Category Archives: Robert powell

Singles swing into retirement with little savings

May 16, 2013 7:37 amLeave a Comment

If you think it’s hard saving for retirement as a couple, trying doing it as a single. According to a study—described by one expert as the most intriguing of 2012—the amount of money singles in their late 60s have saved up for retirement is dramatically less than that of married-couple households.

In fact, the median married household had in 2008 nearly 10 times more saved up for retirement than the median single-person household, $111,600 vs. $12,500. (Savings, for the record, included 401(k)s and IRAs and all taxable savings and investment accounts, but it did not include Social Security, pensions, or housing wealth. And single, at least for the purpose of this research could mean divorced, widowed or unmarried for most/all of their life.)

The difference was also extreme at the extremes, according to a blog post by Steve Utkus, who oversees the Vanguard Center for Retirement Research.

In his review of the study, Utkus noted that the top 30% of married households had savings of $332,400 or more while the top 30% of single-person households had just $90,000 or more. The bottom 30% of married households, meanwhile, had less than $24,000 saved while the bottom 30% of single-person households had less than $800.

The paper, from the National Bureau of Economic Research, is titled “The composition and drawdown of wealth in retirement,” and is co-written by James Poterba, Steven Venti and David Wise. Read Utkus’ blog, Retirement: The married/single divide.

Financial savings of households with those ages 65-69 in 2008

Percentile 10 20 30 40 50 60 70 80 90
Married $300 $6,000 $24,000 $55,000 $111,600 $190,000 $332,000 $518,000 $878,000
Single $0 $100 $800 $3,400 $12,500 $39,000 $90,000 $150,000 $380,000

Why the sharp divide?

So what’s going on? What explains this sharp divide?

According to Utkus, divorce is one reason why older single households have less money. When a couple separates, assets are divided, and savings can fall due to legal and other costs.

But divorce isn’t the main reason for singles having less money. If that were the case, Utkus wrote, he’d expect single-person figures to be just under half of those for married couples. But the gap is much wider than that. To be fair, the study doesn’t reflect the value of housing wealth which often becomes part of a divorce settlement, so it’s possible that the gap is not as wide.

The early death of a spouse is another reason why single households have less money than married households, according to Utkus. The all-too-familiar situation goes something like this: “One spouse, often the working male, becomes sick in his 50s or early 60s, loses work, and then dies prematurely,” he wrote. “The healthier spouse, often the female, may have a lower income or may not be working. She spends savings on living expenses and her husband’s medical costs. The loss of savings accelerates if they lose health insurance. Long-term care such as a nursing home can also accelerate the loss of assets. Medicaid, which can be used to pay for nursing care, doesn’t kick in until the household depletes most of its savings.”

And being single for most if not all of one’s life is yet another reason why single households have less money than married households. “When you live alone, you don’t benefit from the economies of scale of sharing costs with another person in the household, and so you may save less over your lifetime for a given level of income,” Utkus wrote. “If you lose your job, you don’t have the self-insurance that comes from having another household member with income and health benefits.”

So what lessons can be drawn from the findings? In general, if you’re single you’ll need to accumulate much more in your nest egg than your married counterparts, according to Utkus.

Plus, you need to make sure you have the right kinds of insurance in place. “You need also to protect against large, unexpected claims,” he wrote. And that means, having disability, life, and health insurance. “The new health care act may help when you lose workplace coverage—but of course you’ll still need to buy a policy,” he wrote.

But what one does to counteract the risks of being single depends also on the nature of the household.

Single for life

For instance, Utkus said, those who are single/unmarried for life tend to underestimate the amount of savings they need while those who are married/partnered tend to save more because they are saving for two rather than one.

“This, I believe, is still conjecture, but if it is true, it suggests that those not married need to make a special effort to save more than they might otherwise believe,” Utkus said. “Singles need to be aware that they are in a riskier position. There’s not second-income potential in the household, no sharing of living expenses. So they should be aggressive savers.”

Changes in marital status: divorce

As for those who are either divorced or want to protect against the risks associated with being divorced, Utkus had this advice: “Divorce can set back a retirement plan,” he said.

It raises cost of living (two live more cheaply together than on their own), and it reduces savings because of fees, such as lawyer expenses).

