Instead of drastically cutting back expenses, retirees can salvage their retirement by working part time and annuitizing a portion of their portfolio, says an article in the January 2009 issue of the Journal of Financial Planning, published monthly by the Financial Planning Association.

In an earlier published paper (September 2008), Gordon B. Pye, Ph.D., a financial consultant and planner in New York City, explored the problem of people reaching retirement but finding that withdrawing only what is typically considered a "safe," sustainable amount—4 percent of the initial portfolio value adjusted annually for inflation—will leave them well short of their living expenses. The typical advice is for retirees to slash living expenses. But Pye found that by using a "retrenchment rule" retirees could postpone a painful reduction and withdraw a significantly higher percentage of the account's value, at least during the early years. The retrenchment is deferred to a time when future events indicate how much retrenchment is really necessary. For example, if the retiree's portfolio performs above expectations and the retiree's life is short, he or she may not need to make painful standard-of-living reductions later in retirement.

Nevertheless, the strategy still runs an uncomfortable risk of having to take very low withdrawals later in retirement (though generally no lower than if the retiree had cut back early in retirement). So what can retirees do to reduce that risk of severe retrenchment? Part time work and portfolio annuitization can be the answer, says Pye.

Building on the example he used in his earlier article of a 65-year-old woman facing retrenchment, Pye looks first at two part-time work scenarios: earning $12,000 in inflation-adjusted dollars for five years, and earning $24,000 for 10 years. With minimal part-time earnings, her chances of having to slash her portfolio withdrawals to 3 percent by age 85 are reduced from 24 percent to 18 percent, and her chances of keeping withdrawals above 7 percent increase from 18 percent 27 percent. Maximum part-time earnings would give her a 50/50 chance of sustaining her initial standard of living over all of retirement.

Pye then examines the benefits of combining part-time earnings with annuitizing a portion of a retiree's portfolio. For example, if the woman makes minimal part-time earnings but annuitizes 50 percent of her portfolio, she dramatically reduces her chances of having to severely slash her retirement withdrawals later in retirement. At the same time, however, because annuitization reduces the opportunity for earning higher-than-average returns, she reduces her chances of keeping her withdrawals above 7 percent. She'll likely have to reduce her standard of living later in life, but probably not drastically.

Moreover, Pye finds that with maximum part-time earnings and 50 percent annuitization, the retiree not only nearly eliminates the risk of low withdrawals, she maintains her chances of keeping her withdrawals above the desired 7 percent rate.

Pye also studied the impact of investing in fixed-income issues instead of annuities. While the strategy worked for younger retirees, it failed for older retirees.