Use These Strategies to Help Stretch Your Dollars
Despite a tumultuous political climate, Social Security seems safe. But Social Security is rarely enough to cover more than the most basic living needs. And with the average monthly Social Security benefit coming in around $1,250 and growing slowly, this fact isn’t going to change anytime soon.
For some, a government or corporate pension may provide additional, regular income. The majority of Americans, however, will have to maximize what they themselves have set aside in their retirement plans to sustain their standard of living throughout retirement.
I spoke with a couple about to retire recently. They told me about all the things they anticipated doing in the next few years: travel, taking some classes at the local community college, becoming more tech savvy to keep up with the grandkids. A shadow, however, passed over the wife’s face as she mentioned something she was NOT looking forward to - retirement.
“I’m going to miss that green envelope,” she said. “Knowing I won’t be seeing it in our mailbox makes me really nervous.”
She was referring to her husband’s monthly pay receipt. For decades, his paycheck had been deposited as regularly as clockwork in their checking account and was the anchor and compass of their financial management. Without it, they felt like they were on their own trying to figure out how much they could withdraw from their retirement reserves – not to mention how to plan for taxes, deciding which accounts to draw from first, and how to invest.
In many cases, after a lifetime of receiving paychecks on a consistent basis, retirees must shift gears and start creating their own income. However, like my retiree couple, they find the prospect pretty challenging and, at times, overwhelming.
To take back control of their financial future, retirees must learn to separate fact from fiction when it comes to generating the income needed for their sunset years. By focusing on actionable goals, retirees can maximize their retirement assets. First, let’s get the fallacies out of the way.
- One magic withdrawal rate will ensure you will never run out of money.
It’s true that there has been considerable research done on “safe withdrawal rates” — defined as the highest yearly payout from an investment portfolio that will keep the portfolio intact over a given period. While so much depends on the parameters used to identify this rate, there is generally a consensus that a 4 percent annual withdrawal rate is a reasonable payout over the life expectancy of most retirees.
But retirees need to understand that this rate should be flexible. There may be years that a higher rate is warranted or necessary – during times when the investment portfolio is doing well, for example, or when there are large expenses, perhaps for medical costs.
This is where an annual conversation with a financial advisor works better than a hard-and-fast rule. Each year, the advisor can help reevaluate the need for greater or lesser withdrawals from the portfolio, while also considering the longevity of the portfolio in a way that fits the unique circumstances of a retiree’s life.
- Safe, income-producing investments can be relied on to create income in retirement.
It’s too simplistic to call investments that pay interest or dividends “safe,” and say that growth stocks are not.
Retirees often confuse regularity with safety. For example, while bonds provide predictable income, this does not mean that this income is perfectly safe. Bond issuers default sometimes, and companies that pay dividends occasionally cut their payouts to shareholders. Furthermore, inflation will also reduce the purchasing power of those regular payments from bonds and dividends.
And in today’s low interest rate economy, it can be difficult to find yields on fixed income investments sufficient to maintain a retiree’s lifestyle. This scenario drives many retirees to search for higher yields, which often carry unacceptable risk.
For most retirees, a healthy allocation of investments that will grow over time, rather than those that promise regular income, is warranted. Today’s growth is needed for higher payouts in the future.
- Spending capital from the retirement portfolio is a bad idea.
Traditional IRAs, 401(k)s, 403(b)s, and self-employed plans are structured, under the tax laws, to be paid out over our lifetimes. In fact, retirees are penalized if they fail to take principal from these accounts at a certain age. Many retirees find the prospect of spending down these accounts very upsetting, when, in fact, doing so under the guidance of a qualified financial professional can result in a far more comfortable, secure retirement.
And now for the facts: here’s what really matters to a retiree drawing out income from his or her retirement savings.
- Taxes matter.
Of course they do – and where they really matter is in determining acceptable withdrawal rates.
Suppose, for example, a retiree decides he needs about 4 percent from his retirement portfolio to cover his annual living expenses. As discussed above, a 4 percent payout is a reasonable (but not certain) rate to ensure portfolio longevity.
But when this payout is made from a tax-deferred retirement account, the retiree will need to withdraw an additional 1 percent from the portfolio to cover the tax liability on these withdrawals. As a result, the sustainability of the portfolio over his lifetime may drop considerably.
When saving for retirement, many individuals fail to appreciate the importance of using both taxable and tax-deferred accounts. Having the flexibility to choose between the two types of accounts when it’s time to make a withdrawal, and thereby controlling the amount of taxes owed in any given year, can be critical to sustaining the retirement portfolio.
- Timing matters.
The month and year a retiree chooses to start taking income from his or her retirement accounts can make a huge difference. As individuals who retired in 2007 or 2008 are all too aware, a bad investment market combined with portfolio withdrawals may diminish the sustainability of those withdrawals by several years. In cases of bear markets, those able to delay retirement and continue earning income rather than consuming assets are in a much better position to avoid running out of money during their lifetimes.
- Spending matters more than investments.
Many retirees believe that if they could just get the portfolio allocation and security selection “right,” they will have enough for their retirement. It may surprise them, however, to realize that in the studies done on sustainable withdrawal rates, the allocation of the portfolio providing the withdrawals was not very important to the results.
Instead, the most effective way to ensure that retirees’ resources will last in retirement is for them to focus primarily on expense management.
Taxes, timing, and spending are fairly simple principles. What’s not so simple is coordinating the three. Finding a financial professional can make a big difference here: He or she is trained to take all these factors into account in designing an individual retirement income strategy that makes sense for you.