“Those getting divorced, particularly later in life, should do so with their eyes wide open,” he said. It’s best, he said, not just to consult a lawyer but also talk with a financial planner about the post-divorce financial situation. Among the things to address is whether and how to divide assets.

For the record, the Society of Actuaries (SOA) has published a guide to help you address some of the risks in retirement, including changes in marital status and becoming a widow or widower.

According to the SOA, divorce is a personal issue and there are no formal risk-management programs. But there are some things to consider. “At divorce, the law allows for split of private pension plan benefits covered by ERISA,” the SOA writes in its guide. “For this purpose, divorcing spouses need a properly drafted qualified domestic relations order (QDRO).”

And older couples who marry, especially those with children, may want a prenuptial agreement that defines each party’s rights to distribute or dispose of property as they wish, not as a court would decree, the SOA wrote.

The death of a spouse

Coming up with ways to protect against the risk of becoming a widow or widower requires more research, according to Utkus. “One of the unanswered questions in this area is the number of single-person households which arise due to death of a spouse and depletion of assets—either on health costs that are uninsured or on long-term care costs, such as nursing care or nursing-home care not covered by personal savings,” he said. “I think we need to know more about this area is clear. But if it is long-term care, it’s a complex issue.”

Study: Couples are more successful in saving

According to the SOA guide, it’s very difficult to predict which spouse will live longer in individual cases. But on average, women are widowed more often than men. And when that happens, there’s typically a decline in economic status. The SOA suggests that many financial vehicles can be used in combination to manage the death-of-spouse risk. Those include life insurance; survivor income in Social Security, pension plans and annuities, long-term care insurance, and savings. Wills and estate planning are important tools to provide for a surviving spouse. And a well-structured retirement-income plan can be an important source of stability for the surviving spouse. Read “Managing Post-Retirement Risks.”

Read related column, “True love means planning ahead.” That column detailed 10 ways husbands could help their wives survive widowhood.

Utkus said: “In many studies of retirement preparedness, getting divorced, becoming a widow or widower, or being single are risk factors associated with being financially unprepared for retirement. This important study (from Poterba, Venti, and Wise) reminds us why—and also suggests how, as individuals, we might counteract some of these risks.”

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Divorce and Finance, Featured Contributors, Retirement Planning, Robert Powell, Singles and Finance

Raiding your retirement to pay for college

May 10, 2013 11:42 amLeave a Comment

Find ways to help kids without risking your safety net

Conventional wisdom suggests, as do prudent advisers, that you should never, ever raid your retirement accounts to pay for your children’s or grandchildren’s college costs.

After all, you or your children can borrow money to pay for school; you can’t do the same when it comes to your retirement. But as parents of college-age children look at the financial aid packages now arriving in their mailboxes, and as these very same parents look at their first quarter balances in their 401(k) and IRA accounts, it would be hard not to ask the question: Are there times when it makes sense to raid your retirement account to pay for college?

Generally the answer is no. “The problems with using retirement accounts to pay for a child’s or a grandchild’s education are real,” said David Mendels, director of planning at Creative Financial Concepts. For starters, he said most of us have inadequate retirement savings and can ill afford to use them to pay for anything other than their intended purpose.

Others are of the same opinion. “My initial advice would be ‘don’t do it!’ but blanket statements are dangerous,” said C.E. Scott Brewster of Brewster Financial Planning.

So what then are exceptions to the rule?

Are you 100% funded?

Well, in rare instances it might make sense as part of an overall plan. “If someone was 100% secure in their own retirement and did not need the money they might then use some of their IRAs or 401(k)s to pay for their children or more likely grandchildren’s college costs,” said Brewster.

He noted, for instance, that many grandparents pay no taxes at all because they have high medical costs that as a tax deduction wipe out any taxable income they have. “Those grandparents in a 0% tax bracket might find distributing some money from their retirement plans is a very wise thing to do,” said Brewster. “Better to distribute it when you are in a 0% tax bracket to pay [for] grandkids’ college or grad school than leave the IRA or 401(k) to your grandkids when you die and then when they take the money out the grandkids could be in a 50% tax bracket—federal and state—if they, because of great schooling, became a doctor or lawyer or other high-income professional.”

The bottom line, said Brewster, is if you take money out of IRAs and 401(k)s, make sure you have a plan and know why it is an intelligent thing to do.

