Planning for Life

5 Steps to Avoid Outliving Your Money

Posted by Harry S. Margolis on January 13, 2015

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By Harry S. Margolis

The first issue of a new UBS publication, Your Wealth & Life, focuses on "Navigating longevity," or how to make sure your savings and investments last as long as you do. This is especially important as our odds of living long -- and long after retirement -- increase. Half of today's 65-year-olds will live to 85 or older; women have almost a one in three chance of living to age 90; and for a couple there's a 50% chance that one of the spouses will live to age 90 or beyond.

This means that if you retire at age 65, unless you know for health reasons that your life expectancy is shorter than average, you need to have enough savings or guaranteed income to last 30 years, which is a long time by any measure. Here are a few tips from the UBS report to make this work:

  1. Withdraw 4% Plus. The first is that you may in fact be able to spend more of your savings than you anticipated. Often retirees are advised that they can safely withdraw 4% of their portfolio in year one and increase this amount by the inflation rate each year. So, if a new retiree has a $1 million portfolio, she can safely withdraw $40,000 in year one. If the inflation rate that year is 3%, then in year two she can withdraw and spend $41,200, and so on. The good news is that this is too conservative and that the retiree can withdraw more based on the performance of her investment portfolio. Michael Crook, Head of Portfolio & Planning Research for UBS, recommends withdrawals at what he calls the "dynamic safe depletion rate" (DSDR), which would permit greater withdrawal rates based on the retiree's age and likely lifespan. While a 65-year-old would stick with the 4% rule, a 75-year-old could safely withdraw 4.8% of her savings and investments.

The retiree under this approach would likely have significantly more spending money, assuming that her investment portfolio grows faster than inflation. At age 75 she would be withdrawing almost 5% of a larger amount. The losers, however, would be her heirs. Based on average investment returns between 1963 and 2013, a retiree following the 4% rule would more or less double the value of her portfolio in real dollars after 30 years, leaving $2 million (inflation adjusted) to her heirs. By following the DSDR scheme, the heirs would only receive about $800,000 (inflation adjusted) after 30 years, 60% less. Retirees must balance their own lifestyle desires with their wish to leave something to their heirs.

Also, whether the DSDR plan really permits increased spending depends on the timing of retirement. Retirees will do much better if they retire in a rising market than in a falling one. According to Cook, someone retiring in 1968 would do no better than the usual 4% rule under his plan, while those retiring in 1992 would be able to withdraw twice as much after 10 years and those retiring in 1985 could withdraw more than three times as much after 15 years.

