How long might you live in retirement? Think carefully. Your answer could influence whether you have enough money for a comfortable retirement or just scrape by.
According to pension mortality tables, at least one member of a 65-year-old couple has a 72% chance of living to age 85 and a 45% chance of living to age 90.1 This suggests that many of us will need to plan carefully to ensure that we don't outlast our assets.
Live Long and Prosper
The first step in tackling longevity risk is to figure out how much you can realistically afford to withdraw each year from your personal savings and investments. You can tap the expertise of a qualified financial professional to assist you with this task. Or, you can use an online calculator to help you estimate how long your money might last.
One strategy is to withdraw a conservative 4% to 5% of your principal each year. However, your annual withdrawal amount will depend on a number of factors, including the overall amount of your retirement pot, your estimated length of retirement, annual market conditions and inflation rate, and your financial goals. For example, do you wish to spend down all of your assets or pass along part of your wealth to family or a charity?
Protecting Your Retirement Paycheck
No matter what your goals, there are ways to potentially make the most out of your nest egg. The remainder of this article examines how a strategy might play out with assets held in taxable accounts.
First, you'll likely need ready access to a cash reserve to help pay for daily expenditures. A common rule of thumb is to keep at least 12 months of living expenses in an interest-bearing savings account, though your needs may vary.
Then, consider refilling your cash reserve bucket on an annual basis by selectively liquidating different longer-term investments, timing gains and losses to offset one another whenever possible.
Developing a Diverse Income Strategy
Responding to the current interest rate environment is one way to potentially squeeze more income from your savings and stretch out the money you've accumulated for retirement. For example, if rates are trending upward, you might consider keeping more money in short-term certificates of deposit (CDs).2 The opposite strategy may be employed when rates appear to be declining.
Most retirees need their investments to generate income. Bonds may help fill this need. "Laddering" of bonds can potentially create a steady income stream while helping reduce long-term interest exposure (see illustration).
Building a Bond Ladder
Laddering bonds is a popular strategy used by income investors. This strategy involves buying an assortment of bonds of different maturities and staggering the maturities over time. In the above example, an investor initially buys bonds with maturities of one, two, and three years. As each bond matures, it is reinvested in another three-year bond to retain the staggered bond ladder. Total yield (income) is potentially higher than if continually reinvested in one-year maturities. Risk is also potentially reduced due to investing in a mix of maturity rates.
A common way to help temper investment risk is to spread it out by diversifying among different types of securities. A retiree seeking income can use the same strategy by adding dividend-paying equities to his or her portfolio. But be aware that diversification does not ensure a profit or protect against losses in a declining market.
These stocks potentially offer the opportunity for supplemental income by paying part of their earnings to shareholders on a regular basis. Another potential attraction? Qualified stock dividends are currently taxed at a maximum rate of 20%, rather than ordinary federal income tax rates, which currently run as high as 39.6%. Also, keep in mind that investing in an equity-income mutual fund, which generally holds many dividend-paying stocks, may help reduce risk compared with investing in a handful of individual stocks.
Adding Annuities to the Mix
One way to potentially provide regular income and address longevity risk is to purchase an immediate annuity. In exchange for giving an insurer a specific amount of money, you're guaranteed income for either a specific period of time, or life. Keep in mind, however, that guarantees are backed by the claims-paying ability of the issuing company.
One tactic might be to figure out your annual expenses and determine how much income you'll receive from Social Security and pensions (if any). Then, consider purchasing an annuity that will make up any shortfall. This potentially allows you to cover your regular expenses. Then, you can put your other investments to work pursuing growth.
There are many types of annuities, so speak with a financial professional to carefully weigh your options, and be sure to examine fees and other charges before buying.3
Accounting for Growth
Finally, be cautious about being overly conservative with your investments. Many people may live 30 or more years in retirement. Therefore, your portfolio may need a boost of stocks to outpace inflation over the years.
These are just a few ideas for developing an adequate income plan during retirement. Consider sitting down with a qualified financial professional to discuss these and other strategies that might be appropriate for your situation.
1Source: Society of Actuaries, Risky Business: Living Longer Without Income for Life (2013).
2Certificates of deposit (CDs) are FDIC insured and offer a fixed rate of return if held to maturity.
3An annuity is a long-term tax-deferred investment vehicle designed for retirement purposes and may contain both an investment and an insurance component. Guarantees are based on the claims-paying of the issuer and do not apply to a variable annuity's separate account or its underlying investments. Withdrawals from annuities prior to age 59½ are subject to a 10% additional tax. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Issuing companies may also charge surrender charges for some early withdrawals. Neither fixed nor variable annuities are insured by the FDIC, and they are not deposits of -- or endorsed or guaranteed by -- any bank. Investing in variable annuities involves risk, including loss of principal.
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