Pay interest on college loans instead of raiding retirement accounts

Others agree that it makes sense to raid your retirement accounts, but only under rare conditions.

“The only exception would be if someone’s retirement account was so well funded and they were absolutely certain that the market was not going to go south in their lifetime and they know they will never outlive their retirement savings,” said L. Ann Coulson, an assistant professor at Kansas State University. “Then raiding retirement funds would be fine.”

The only problem is that it is unlikely that any of that would happen. “The reality is that there are too many uncertainties with retirement and retirement savings,” said Coulson.

Others note that raiding one’s retirement account leaves one little time to make up for any distributions. “The older you are, the less time you have to make up for the loss,” said Rosilyn Overton, an associate professor at New Jersey City University.

To be fair, Coulson said, there are ways for parents to help their children or grandparents to help grandchildren pay for college costs without putting their own retirement at risk “If they truly want to help their children/grandchildren, let the child borrow conventional student loans and then the parent/grandparent can pay the interest costs on the loans while the child is in school—that way interest is not accruing on interest,” she said.

Then once the child has graduated, if the parent is feeling fairly confident about retirement savings, they can help the child pay the loans off. But, Coulson noted, that should she would be much more comfortable if they used current income rather than retirement funds to do that.

Others also recommend that tactic and give permission to use retirement funds to pay back college loans. “Generally speaking, it is preferable to allow the child to take out loans and then, if need be, help the child to pay them off—even if that meant dipping into retirement savings at a later date,” said Mendels.

Other exceptions to the rule

Overton also agrees it doesn’t usually pay to raid retirement accounts to pay for college costs. But there are exceptions to the rule.

For instance, if there is a cash flow problem—such as tuition is due and you won’t have the funds until next month—and you can replace the funds within 60 days, then no harm done. “You must be disciplined enough to actually pay it back within the 60 days,” Overton said.

Another exception is this: If you have low income this year, you have exhausted all financial aid and scholarship opportunities, your child or grandchild has does his or her part by working, and the withdrawal won’t push you into a higher income-tax bracket.

Overton also said it might make sense to raid retirement accounts provided you don’t adversely affect the child’s eligibility for financial aid or scholarships. “Since retirement plan distributions will increase a parent’s income they may end up reducing the financial aid available and so end up being of little net benefit and at great net cost,” said Mendels.

Avoid the 10% penalty

If you do plan to raid your IRA to pay for college, consider this: Uncle Sam may cut you some slack. Generally, if you take a distribution from your IRA before you reach age 59½, you must pay a 10% additional tax on the early distribution, according to the IRS.

This applies to any IRA you own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA, or a SIMPLE IRA. What’s more, the additional tax on an early distribution from a SIMPLE IRA may be as high as 25%. However, you can take distributions from your IRAs for qualified higher education expenses without having to pay the 10% additional tax, according to the IRS.

True, you may owe income tax on at least part of the amount distributed, but you may not have to pay the 10% additional tax, says Uncle Sam.

Note, too, that there are procedures to follow to show that the withdrawal is for qualified educational expenses, so it pays to work with a professional adviser. Generally, according to the IRS website, if the taxable part of the distribution is less than or equal to the adjusted qualified education expenses (AQEE), none of the distribution is subject to the additional tax. If the taxable part of the distribution is more than the AQEE, only the excess is subject to the additional tax.

All the details can be found at Education Exception to Additional Tax on Early IRA Distributions.

Overton suggests that if you have made after-tax contributions to your IRA, withdraw these first. As an aside, Overton also said it is always best to put after-tax contributions to an IRA in an account separate from your pretax IRA so that it is clear which funds are which.

In the main, however, Mendels noted that retirement accounts are generally far less effective for funding college because they are taxable. For instance, withdrawals from retirement plans other than IRAs may not even be available and would be subject to an additional 10% early withdrawal penalty.

Education expenses—as noted—are penalty exempt for IRAs, but not qualified plans.

Conventional advice revisited

“The conventional wisdom is not unfounded, but not infallible either,” Mendels said.

He noted, for instance, that the problems with using retirement distributions do need to be understood and not every child needs to or ought to go to college. “Still, if my child or grandchild were faced with the prospect of not being able to attend college at all, or not being able to attend a college that was clearly the better choice for him or her, would I ‘never’ consider using retirement savings?” he asked. “I can’t say that.”

