Portions of this article appeared in an article on Forbes.com and Yahoo Finance Monday, November 1, 2010. We have also added our insight and information. We hope you receive benefit from this article and encourage you to contact us if we can help answer any questions. Enjoy!
How To Make Your Money Last in Retirement
People are living longer and saving less. But there are ways to stretch out your dollars.
If you're like many people, you've put considerable time and effort into socking away money for retirement. But you've probably put less thought into how slowly you'll spend the money and in a way that will make it last--a potential disaster.
A perfect storm has foisted this challenge upon individuals. People are living longer. Fewer have pensions. Instead they have 401(k) plans that may have been decimated. Assets in savings accounts may actually be losing value thanks to short-term interest rates that are actually lower than the inflation rate. And Social Security seems iffy for younger workers.
There are steps you can take to make your money last. Spend less and work longer, of course. But even then you can't know how long you're going to live. All you have are the odds: for a married couple at age 65, there's a 58% chance one person will live to 90; a 50% chance one will live to 92; and a 25% chance one will live to 97.
Many clients plan for a retirement of 30 to 35 years. How can they make their money last that long, or longer? Let's say you're 65 years old, want to retire now, and expect to need $100,000 annual income in retirement. You'll need to adjust that $100,000 to rise with inflation. Here are some options for you, with pros and cons.
If you have a Depression-era mentality, put your nest egg in savings accounts and certificates of deposit with no more than the FDIC-insured limit of $250,000 in any one bank. It's safe and will be there for you no matter how the markets do.
Unfortunately such low-risk investments may lose value over time after inflation and are unlikely to generate much income. If you have a pot of money to get you through your golden years, the most that can be withdrawn over a 30-year period is 5% (some people say 4%) per year, adjusted for inflation. At current interest rates of 2% or so, you'll need to start with $5 million to generate $100,000 a year in income. But that doesn't allow for $100,000 to grow with inflation, so plan to draw down that $5 million over time.
A Balanced Portfolio
If you don't just happen to have $5 million lying around, you'll need to take some more risk to have any chance of generating that $100,000 a year you desire. One alternative is to put money in a diversified portfolio of stocks, bonds and real estate that pays dividends. If you start with $3 million and the market performs as it has over the past 70 years, you should be in good shape. But if the market lags or companies cut their dividends, your money might not last.
Of course the downside of this option is that your money is 100% at risk. Many of our clients are not interested in seeing their retirement funds take another 20-40% hit as many have in the past 5 years. Many people are just now getting back to the levels they were 10 years ago.
With a deferred annuity, you pay now and accumulate assets through either a variable product that invests in equity mutual funds or a fixed product that offers bond-like returns. How much you'll receive each month when you start to draw down your annuity will then depend on how your variable or fixed investments do over time. Also, most deferred annuity products start you off with a 10% bonus of your funds. Try asking your stock broker for a 10% bonus to start your account!
Putting aside money this way encourages you to save for retirement. However, it also allows you to have access to your funds, normally up to 10% per year, without incurring any fees or surrender charges.
Another reason to consider deferred annuities is that they enable you to continue saving tax-deferred after you've maxed out your 401(k) and your IRA. You will still have to pay taxes as you withdraw the money. Just like with an immediate annuity, if there's a balance when you die, it goes to your heirs.
Many people are afraid of deferred annuities because they have heard there are large surrender charges that “lock up” your money without access. This could not be further from truth. Most deferred annuities allow an annual withdrawl of 10% of the value without any penalties or fees as well as other 100% liquidation options based on health issues. These products do not fit all situations, but if you have the ability to let your money sit and grow for 3-5+ years before you need access to it, but without the risk of the stock market, deferred annuities are a great option for your retirement funds.
Guaranteed Lifetime Withdrawal Benefits (GLWBs)/ Income Ryders
Many deferred variable annuities buyers avoid the risk of out-living their savings by paying for guarantees that payments will last until they die. That's one way to guarantee your $100,000 annually lifetime income will continue.
Although $100,000 will not buy in 20 years what it does today, attaching an Income Ryder to your deferred annuity will insure that you will never out live your retirement funds. Many annuity companies now offer an increasing payment option that adds a 3% cost of living amount to your income stream. The down side of this is that you start with a lower amount of income but over time, the income grows at a 3% pace to keep up with inflation. Given enough years (approximately 7) you will be making more income than if you would have chosen the flat amount.
With an immediate annuity, you put money in an insurance contract that usually pays a fixed rate of return (much like a certificate of deposit) and start receiving payments immediately. How much income your lump sum will generate depends on how much you invest, your gender and age at the time you buy the annuity, as well as the prevailing interest rate environment.
It pays to comparison-shop for immediate annuities. Also consider tailoring the annuity, for example, by arranging for payments to continue until both spouses pass away.
One downside is that an immediate annuity ties up your money, so you won't have access to it in an emergency. It also locks into the prevailing low-interest-rate environment. You can get around this by buying annuities in chunks over several years. To lock in real, after-inflation income, opt for an inflation-adjustment rider, but understand that it will cut into how much you'll receive each month. This product is normally recommended for those that need the money now and can’t wait a few years to allow their assets to grow.