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There are hundreds of resources to tell you how to save and
build for a comfortable retirement. Surprisingly, very few provide useful information
about how to manage your accumulated money once you reach retirement. Running out of money
in retirement is a serious concern you may have to deal with.
With advances in healthcare and better nutritional
education, life expectancies are getting longer. This may pose serious financial problems
to those who retire at 65 and live another 20 or 30 years. Our longer life expectancy is a
double-edged sword. "You may outlive your money," Chris Brown, a certified
financial planner and president of CommonWealth Advisory Group in Gaithersburg, Maryland,
warns.
What to do with your savings is something retirement plan
providers and human resources departments don't often discuss. When you reach the last day
of work it's … good luck, you're on your own.
Managing a several-hundred-thousand-dollar-plus nest egg
isn't a skill many of us acquire during our working life. Let's take a brief look at
different ways to turn a nest egg into an income stream that can last through your
retirement.
While we can offer some guidelines, you may want to consult
a professional financial planner to work out the best solution for you.
Golden Years and Financial Fears
Jerry Rozak, 60, is tired of the corporate world. "I
don't want the pressure or the hours of a corporate position. I want a life," he
said.
So, he and his wife, Nancy, are selling their Midwest house
and heading south. Even though he'll start drawing from his pension this year, Rozak
expects to work another seven years at a second, less-consuming career before completely
retiring.
One question on his mind is how to make his money, which
includes his pension, a $150,000 annuity and a $200,000 IRA, last throughout his
retirement. "I'm not sure when you can begin to withdraw or how to withdraw," he
said.
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"I'm not sure when you can begin
to withdraw or how to withdraw."
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| — Jerry Rozak,
60-year-old ready to retire at age 67. |
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Rozak's questions are the sorts of concerns that arise for
many seniors easing into retirement. After they figure out their retirement goals, and how
much it will cost to achieve them, the next question seniors have to consider is how
actively they want to manage their money.
Hands-off Money Management with Annuities
If you don't want to hassle with managing your finances in
retirement, and want the same amount every month for the rest of your life, an annuity
might be the best solution for you.
An annuity is an insurance product for which you pay a lump
sum of money. The insurance company's actuaries figure out an average life span for you
then come up with a fixed payment for the rest of your life. At the same time, you pay
fees that are generally higher than what you would pay for a mutual fund investment
outside an annuity.
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"An annuity assures that you will
never run out of money at life expectancy ... It's a contract between the insurance
company and the person. We will guarantee payment."
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| — Debbie Mazza,
manager, sales support with Allmerica Financial Corp. |
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Annuities are either fixed or variable. A fixed annuity
pays a fixed income stream for the life of the contract. One problem with this type of
annuity is the payment isn't adjusted upward to account for inflation.
"What I try to emphasize to clients is that the two
biggest risks they face are longevity and inflation risk," said certified financial
planner F. Dennis DeStefano, president of DeStefano Wealth Management in Hawaii.
"(People) don't take into account inflation" as they plan for retirement. The
cost of living for someone retiring at 60 will double by the time he or she reaches 78, he
says. You can offset rising prices by creating what is known in financial terms as a
hedge. A hedge is an investment whose only purpose is to offset some kind of risk, in this
case inflation. You don't use it to generate profits.
With a variable annuity, the payments may change according
to the relative success of the investments you choose. "What the variable portion
does is allow you to hedge inflation. It gives the potential for greater returns,"
said Debbie Mazza, manager, sales support with Allmerica Financial Corp.
Variable annuities can be structured so that you can have a
portion of fixed income and a portion of variable. Thus, you get the comfort of a fixed
payment boosted by the influence of the market.
The problem with any type of annuity is that when you die,
the insurance company keeps the remainder of your unpaid money. You may, however, be able
to extend benefits to your spouse by paying more up front or lowering the monthly payments
you receive.
Self-managed Options
Managing your retirement finances yourself requires more
effort on your part, but has the potential for greater reward. Say you roll your 401(k)
money into an IRA account at a big mutual fund house. You may be able to direct the fund
provider to send you periodic withdrawals. The advantage is that this has low or no cost,
you can keep up with inflation, and you can easily pass on the account balance to a spouse
or heir.
The disadvantage is that you need to research the funds
you're invested in on a regular basis, to find the best performers. You don't have the
guaranteed return you would have with a fixed annuity.
If you're a person with strong financial discipline, you
might want to manage the entire process yourself.
Chris Brown offers one suggestion. You can roll your 401(k)
money into a brokerage account and choose your own investments. You can run through the
numbers to calculate your life expectancy, monthly expenses, and expected rate of return,
and then come up with an amount to withdraw from the fund, say, on a monthly basis.
"That, in essence, is paying yourself an
annuity," he said.
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| Read More: |
Visit the IRS Web site and read publication
590 to get a full explanation of life expectancy rules and minimum-required distributions.
Click here
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One caveat: if you need more money than you have when you
begin your retirement, you may need to invest more aggressively.
Finally, you can set up an automatic distribution from the
brokerage firm to your checking account. And, you could even have your bills automatically
paid from the account.
The Mix and Match Approach
You should be aware that many financial planners have
strong opinions for or against annuities or self-managed approaches. The annuity means
fewer hassles, but at a higher cost, while self-managed programs require more work on your
part, but generally cost less.
Tom Schlossberg, president and CEO of Diversified
Investment Advisors, says a combination of these approaches may be the way to go for some
retirees. You may want a monthly, guaranteed annuity payment to salve the "I don't
want to run out of money" fears, and a self-managed portfolio, to help beat inflation
and give you more control.
Jerry Rozak plans to use a hybrid approach. When he finally
quits working at age 67, he plans to use his pension and Social Security to provide
regular monthly payments. At age 70, he plans to start taking payments from his annuity,
and his IRA money will be his inflation hedge. "My plan is to put it in the stock
market," he said.
Other Factors to Consider
As you plan your retirement, you should be aware that the
assumptions that may have driven your parents or grandparents are changing. When you
retire, you will likely live longer and at a more expensive level. Taking an active role
in managing your retirement money might be the only way to live comfortably in your golden
years.
How much do you need? Brown offers a good rule of thumb,
"for every $50,000 you want to pull out of your retirement account each year, you
need to have $1 million in assets."
The table below shows the probabilities of how long your
money will last, depending on your investment mix and your withdrawal rate. As you can
see, with a 3% withdrawal rate, your portfolio will last a long time. But, as you increase
your withdrawal-rate percentage, your portfolio longevity starts to decline.
If you manage your money in 401(k) and IRA plans, you
should be aware that the government requires what are called "required minimum
distributions." You must begin to take them after you reach 70ý, whether you need
the money or not. (A Roth IRA doesn't have any requirements for required minimum
distributions.) These distributions are calculated using IRS life expectancy tables that
are in Publication 590. You can extend
the required minimum distributions if you are married. Then you calculate the
distributions using your combined life expectancies.
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