As a financial planner, Mendels said he would have to consider its impact on his own retirement plans, though he noted that we do “make sacrifices” for our children.

“At that point, it would come down to a matter of priorities which would be a deeply personal decision,” he said. “Would I encourage a client to do it? No. Would I discourage a client from doing it? That is really not my place or my job. My job is to help my clients to make informed decisions, not to make the decisions for them. I would help them understand the consequences, but the choice would be and ought to be theirs.”

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in College Funding, Featured Contributors, Robert Powell

Housing, health-care costs are retirement killers

April 25, 2013 11:37 amLeave a Comment

Plan now to manage these expenses later

Retirement planning, in many ways, is all about the rows and columns. How much money is coming in, how much is going out, and for how long. But far too often, some retirees and many pre-retirees don’t have a handle on what their expenses will be after age 65.

A new report from the Social Security Administration should, however, go a long way toward helping those who haven’t built a spreadsheet get a sense of where their money will go in retirement, and how much they might need set aside for various types of expenses.

Read Expenditures of the Aged Chartbook, released March 2013.

So what does insights can be gleaned from the SSA Chartbook?

Housing is a budget buster

Most noteworthy is that housing is the largest component of the average retiree household’s expenditures. In fact, housing represents 35% of expenses followed by transportation (14%); out-of-pocket health care (13.2%); food (12.3%); entertainment (5.1%); and apparel (2.6%). Other expenses, such as alcohol, personal care, reading, education, tobacco, miscellaneous items, cash contributions to persons or organizations outside the household, personal insurance, pension contributions, and Social Security payroll taxes, accounted for 17%. And Social Security payroll taxes and pension contributions were small components of total expenses (3% and 1%, respectively).

To be sure, expenses—including that for housing—differ depending one’s income, sources of income, and age. For instance, those age 65 and older and who have earned income spend less on average on housing (33.6%) than the average retiree household; while those in the lowest income quartile (those with income of $16,207 or less) spend more on average (42.6%) than the average retiree household. And housing represented 34.9% (or $10,784) of expenditures for those age 65 to 74 and 35.9% (or $7,832) for those age 70 or older.

But no matter how you slice the data, the inescapable truth about retirement is that housing is year-in and year-out budget buster. It represents, if you want to use walking-around numbers, a good third of your expenses in retirement. What should you make of that?

Retire debt-free

Well, if you have designs on aging in place, some experts recommend that you minimize housing costs as much as possible. “It is so essential for retirees to minimize housing costs during retirement,” said Ron Rhoades, an assistant professor at Alfred State College, SUNY as well as the curriculum coordinator for the financial planning program at the very same school.

“Since many retirees desire to stay close to their family members, rather than move to more distant and often cheaper retirement housing destinations, a strategy every working American should have in place is to own a home, outright and with no mortgage or other debt, by the time they start retirement,” Rhoades said.

By doing so, he said, your home can also serve as a source of funds in retirement, through a reverse mortgage, should the need arise.

Don’t underestimate rising costs

If you do age in place, don’t overlook the rising cost of property taxes and maintaining your home. “With all the focus in the cost of health care, we may lose the awareness that housing is the biggest item in retirees—probably everyone’s—budget,” said Michael Lonier of Lonier Financial Advisory. It’s three times higher than out-of-pocket health care, three times higher than food, two and one-half times transportation, and two times ‘other.’”

According to Lonier, maintaining your home during your later years is just as important as maintaining your body. “It’s best to look after your roof and your basement as well as your heart and diet,” he said.

What’s more, he warned that rising property taxes, like rising health insurance, are the villains of inflation that can undermine retirement plans.

Read “The most tax-friendly states for retirees” if you’re interested in moving move to a state with generally low property tax rates.

Don’t age in place

Others, meanwhile, advise against aging in place. “One way to plan for a secure and sustainable retirement income is to lower housing costs for the entire retirement period,” said a Kenn Tacchino, a professor at Widener University and the editor of the Journal of Financial Service Professionals.

According to Tacchino, housing costs may be unnecessarily high for the majority of consumers who choose to age in place. “This lifestyle choice may cause them to jeopardize financial security,” he said. The house that was suitable for raising a family may not be financially suitable for retirement living.”

