You Choose to Outlive Your Retirement Income
A generation ago, it was easy. Case in point: My Dad spent 35 years working for Bethlehem Steel. He was a union man that knew his pension and retired health benefits were coming after he called it quits. On top of that, he would also file for social security to give him an added boost in retirement income. And that’s how it would be for the rest of his years.
Then that reality changed. For the most part, the private sector realized that pensions – and the actuaries that ran them – put a hurting on their bottom line. Workers would be OK because those 401(k) plans that Congress created finally started to really catch on in the 1990s. Thirteen or 14 years ago a 401(k) would burst off the charts with tech funds and when you wanted to play it safe a money market fund would give you 5%. This saving for retirement stuff wasn’t so hard. Can you say, “The good old days?’’
Let’s fast forward to 2012. We just saw the greatest economic downturn since the Great Depression four years ago. The ball game has changed. Gone are the days when retirement was just simple math. You knew exactly how much retirement income Social Security, savings and your pension would deliver. Then, you would cut back any unaffordable expenses when you hit 65.
With Social Security and Medicare’s future uncertain due to our budget crisis and a market that makes your employer benefit retirement plans remind you of a rollercoaster, the retirement planning process went from pretty simple to very complicated.
The current landscape has caused a great deal of pessimism concerning the retirement years. This new retirement reality is reflected in the fact that only 14% of Americans polled in the 2012 Retirement Confidence Survey conducted by the Employee Benefit Research Institute said they were “very confident they will have enough money to live comfortably in retirement.”
“Will I or we have enough money to maintain a comfortable lifestyle and make adjustments that may be necessary once I stop working?” This question is a burden weighing on the hearts of many. More than half of those surveyed said they had not even tried to calculate how much retirement income they will need.
Sit Down And Write Up A Plan
As you enter that stage where you’re really thinking about how to use retirement money for living expenses, you probably need to come up with a spending plan. Figure out the income you will have and what costs you will be paying out to help make your retirement income last over the long haul. This plan cannot be based on wishful thinking. Let’s be brutally honest. Let’s take into account the following:
- Future inflation
- Life expectancy
- Health care costs.
There is a risk these days of your nest egg running out while you are still alive and kicking. Technology and the knowledge of how to live better have us living longer. According to the Society of Actuaries, at age 65:
- The average life expectancy is 17 years for men and 20 years for women.
- Men have a 41% chance of living to age 85 and a 20% chance of living to age 90.
- Woman have a 53% chance of living to age 85 and a 32% chance of living to age 90.
- For married couples, there is a 72% chance that at least one of them will live to age 85 and a 45% chance that one will live to age 90.
To sum it up, this money better last cause chances are that you will.
You’ll Most Likely Have a Funding Gap
Given your investments, rates of return, life expectancy and amount of risk you’re taking in your 401(k) portfolio, how much money will you need? The run-of-the-mill retirement model will tell you to assume you’ll need to replace 80% of your pre-retirement income. For most people going through this process, many find that there is a gap between projected income and expenses during retirement.
Your plan’s possible “funding gap” will show that some changes in behavior may be necessary to meet objectives. This could be accomplished by increased contributions to retirement plans, a larger allocation to stocks or greater outside savings. It is essential that you determine how you will fill the gap through creating your retirement spending plan.
How to Attack the Gap
You need to determine a strategy for using all of your investment accounts and IRAs to bridge the gap. You might want to start by taking the following steps:
- Determine the current market value of all your investments and estimate expected rates of return. You need this information so you can see how to go about withdrawing money in your retirement to meet all your known expenses.
- Rather than drawing down with specific monthly dollar amounts, you may want to take out a periodic percentage of the sum. Using a percentage can be your best bet against outliving your retirement income.
- Take note: A method popularized by William P. Bergen, a certified financial planner practicing in California, uses an annual withdrawal rate from retirement assets of 4% plus annual increases of about 3% to compensate for inflation.
For the moment, all of this is preliminary planning because Social Security and Medicare are wild cards.
If your gap really scares you, you also can take these additional steps now:
- Tell your employer to raise your pretax contribution to your employer-sponsored retirement plan.
- If you are self-employed in any manner, you can set up your own small business plan such as Simple or SEP-IRAs or a Profit Sharing or Money Purchase Pension Plan.
- Also, contribute as much as you can to your traditional IRA and/or Roth IRA.
- Then there’s the obvious. Save more in your traditional accounts!
Allocate and Make Decisions
Allocate your retirement assets to accomplish the complementary strategies of asset preservation and growth. You’ve heard this from Investment U before. Because different asset classes are imperfectly correlated – some zig, while others zag – our approach allows you to boost returns while reducing your portfolio’s volatility. True Asset Allocation should be the foundation stone of your whole investment strategy. It’s critical to your long-term financial health.
To do this, you use a special asset allocation percentage among large and small stocks, foreign shares, real estate investment trusts (REITs), gold stocks and three different types of bonds (high grade corporates, junk bonds and inflation-adjusted treasuries). The actual percentages run as follows:
- 15% – US Large Caps,
- 15% – US Small Caps,
- 10% – European Stocks,
- 10% – Pacific Rim stocks,
- 10% – Emerging Market Stocks,
- 10% – High Grade Bonds,
- 10% – High Yield Bonds,
- 10% – TIPS,
- 5% – Gold mining stocks,
- 5% – REITS
Remember that just sticking your money in money market accounts and Treasuries doesn’t cut it anymore. According to the Society of Actuaries, from 1980 to 2007, annual inflation in the United States has averaged 3.5%, so keeping some of your money in equities is vital if you expect your retirement funds to last by keeping pace with inflation.
Finally, a good idea would be to keep your retirement funds in separate “buckets.”
- Money that you will need in the 12 months or less to meet monthly expenses in cash or cash equivalents.
- Money that you expect to need in 2-5 years in fixed investments, which entail less risk and are likely to preserve your retirement capital.
- Finally, keep any money that you don’t expect to need for five to 10 years in equity investments where you will get the growth needed to keep pace with inflation.
Choose the retirement assets that you will draw down first with consideration for tax advantages. Consider withdrawals from taxable accounts first and then tax-deferred accounts such as traditional IRAs, 401(k) plans, 457 plans and the like. Roth IRAs should be drawn down last to allow the tax-free earnings to continue growing as long as possible.
I hope this is a start and gets rid of some of that pessimism.