In a 2015 survey of workers across the United States, the Transamerica Center for Retirement Studies found that 44 percent of people of all ages cite running out of money as their greatest retirement fear.
This finding is a huge wake-up call because this fear isn’t just a possibility — it’s an all-too-real scenario that many retirees face. We all run the risk of running out of money during our retirement, no matter how much we have set aside. It is also a reality that’s difficult to protect against, no matter how much you scrimp and save, because there are so many variables to plan for. Retirement planning isn’t just about setting aside money, it’s about considering your life expectancy, your health, your income needs, your risk tolerance, the stability of your investments, the impact of inflation, rising health care costs, and unforeseeable changes in taxation, Social Security and Medicare.
Pre-retirees and retirees should take heart, however, because there are a number of steps you can take to minimize the much-feared risk of running out of money without looking forward to a retirement spent counting pennies and skimping on needed medications.
Can Diversification Make Enough of a Difference?
Many savers use a buy-and-hold strategy to save for retirement. Buy-and-hold is the tactic of buying stocks and holding them in your portfolio for years. While investing in stocks can help grow your savings so that you’re less likely to run out of money, the market can also introduce risks that put your money in danger, which means you need to do more than simply buy positions and hold onto them. A properly diversified portfolio is one of the preventive steps seniors can take to align both individual goals and risk tolerance.
Portfolio diversification involves more than merely spreading risk by investing in bonds, stocks, money markets and CDs. It also involves a strategy of hedging against losses by looking for different types of bonds, stocks from different sectors, and a variety of fixed and income-generating assets based on a senior’s potential income needs.
A diversified portfolio also requires attention and maintenance because as some of the holdings grow in value, others will perform differently over time, causing the portfolio to go out of balance with the senior’s risk tolerance. As a result, the portfolio will end up less diversified. To avoid and prevent this, rebalancing at least annually is a good rule, even if you are not withdrawing money.
Social Security and Annuities: Actual and/or Potential Safety Nets
Social Security was originally designed as a form of social insurance to protect against the economic hazards faced by the elderly. It was, and still is, a way to provide a minimal income to seniors while supplementing pension income and other savings.
Social Security was never intended to be the sole source of income for seniors, but seniors have relied upon this income far more heavily since the 80s. It was during this decade that most defined-benefit pension plans were replaced with defined-contribution plans that offer no guarantee of lifetime income. This change left individuals with the responsibility of creating their own retirement income plan.
This means seniors today need to be careful to maximize their Social Security income as much as possible. By not taking Social Security until after age 70, a senior can increase lifetime benefits by as much as 8 percent. A senior who keeps working may also be able to avoid tapping into tax-sheltered retirement savings and, at the same time, modestly increase future social security income. These strategies will give savings even more time to grow and provide enough flexibility to time liquidations when the market is strong.
Annuities, which are contracts for guaranteed income issued by insurance companies, also can help seniors maintain steady income throughout retirement. Since annuities have surrender fees during the first few years, seniors do need to be aware of how the annuity is designed and how much principal they contribute. An advisor can help you decide how much of your savings to allocate to annuities. Too, you should ask yourself some questions before committing to an annuity. These include:
- Is one of the purposes in buying an annuity to plug the income gaps of Social Security?
- How much do you need to have available for emergency funds?
- What is your risk tolerance? Will too much exposure to market volatility make you feel uncomfortable? If so, a fixed annuity might be a better choice than a variable.
Brexit: An Example of Sequence of Returns Risk
Americans got hit with some bad news June 2016 when Britain’s residents voted to exit the European Union in order to take control of their economy and borders and untie themselves from the rules and regulations of the EU. While retirees planning a trip abroad may benefit from lower exchange rates, lower stock values hurt those who needed to liquidate positions in their portfolio. In fact, the Dow Jones Industrial Average (DJIA) fell 3 percent the day after Brexit, marking one of its largest-ever losses, although it has since recovered.
Such international events and their effects on the stock market are among the many potential pitfalls in retirement and post-retirement income planning. One such pitfall is called sequence of returns risk. A retiree who must liquidate positions in a declining market early in retirement may be forced to liquidate a higher percentage of overall holdings than the retiree would if the market were rising.
It doesn’t take another Brexit for sequence of returns risk to become a problem for retirees. Anything that causes the market to fall creates lower portfolio values and requires the sale of more shares to create needed income. Once those shares are gone and losses are realized, there are fewer remaining shares to help recover account values once the market recovers.