He noted, for instance, that high taxes, extra home heating and cooling costs, and costly home maintenance can be mitigated by downsizing to a home that is more senior-friendly. “This constitutes a win-win for the retiree,” he said. “It frees up needed cash and it creates a safe and manageable environment.”

What’s more, he said, retirees can have their cake and eat it too; they can choose to remain near family, keeping the same church, doctors, and community. “Seniors need the courage to move to a living arrangement that suits their retirement budget,” Tacchino said. “Retirees who are house rich and cash poor must remember that counting on the home as an investment may be problematic because of the lack of liquidity and the lack of diversification, not to mention fluctuating housing prices.”

According to Tacchino, downsizing can, among other things, turn the equity in your home into cash that can be invested and/or used fund your retirement expenses. “Any retiree who can downsize and eliminate mortgage costs has already guaranteed a rate of return equal to the interest rate they used to pay to the mortgage company,” he said.

Don’t forget about health-care costs

Health-care costs, which—according to Rhoades—are largely contained at the moment thanks to Medicare, are another expense about which to worry. According to the SSA Chartbook, out-of-pocket health-care expenditures ranged from ranged from 5% of total expenditures for retiree households aged 55–64 to 14% for those aged 75 or older. And on average, in 2010, retirees spent $3,091 per year on health insurance premiums, $792 on medical services, $805 on prescription and over-the-counter drugs, and $158 on medical supplies.

In the main, however, Rhoades noted that the Medicare system now removes “most of the largest financial risk present” and that just 13% of seniors’ expenditures, on average, are for out-of-pocket health-care costs. “The saving grace for many retirees is the U.S. Medicare system, which was substantially enhanced with the addition of prescription drug benefits,” he said.

But health-care expenses as a percent of a retiree’s budget could change for the worse in the near future for at least two reasons. One, future changes to the Medicare system might increase the percent retirees spend on health care. And two, shocks and long-term care costs tend to dramatically change how much one spends on health care.

“Future efforts to restrain spending in this huge government program, including proposals to move to a voucher system, would likely greatly increase the financial burden upon seniors as to health-care costs,” he said. “It is doubtful that most seniors can afford any material increase in health-care costs.”

What’s more, he said those seniors with some discretionary funds—for entertainment, travel, or small gifts to family members—would likely see those discretionary funds used instead for health-care costs, should some of the current proposals floating around in Congress be enacted. “Now is the time for seniors to voice their concern to their elected representatives in Congress,” Rhoades said.

Others also expressed concern that health-care costs are problematic given potential changes to Medicare. “Whether Medicare and other insurance programs will continue covering some very expensive drugs will be an issue,” said Sherman Hanna, a professor at The Ohio State University and chair of that school’s undergraduate financial planning program. Hanna doesn’t expect real ‘death panel’ decisions soon, but he said the current policy direction would be to move us more toward the British National Health Service model with higher-income households having the choice to maintain life and/or quality of life by spending tens of thousands of dollars per year on prescriptions if Medicare cuts back because of efforts to control costs.

Beware long-term care costs

Rhoades also noted that Medicare doesn’t provide much in the way of support for the expenses of long-term care. “In that circumstance, many seniors who become impoverished turn to the states’ Medicaid system.” He said. “Many more are cared for by younger family members, often placing a huge burden on caregivers, and removing skilled workers from the workforce.”

His advice for those age 45 or older who have significant assets to protect against the ravages of long-term care, where facility costs often exceed $100,000 a year and much more in some states, is to consider long-term care insurance.

Rhoades also noted that roughly 40 states have “partnership programs,” in which qualifying long-term care insurance policies can protect a person’s assets, even if the length of stay in a nursing home or other long-term care facility exceeds two or three years.

Save early, save a lot

Overall, Rhoades said the SSA’s Chartbook paints a bleak picture of retirement. “Most senior Americans are ill-prepared for retirement and are, as a result, living on very limited incomes,” he said. “On a per capita basis, 73% of retirees spend less than $25,000 a year. Does this show frugality? Only in a mandated way, as most retirees have inadequate retirement savings to supplement their receipt of Social Security benefits.”

The SSA Chartbook also reveals, he said, that only 13% of senior Americans are spending $35,000 a year or more in retirement—a level which permits a greater opportunity to pursue long-awaited lifetime goals. Yet most of the income for those in this 13% upper level is derived from continued work, not from accumulated retirement savings.

