.7%.

Active management has much to do with this performance. "While we were 89% long equities at the beginning of 2007," recalls Scheffler, "by July we had ratcheted back our net long exposure to just 18%. And by the beginning of 2008, we were 5% net short."

By the middle of 2009, the firm had shifted back to a substantial net long position. As of April 2010, the firm was 93% long equities. While that sounds high for a retirement account, Scheffler explains that in today's environment, to realize even modest growth requires more than what bonds can generate, and the firm is quick to alter its risk profile to meet changing markets.

While Ron Weiner's retirement portfolios are not as heavily equity-weighted, he agrees it makes sense to occasionally look outside traditional boundaries when opportunities present themselves. While many retirement advisors may have avoided investment-grade corporate bonds and preferred stocks when the market bottomed last year, recalls Weiner, these prices presented a unique buying opportunity.

"If one had faith and saw that panic, not fundamentals, were driving securities into the basement," says Weiner, "then those who kept their heads and bought when it was darkest locked into rare yields that will serve retirement needs well."