The Ill-Fated 4 Percent Rule
As people get close to retirement, their risk tolerance tends to become lower. They realize they have fewer years to earn an income and save, so holding onto what has accumulated becomes extremely important. Because of this lowered risk tolerance, many seniors allocate more of their savings to fixed investments such as CDs, savings accounts and money markets. The Federal Reserve’s effort to stimulate the economy have led to significantly lower interest rates, which have remained low for years. These low interest rates severely hurt risk-averse seniors who placed their savings in what they believed were so-called ”safe” fixed accounts.
With such low interest rates, seniors can no longer rely on what is known as the 4 percent rule to guide their distributions. This rule used to provide seniors with a guideline to limit their distributions to 4 percent of their total retirement holdings to prevent running out of money. Decades ago, when interest rates on fixed products were higher, the 4 percent rule made sense, but with the low interest rates in place at the time of this writing, fixed products rarely deliver 4 percent returns. Consequently, abiding by the 4 percent rule can deplete principal and restrict future growth, which is why seniors can no longer rely on this guideline.
Designing a Responsive Drawdown Plan
Today’s seniors tend to avoid following a fixed plan for drawing down income — income that many are required to begin taking from Traditional IRAs at age 70.5 as required minimum distributions. Instead, seniors should design a plan that’s responsive to the market, specific changes within their portfolio of holdings and to the changes in their health and lifestyles that may dictate the need for more or less income.
The first step toward designing a responsive plan is to maximize Social Security so that this asset becomes the foundation of a senior’s income. Next, seniors should use online calculators (Bloomberg, American Funds, Bankrate, and Merrill Edge are examples) to design a post-retirement budget that relies mostly on their anticipated Social Security income and requires little supplement from their savings.
Having done this, the bulk of their savings can be reserved for unexpected emergency expenses and fulfilling their expensive retirement goals — such as travel — and for leaving a legacy for their heirs. This will not only allow seniors to time asset liquidations properly but also to budget their overall savings.
Ultimately, one of the best ways to ensure your assets last is to create a spending plan before you retire. (ConsumerReports, TIAA, AARP, and BlackRock provide retirement worksheets on their websites.) Not only will this help guide the use of your funds, it will also help you choose investments that align with your goals, needs and risk tolerance. Some of the things you need to consider when creating a spending plan are possibilities such as downsizing your home or relocating to a less expensive neighborhood or geographic area. It’s also a good idea to create a plan that cuts back on spending — especially important if you are used to a lavish lifestyle.
Five Ways to Help Secure Your Post-Retirement Income
The more control you have over the timing of your portfolio liquidations and the less you rely on savings for your post-retirement income needs, the more secure your golden years will be. Let’s take a look at 5 additional steps you can take to bolster your income and preserve your savings.
1. Keep earning money. There is no rule that we have to stop earning once we hit age 65. In fact, this age became synonymous with retirement back in the 1880s when less than half of the population even reached that age. Today, with life expectancy easily stretching into the 80s, people can work much longer, provided they want to and have the physical and mental capacity to do so.
Seniors who want to continue working past age 65 have options. Some may simply continue working a full 40-hour week in their chosen profession. Others may decide to reduce their hours or work a flexible schedule so they have more time for themselves. Others may retire from their former career and try something new, or take on a part-time job or temp work. Check out job sites that specialize in jobs for seniors, among them — SeniorJobBank.org, WorkForce50.com, RetiredBrains.com, RetirementJobs.com — to explore opportunities.
No matter which option is the best fit for you, having continuing income provides more independence and reduces the likelihood that you’ll need to tap into your savings. Further, this ensures that both your Social Security earnings and assets continue to grow.
2. Another way to add extra income during your retirement years is to turn a hobby into an income-generating endeavor. This can be done by selling things you make, such as hand-thrown ceramics, tie-dyed t-shirts and hand-worked wood platters and bowls, at local craft fairs or art walks. You could also consider selling your baked goods and homemade jams at local farmers markets. If you decide to do either of these things, you need to factor in potential liabilities, licensing and entry fees, as well as supply costs and other costs and balance these against your income.
3. When you’re retired, one thing you have is time. That time can be spent in a lot of ways — including running errands and providing services to your neighbors and friends. You can earn some extra cash by cleaning and shopping for people, house sitting, pet sitting and even dog walking. Again, be careful to consider potential liabilities and balance your earnings against the effort put into the work.
4. If you have an extra room in your home, you might consider renting it out to a friend or family member you know well. Renting to a stranger or someone you don’t know well may be risky. Before offering the room, make sure you know what your home insurance policy will cover once you’ve taken on a renter.
5. A reverse mortgage is another possibility, though it does not work for everyone. This will allow you to turn your home’s equity into a regular flow of income. Most reverse mortgage plans require no repayment until the home is sold or you move. Because of the many options and plan variations, you should consult a financial planner before taking on a reverse mortgage.