His advice: “Workers today should be saving, starting in their early 20s, at least 11% of their gross incomes,” he said. “If they wait just 10 years to start saving, the individual’s rate of saving needs to approach 18%. And such saving should occur via vehicles which provide tax benefits, such as IRA accounts or which provide matching employer contributions, such as many 401(k) plans. And retirement savings need to be invested wisely, as well—in low-cost, diversified investments.”

And since most Americans are ill-equipped to undertake the strict personal expenditures budgeting process, discern the best method to save for retirement and other needs, and invest correctly, Rhoades recommends that consumers seek out trusted, fiduciary and fee-only advisers.

Two sources he recommended are the National Association of Personal Financial Advisors, and the Garrett Planning Network.

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Featured Contributors, Healthcare, Lifestyle, Real Estate, Retirement Planning, Robert Powell

3 ways to solve the retirement crisis in the U.S.

April 18, 2013 6:36 amLeave a Comment

You might think it’s impossible to avoid a retirement crisis in this country, especially in the wake of a report this week that shows Americans are not very confident about their prospects for having a comfortable retirement.

But Matt Greenwald, the president Matthew Greenwald & Associates, the firm which conducted the research for the 23rd annual Retirement Confidence Survey for the Employee Benefit Research Institute, thinks otherwise. Read Survey: Retirement confidence still lags.

In an interview, Greenwald outlined what it will take for the U.S. to avert a retirement crisis.

Watch Powell’s interview with Greenwald here.

Calculate how much you need

If you want to avert a personal or national retirement crisis, there’s one surefire way to do that: Calculate how much you need to save for retirement, and get others to do the very same. According to Greenwald, this task can help you (and others) go a long way toward making sure that you have the financial resources required for a comfortable retirement.

“Doing a retirement plan helps,” said Greenwald. “People make more accurate assessments of what they need. Most people don’t do any retirement planning and that’s something that’s very important. The people less prepared (for retirement) are the people who do less retirement planning.”

MarketWatch has a retirement-planning calculator here.

Also check out EBRI’s Choose to Save Ballpark E$timate.

In the absence of using an online tool to calculate how much you need to accumulate in your nest egg to fund a comfortable retirement, Greenwald recommends that you consider this rule of thumb: Accumulate 20 times what you need after Social Security and any pension plan that you may have.

To do that, you’ll need to figure out how much you’ll be getting from Social Security. You can check your Social Security benefit and payment information, and your earnings record at this Social Security Administration website.

How much will you need above and beyond your Social Security benefit is, of course, somewhat tricky. But Greenwald said 20 times (your salary) is a safe bet.

“When making a decision about how much to save and even how much to spend you are really making a decision about giving up some spending now to get a better lifestyle later,” he said. “And it’s the trade off that people really have to (assess).”

Get employer to use auto enrollment aggressively

Greenwald also said that employers can play a key role in averting a national retirement crisis. At the moment, there are too few people saving for retirement according to the EBRI study. Just 57% of workers are saving for retirement. “It’s very important for those people to aggressively save more to at least build a foundation by age 60,” he said. “Because after that, the risk of not being able to work goes up.”

Consider this: When workers who are not eligible to participate in an employer-sponsored retirement are asked this question: “If you were in a retirement plan and you were automatically enrolled at 3% or 6% of your salary would you opt out of the plan, or stay in at those levels, or increase your salary deferral?” Greenwald said many workers would not opt out of the plan.

“Auto enrollment works,” said Greenwald. “Employers who have plans who automatically put people in at a higher level, such as 6%, will be doing their workers a favor. People know they should be saving more. And they know automatic enrollment helps them get through that inertia that often stops people.”

Time to provide more retirement education and advice

Greenwald said the U.S. does have a retirement crisis, and that there are a number of people who run the risk of having lifestyles in retirement that are threatened. But he stops short of calling the crisis a public policy disaster in the making. “What we need to do is make more use of the resources and mechanisms we have,” he said. “In some ways, that’s free money.”

Greenwald said the U.S. doesn’t want a system where all the pressure is on Social Security program, which is likely at this stage to reduce the income going to future retirees, is coupled with lack of savings. So, besides encourage employers to make more aggressive use of auto enrollment and auto escalation, Greenwald said another important task is to provide workers with education and advice.