2. Use Annuities. Annuities have gotten a bad rap for a number of reasons, but they can be a good tool against longevity risk. Think of it as a private pension or enhanced Social Security. While many fewer companies offer defined pensions, they are great hedges against living too long because, like Social Security, they will keep paying even if you live past 100. (I'm talking about immediate annuities, not deferred annuities which are really a form of tax-preferenced investments that often have hidden fees and penalties for early withdrawal.) However, they are not used very much. In addition to a natural reluctance to pay a large sum up front for an annuity, which could be a real loss (again for the heirs) if the retiree only lives a short time, investors don't know how much guaranteed income they should buy.
Michael Oleszkowicz of UBS offers the following guidelines. First, divide your spending into three categories: needs, wants and wishes. Needs are the basics you require to live on -- rent or mortgage, taxes, utilities, food, insurance, etc. Wants are normal entertainment and recreation -- gym membership, eating out, entertainment. Wishes are more discretionary -- vacation homes, first class travel, country club membership, charitable gifts, support of children and grandchildren. Annuities should be used to make sure that your basic needs will always be met. So, for instance, if you determine that your basic needs total $60,000 a year, and you receive Social Security of $30,000, then purchase an annuity paying $2,500 a month, adjusted annually for inflation, will make up the difference. It will allow you to be sure that you will always have enough to put a roof over your head and food on your plate.
3.  Draw Down Retirement Plans Last.  Most retirees have a mix of tax deferred retirement plans and traditional investments and savings. Withdrawals from IRAs and 401(k) plans are taxed as income. Those from other accounts are not taxed, except to the extent that the sale of securities (stocks and bonds) will be subject to tax on capital gains. Depending on one's tax bracket, capital gains are usually taxed at a lower rate than regular income. In addition, while earnings with retirement plans are not taxed until withdrawn, dividends and capital gains are taxed in the year they are realized even if the funds stay in the investor's portfolio and are not spent. Finally, beginning in the year after reaching age 70 1/2, owners of retirement plans must begin withdrawing, and paying taxes on, their required minimum distributions set by the IRS. These start low at 3.65% but grow each year to, for instance, 6.75% at age 85.
Based on these rules, UBS recommends that other than taking the annual minimum distributions, retirees should draw down their retirement plan assets last. This will minimize the taxes on these assets and permit the funds that would otherwise be paid in taxes to be invested and continue to grow in value. In its analysis, using the 4% rule, a portfolio which liquidated retirement funds before drawing on non-tax deferred accounts would run out of money after 27 years and one that drew down non-retirement accounts first would last about 39 years. The publication does not disclose what proportions of the account it tested were in tax deferred retirement plans, but it does say that the portfolio totaled $10 million at the outset. Since this would likely mean that the taxpayer is in a higher tax bracket than most -- a 4% withdrawal totals $400,000 -- the tax implications are probably somewhat exaggerated. But even if following this advice does not lengthen the life of a portfolio by 40%, as it does in the the UBS portfolio, it still makes good sense in most cases to stretch one's retirement assets further by minimizing and delaying paying taxes.
The UBS report covers a number of other issues, including taking advantage of current low interest rates to take out mortgages, that are more arcane, but worth reading for those who want to delve deeply into the topic of retirement planning. If you are one of them, click here. Following are two more tips I've learned from other reading:
4.  Delay Retirement, or At Least Keep Doing Some Work. The later you retire, the fewer years your money and savings will have to last. In addition, your likely to be able to set more money aside. If you retire at age 60, you should have enough funds to cover your needs for at least 35 years. At age 70, the magic number may be 25 years, so you will need significantly less money set aside. Of course, no one knows how their health and energy will stand up. It would be a shame to work hard for those extra 10 years only to lose the opportunity for the recreation and travel you might have enjoyed during your 60s. I have a friend and colleague who is a geriatric care manager and has seen a lot of her clients fall ill at relatively young ages. She and her husband plan to retire in their early 60s so that they can travel and hike, which they really love. Another client is planning to retire at age 65 so he can also hike -- the Appalachian Trail -- and bike across country.
But they are all sufficiently financially secure to be able to do this. What if you're not? The answer may be that you can work less, whether that is working fewer days a week or weeks a year at your current job, or quitting what you're doing now, but switching to work that you find either more fulfilling or less demanding. If you have enough in savings to last 20 years or more, but not enough to last 30 years, depending on your investment returns, you may not need to continue setting money aside. In that case, you may only need to earn enough to meet your needs and postpone taking Social Security benefits (see tip 5 below) until you reach age 70. Keep contributing, but take time to relax as well.
5.  Postpone Taking Your Social Security Benefits Until Age 70 (Unless You're Married).
Full retirement age for Social Security is 66. Beneficiaries can begin taking a lower benefit at age 62 or delay retirement and take a higher benefit at age 70. Whatever choice a beneficiary takes will follow him the rest of his life. By waiting until age 70, you will receive 32% more every year for the rest of your life, a huge raise. Of course, you will give up four years of benefits, but this is a good trade off if what we're concerned about is outliving our money. For a beneficiary who is entitled to $2,000 a month of benefits at age 66, waiting four years will mean the loss of $96,000. With the new benefit of $2,640 a month beginning at age 70, 12 and half years to make up the difference. But beginning at age 82 and a half and going forward for the rest of the retiree's life, he will be substantially better off having postponed taking Social Security. This benefit increases over time as annual cost of living increases are calculated on a larger base. There is no cheaper longevity protection than delayed Social Security retirement. And married couples can often mitigate the loss of four years of benefits through the "file and suspend" method which permits one spouse to begin taking benefits at age 66. Click here for an explanation of the file and suspend strategy by The AARP.
In short, retirement planning is complicated and based on a lot of assumptions about health, investment performance and financial needs. These five steps, however, can help make it more secure.

Topics: social security, Retirement Planning

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