What you need to know about… Retirement Planning
Author: Lew Wessel | Photographer: photography by anne
Retirement planning, financially-speaking, is a lifetime process. You need to start your plan during your first working years, tweak it constantly along the way and begin to finalize it perhaps a decade before you cash your last paycheck. Following are some pointers to help you along the way.
Times have changed. As the saying goes, this isn’t your father’s (or mother’s) retirement. First of all, most of our grandparents didn’t retire at all. In 1900, male life expectancy was 46 years and a female’s was 49. Until 1950, the average male worked past 70 and retirement averaged less than five years.
In addition, what minimal retirement income was needed back then was usually taken care of through a combination of Social Security and the pension plan from the company you worked for all your life.
Fast forward to today. Only around 15 percent of us are covered by a pension (or “defined-benefit”) plan. The rest of us have to provide our own retirement income, or “personal pension” with whatever resources we’ve managed to accumulate during our working years. In addition, we now live forever… well, a long time anyway. A 65-year-old has a 33 percent chance of living to age 90, and the odds are better than 50/50 that one member of a healthy 65-year-old couple will make it to age 95. In other words, plan on a 30+ year retirement.
Retirement planning has two phases: the accumulation phase (pre-retirement) and the distribution or withdrawal phase (post-retirement). The basic task is to save enough money while working to accumulate enough funds at retirement age to be able to withdraw enough money to pay all of your bills without working for the rest of your life. Simple enough, right? As I mentioned above, it used to be simple when your company did the accumulation and distribution for you through the afore-mentioned defined-benefit plans; now it’s all up to you.
The Accumulation Phase
What you’re trying to do in the accumulation phase of retirement planning is to save as much money as possible or at least enough to reach a certain $$$ goal. The key here is to start saving EARLY and make it a routine. As Bert Whitehead, a well-respected Mid-Western financial planner points out, if you save 10 percent of your gross (before tax) income you accomplish two things: you get in the habit of living within your means (no fudging with credit cards!) and you successfully build your retirement nest egg.
The earlier you start saving, the better. Albert Einstein himself wondered at the “miracle of compounding.” You need to take advantage of it. Every dollar saved at age 35 grows eight-fold by age 65 at an earnings rate of a little over 7 percent.
Congress has created a number of retirement-savings vehicles that defer or even permanently eliminate the tax on your investment earnings so that this compounding effect can work more efficiently. These investment vehicles include traditional and Roth IRA’s, small-business plans such as the SEP-IRA and SIMPLE and numerous “qualified” plans for small and large businesses. Which of these to select is beyond the scope of this article, but you owe it to yourself to get educated in this area or at least consult a tax and/or financial professional about them. An obvious piece of advice is that if your company offers a 401K with a matching contribution, make sure to do whatever you need to do in order to max out their contribution.
Investing for retirement
Literally thousands of articles have been written on how to invest for retirement. The advice has generally been to invest in a solidly diversified portfolio of equities (e.g. stocks) and fixed income (e.g. bonds) and to allocate a percentage to each based on where you are vis-à-vis retirement age. The further away you are from retirement, the higher risk/reward you can afford to take, i.e. the higher percentage you can allocate to the equity part of your portfolio. As you approach retirement, the portfolio should shift more and more to the safer part of your portfolio, i.e. bonds, with perhaps a 50/50 stock/bond split at retirement.
I think this basic framework still works well for most people, BUT, as I’ll discuss below, it’s become apparent now more than ever that you need to start thinking about the actual retirement income you need long before you reach retirement age. What the recent stock AND bond market meltdown has demonstrated is that markets can stay down for 10 or even 15 years, so that perhaps the age of 45 or 50 is not an unreasonable time to start thinking about “locking in” future income.
The Distribution/Withdrawal Phase-The “Single-Bucket” Approach
As the first wave of baby boomers have reached retirement in recent years, more and more financial articles have focused on the withdrawal part of the retirement equation. Here again, the most common advice has been to stay invested in a diversified portfolio and take withdrawals from that portfolio at a rate that “guarantees,” with a 95 percent certainty, that you will not outlive your money. Most planners set this initial withdrawal rate at 4-5 percent of the retirement portfolio and then adjust it for inflation over a 30-35 year retirement. Think of this retirement “model” as the “one-bucket” model, with all income and withdrawals coming from the same diversified portfolio.
Toward a safer retirement income paradigm
The 2008 market meltdown has, in many planners’ opinions, put a gaping hole in the “single-bucket” strategy or at least demonstrated that a 5 percent chance of failure is not good enough in real life. In addition to the very real damage that the unprecedented market swoon has put in retirees’ portfolios, the withdrawal of funds to pay for retirement expenses from that same portfolio has greatly exacerbated the wreckage and raised the real possibility of the retiree outliving his money. In addition, many retirees have simply panicked over their losses, sold their portfolios and are now trying to live on the meager earnings from money-market funds, CDs or US Treasuries. Needless to say, many professionals are looking for a new withdrawal model.
An alternative approach to retirement income planning is to carve out enough money from a retirement portfolio to create a “guaranteed” stream of income that will match your non-discretionary expenses such as housing, food and transportation. Supplementing Social Security and any fixed pension, this “guaranteed” stream would include guaranteed withdrawal or income benefits from variable or fixed annuities, immediate fixed-annuities, bond “ladders,” reverse mortgages, CD ladders and other “investments.” With this “guaranteed” income stream in place to cover “the basics” the retiree can continue to invest other funds in a portfolio without having to resort to panic selling during severe market downturns. As mentioned earlier, this “carve-out” of income needs to be planned well in advance of retirement in order to quarantine these funds from market loss.