“Encouraging employers to give people a better sense of what they are likely to get at retirement if they keep saving at the same levels” can improve retirement confidence and success, he said. And, he suggests that employers provide workers with more education and advice about how make better use of their money in retirement.

Greenwald said studies suggest that if people make better decisions about managing their money in retirement they could get 29% more income. “That’s free money,” said Greenwald. “If we get people to be more educated about how to manage their assets, they will have more financial security…without costing the taxpayer anything.”

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Featured Contributors, Retirement Planning, Robert Powell

How to keep stocks from ruining your retirement

April 17, 2013 6:32 amLeave a Comment

Your need to reduce the sequence-of-return risk

You might not think it’s a risk at the moment, what with the market close to all-time highs. But at some point the market will fall again. And when it does, current and future retirees will get to experience what the experts refer to as sequence-of-returns risk—the risk that you’ll withdraw money from a nest egg that keeps falling in value, especially in the early years of retirement.

“One of the biggest risks to a successful retirement is the exposure of savings to one or more adverse negative investment returns in the early stages of the retirement,” W. Van Harlow, director of research at the Putnam Institute, wrote in a recent paper.

In truth, there is some debate among academics and advisers in the retirement-planning world about whether this risk is real or not. In one corner, for instance, are advisers who say retirees who withdraw money from nest eggs that fall in value, including during the early stages of retirement, don’t really run out of money, nor do they have to lower their standard of living, even in the late stages of retirement.

And in the other corner are academics such as Van Harlow and others who publish paper after paper warning of this risk and the need to deal with it somehow, someway.

The risk, they say, is real and can put a big wrench in one’s retirement plans—as those who experienced it in 2000 or 2008 can attest. (Many who experienced sequence-of-return risk in 2000 and 2008 had to delay retirement or return to work, or reduce their lower their standard of living, or live in fear of running out of money, or all of the above.)

“Retirees need to know that—if they are invested in assets with a risk of negative returns such as stocks and bonds—their ability to withdraw a steady amount to provide income throughout retirement is not certain,” said Brandon Bellin, senior associate actuary at Securian Retirement.

“If their portfolios suffer significant market losses early in retirement, this can result in their money running out much earlier than expected, or force them to take a lower withdrawal amount—i.e. live on less—to help prevent that. This ‘sequence-of-returns’ risk is real, as many, especially newer, retirees experienced with the 2008 market downturn.”

Who to believe? Well, the research produced by experts from around the globe is extensive and—without examining each and every assumption used—seems hard, if not impossible, to dispute.

Here are links to just some of the many recent studies, white papers, and articles on the subject:

And then there are books that discuss how to deal with sequence of return risk, including “Are You a Stock or a Bond,” by Moshe Milevsky; “The New Wealth Management: The Financial Advisors Guide to Managing and Investing Client Assets,” co-author by Harold Evensky, Stephen Horan, and Thomas Robinson; and “Retirement Income Redesigned: Master Plans for Distribution—An Adviser’s Guide for Funding Boomers’ Best Years,” which was edited by Evensky.

By contrast, the research suggesting that sequence-of-returns risk is not something about which to be concerned is, well, not nearly as vast. (I couldn’t find much that said it was nothing about which to worry, quite frankly.)

So, given that sequence-of-returns risk is real and not imagined, what can you do to protect yourself?

Build a cushion

“Anecdotally, I would advise that the future is always fundamentally unknowable and any projection using Monte Carlo or other tools should primarily be used as a long-term ballpark guide for general planning purposes,” said Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research. “Anything can happen in the short-term, which is why retirees should build in a reasonable cushion to stay flexible.”

Some advisers are fond of setting aside two years of living expenses in cash as a way to avoid or mitigate the effects of sequence of return risk. Instead of withdrawing 4% per year from their portfolio, they set aside two years of living in liquid cash alternatives. That way, they don’t have to worry about the negatives effects of falling markets on their withdrawal strategy.

Start out with a reasonable asset allocation

Common sense, said Spiegelman, also tells us that a severe market drop early in retirement will translate into either a lower withdrawal rate to achieve the same time period or a shorter time period for sustainable withdrawals using original assumptions.

“But, more important than all the academic number-crunching is the psychological impact of an early-retirement market drop,” said Spiegelman. “Historical hindsight tells us that the average individual tends to bail out at the point of greatest pain, which sadly is also the point of greatest opportunity for those with both the resources and risk tolerance to persevere.”

