Turn your portfolio into an income stream with these withdrawal strategies. By Kathryn A. Walson, Staff Writer June 25, 2008 EDITOR'S NOTE: This article was originally published in the April 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.For your working life, you've religiously socked away money. Perhaps your portfolio is filled with stocks, bonds, mutual funds and commodities. But retirement presents a unique challenge: How do you turn this assortment of assets into a regular paycheck? RELATED LINKS Try Our NEW Retirement Savings Calculator Six Simple Ways to Retire Rich Turn Savings Into Retirement Income Creating cash flow from a portfolio is a daunting task. How do you know when to sell a particular stock? How can you raise cash while reducing the tax bite? "Largely, I don't think people are prepared," says Mark Johannessen, president of the Financial Planning Association and a certified financial planner with Harris SBSB, in McLean, Va. "There are too many options in front of them." Because of the complexity, consider working with a financial adviser, ideally starting five years before retirement. The first step is to figure out how much income you'll need each year. You can predict certain fixed costs, such as housing, taxes and insurance. As for discretionary spending, perhaps you'd like to travel and buy a new car every five years. Creating a budget helps people focus on priorities. "It forces them to make some decisions," says Tim Decker, president of ISI Financial Group, in Lancaster, Pa. Advertisement Then you'll need to see if your investments can generate enough income to meet your goals. Determine the total worth of your portfolio, including expected dividends and interest. You'll also need to look at how your asset mix can generate income. Let's say you have a $1 million portfolio, with 60% in stocks, 35% in bonds and 5% in cash, and you need to have $60,000 in income. Perhaps you can get the first $20,000 from Social Security, a pension and income from a part-time job. You'll have to draw the rest from the portfolio. The rule of thumb is that retirees should withdraw no more than 4% of the value of their portfolio the first year. If your $350,000 bond portfolio provides interest income of 5% a year, that's $17,500 toward your goal, notes Penny Marlin, a certified financial planner with Marlin Financial, in Delray Beach, Fla. If half of your stock portfolio is in equities with dividends yielding an average of 3.5%, that would raise another $10,500. The remaining $12,000 you need could come from cash or selling securities. You'll need to tweak the calculations at the start of each year. Even in the best of times, stick to a fixed payout, plus a flexible additional amount. Some years your portfolio won't generate the returns you need. "You'll be able to ride those times out, as long as the fixed amount is low enough," says Decker. Advertisement Strategies for Creating a Retirement Paycheck Several years before retiring, set up a cash reserve made up of money-market funds, certificates of deposit and short-term bonds. "You want to start accumulating cash before you retire, so you know it's there when you need it," says Barry Taylor, a certified financial planner with Bingham, Osborn & Scarborough, in San Francisco. Many financial planners suggest setting aside several years' worth of estimated expenditures into the reserve. This reserve enables a new retiree to avoid selling stocks during a market downturn. Once you retire, use your checking account for short-term spending needs. Replicate your paycheck by setting up a direct deposit from your cash reserve into the checking account. "Some people like to know on the first of each month they're going to get a check for $3,500," says Tom Geraghty, a certified financial planner with Stonegate Wealth Management, in Fair Lawn, N.J. Advertisement Try not to tap principal in the early years of retirement. One way to generate income without tapping principal is to shift more of the stock portfolio into dividend payers. "Dividend-paying stocks allow retirees to take income no matter whether stocks go up or down," says William Jordan, president of the Sentinel Group, in Laguna Hills, Cal. If your mutual funds pay dividends on a quarterly basis, take the cash for your reserve fund rather than reinvesting. Angie Rust, 67, who lives in Orange, Cal., retired last June from her job as a manager with an engineering firm. With Jordan's help, she set up a withdrawal strategy that will enable her to take a cruise every other year. She's leaving for Australia and New Zealand soon. She has a cash reserve, and while Jordan says that most retirees want monthly income, Rust is opting for a quarterly paycheck. "I'm used to managing my own money," she says. Rust receives about $24,000 in Social Security annually. She'll draw income from annuities, a bond fund and a limited partnership. If that's not enough, she'll take dividends and sell appreciated stocks. Another useful tool to generate regular income is a bond ladder. Instead of investing all your fixed-income assets in a single bond, you divide the investment into "rungs" that mature perhaps every year. When a rung matures, you reinvest the proceeds in new bonds. By staggering maturity dates, you avoid getting locked into a single rate. Someone with $400,000 in bonds could generate $16,000 a year assuming an average rate of 4%. Advertisement However, be cautious about buying bonds in this low-yield market. For now, you probably want to stick to short-term maturities. When rates rise, you can lock into longer maturities. If dividends and interest are not enough, you can raise cash by selling securities when you rebalance your portfolio. If a portfolio that's designed to be split 60% stocks and 40% bonds becomes stock-heavy at 70%, you should sell stocks to get back on track and ship the profits to the cash reserve. Generally look at your best-performing investments as a source to raise cash. "If I'm rebalancing throughout the year, I'm going to sell high," says Geraghty. Your withdrawal strategy should also be attuned to minimizing the tax bite. In most cases, pull assets from taxable accounts first while holding off on withdrawing from a traditional IRA until you're required to take distributions at age 70 1/2. "Everything that is taken out of a retirement account is taxed at an ordinary income-tax rate," Marlin says. Capital gains in a taxable account are taxed up to 15%. You can also generate income while harvesting tax losses, Jordan says. Say you have a stock that has risen in value and another that has declined. You can sell some of each and offset the capital gain on the highflier with losses on the stumbler. 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