That’s why Spiegelman and others say it’s important to start out with a reasonable asset allocation and a plan that allows for the greatest amount of flexibility. “We generally recommend that a retiree who needs to rely primarily on the portfolio for retirement should allocate roughly 40% to stocks and certainly, no more than 60% and perhaps less than that if the person is especially risk averse.

“That way, even if the market drops 50% your portfolio is only down 20%,” he said. “Plus, you have the flexibility to tap fixed income and cash while your stock allocation has a chance to recoup. Allocating too much to stocks means you might have to sell at the worst possible time.”

Others are much more conservative. Van Harlow, in one of his papers, recommends that retirees commit no more than 25% to stocks and something in the range of 5% to 10% would be optimal.

Of course, Spiegelman said outside sources of income could allow for a greater equity allocation and everyone needs to find their own comfort level. “Whatever that allocation level is, ask yourself if you would be willing and able to stick with it in the event of a 40% to 50% market correction in the first five years of retirement,” he said.

Don’t rely on 4% withdrawal rule

Common rules of thumb such as the 4% withdrawal rule—withdrawing 4% of your assets during the first year, and then increasing that dollar amount by inflation thereafter—are useful starting points. “But those rules simply attempt to balance a decent income with a low risk of running out of money too early,” said Bellin. “They have worked well for many over time, but can’t eliminate the sequence-of-returns risk. If you’re unlucky enough to retire at a particularly bad time, it can mean accepting a lower standard of living than you planned.”

Adjust withdrawal rates if need be

In their paper, Frank and Blanchett recommend that adjust your withdrawal rate as market return trends suggest; that you adjust your portfolio allocation to mitigate exposure to negative market returns as market trends suggest; and that you start with a reduced withdrawal rate to reduce exposure to the impact of declining markets on the probability of failure.

Consider downside hedging

In another paper on the subject, titled Improving the outlook for a successful retirement: A case for using downside hedging, Putnam’s Van Harlow suggests that hedging with “costless collars” or with put options can eliminate or significantly reduce funding shortfall risk for a retirement portfolio.

In addition, his paper shows that, for a given level of shortfall risk, hedging can increase the income generated by retirement savings by almost 40%.

Thus, he wrote, that downside-hedging strategies within retirement portfolios appear to offer attractive benefits to the retiree worried about outliving his or her income resources.

One way to hedge the sequence-of-returns risk, according to Van Harlow’s research, is with absolute-return funds.

In 2009, Putnam launched four absolute-return funds, which were designed to seek positive returns above inflation over a full market cycle regardless of market condition, with lower volatility. Putnam’s point of view is that while absolute-return strategies cannot guarantee positive results over an investment cycle, they do have a lower risk profile. And this means they could help limit losses in a down market.

Consider guaranteed sources of income

Fortunately, said Bellin, the lessons of 2008 are resulting in many strategies being brought forth in the financial adviser community that attempt to further minimize or even eliminate that risk.

A common theme, he said, is to make sure you have enough sources of guaranteed income that won’t be affected by market downturns. “Social Security is one such source that almost all retirees have, but it often isn’t enough on its own to guarantee the minimum standard of living the retiree desires,” Bellin said. “Pensions can help fill in that gap, although the trend away from employers offering traditional pension plans means most people retiring today do not have one.”

As a result, he said, annuities are increasingly gaining favor as an effective way to guarantee the portion of needed income that Social Security doesn’t supply. “There are a number of varieties that meet different needs, but in its simplest form the retiree uses a portion of their assets to purchase a fixed, guaranteed stream of income for life and often the life of their spouse.”

“Once a retiree has their basic needs secured through guaranteed sources of income, they can invest the rest of their money in stocks, bonds, and other risky assets to give them some upside without having as big of consequences if those assets decline in value,” said Bellin.

It’s quite possible that you will never experience the sequence-of-returns risk and it’s possible that even if you do, you won’t experience the worst-case outcome. But given the preponderance of evidence that suggests that the risk is real, and given all the strategies you can use to mitigate it, why wouldn’t you protect against sequence-of-returns risk?

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Annuities, Featured Contributors, Investments, Retirement Income, Retirement Planning, Robert Powell