“Money death” is simply a shock-value way of saying that a retiree has run out of money so that his or her basic retirement income needs are no longer being met. The authors of the article that describes their proposed strategy also use the phrase “boomers behaving badly.” The referenced “bad behavior” is a failure to create and implement a plan that to support yourself when you retire. (More than likely, it is a failure to create any plan.)

The strategy is interesting to me and should have appeal to baby boomers who are (a) close to retirement and (b) have already have significant retirement investments in their nest egg, but not enough that they can survive on an ultra-conservative portfolio. What they may not have is (c) a plan to make their nest egg last.

The authors of the strategy note first that trying to survive a lifetime on a low risk retirement portfolio is probably not going to work for most retirees. This is particularly apparent in today’s low interest rate economic environment where Fed policy continues to punish savers in favor of spenders.

What is proposed, then, is this: First, boomers should create a retirement investment portfolio that is heavily weighted in dividend-paying stocks and high-yield corporate bonds. More important, rather than decreasing equity and corporate bond exposure as retirement approaches and begins, this portfolio should remain in place. This creates a reasonable possibility of achieving returns that will support your retirement income needs. This brings us to the second part of the plan: Buy a deferred fixed annuity now as “longevity insurance.” The deferred annuity functions as a safety net, in case the higher risk retirement portfolio crashes and burns (e.g., 2008 all over again.)

A key to the second step is purchasing the deferred annuity at least 20-30 years before you will need it, so that the cost-benefit ratio is quite low. For example, someone who is 60-65 could spend $100k now for an annuity that would pay $75k annually beginning at age 85. The authors caution that this part of the plan would only make sense if the cost of the annuity represented no more than 10% of your wealth. After all, once you spend that $100k, you won’t see any of it again even if you died way before age 85.

The big problem/risk I see with this plan is inflation. Let’s assume that at age 60 you purchase a deferred annuity that will pay you $100k annually beginning at age 85. With average annual inflation at only 3%, the spending power of that $100k will shrink to $48k when payouts start at age 85. If we experience a period of high inflation (certainly possible given recent government spending and borrowing), the picture looks even worse.

But, overall the plan is worth considering. What helps are recent rule changes announced by the federal government that will allow 401(k) funds to be used directly to purchase annuities, without a lot of red tape and immediate tax consequences.

Here is a link to an article that discusses the plan: Do You Face Money Death in Old Age?

If you are  a student of retirement planning like me, you will want to read the full plan article here.

Comments?

Related posts:

1. Get a Lifetime Investment Income From Your Retirement Portfolio
2. Can there be a No Risk Retirement?

The obvious solution is to stash away enough “cash” so that if you need more more income to spend during a down market, you can tap that cash rather than sell investments. I’ve written before about this “cash staff.” I referred to it as a “retirement emergency fund.” The “emergency” in this case is not a car repair or broken water heater. Instead, the emergency is a need for cash to pay living expenses. In good times, you might sell shares of a mutual fund as part of your retirement plan. But in really bad market conditions, over a sustained period of time, you would need to sell many more shares than normal.

A recent article from Smart Money made brief mention of this issue. I was quite pleased to see this particular statement from the author:

Another way is to make sure that your portfolio generates enough guaranteed income (along with Social Security payments) to cover basic retirement expenses, so that you don’t have to depend on stock market returns to pay your bills each year.

That should sound familiar to my readers. If not, go back in my archives and check out these posts:

• Creating a Plan for Guaranteed Retirement Income
• Write Your Own Retirement Paycheck
• Can There be a No Risk Retirement?
• Retirement Income and the Myth of Equity Risk

The author also quotes a financial advisor who suggested keeping your “cash stash” in a ladder of Treasuries and I-Bonds to provide your basic retirement income needs.

Bingo! Welcome to the Failsafe Retirement System!

Here is a link to the Smart Money article:  Enough Cash for a Down Market?

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I’m retired and don’t want to take chances. What’s the best way to draw income from my money?

The smart-ass answer would have been “stuff your money under your mattress.”  The actual response was more thoughtful and properly noted that there are two different risks that a retiree faces when trying to maintain an adequate retirement income. The first is investing risk, e.g., the possibility that a market decline will severely damage your retirement nest egg.

The second retirement income risk is spending power decline or more specifically, inflation. In other words, even if your retirement money is 100% safe, your ability to pay all of your bills for life may not be.

Investing risk and spending power risk are related, of course. The standard approach to dealing with these risks is not to eliminate both of them completely. Rather, the “experts” suggest different ratios of stocks and bonds. They also suggest adjusting those ratios with age.

This conventional approach assumes that historical market returns and fluctuations are indicative of what we can expect in the future.

I’m not buying into that assumption anymore.

Towards the end of the article that responds to the “how do I obtain retirement income without risk” question, the writer starts thinking like me:

Finally, one thing you may not want to take a chance on is the possibility of falling below at least a minimum standard of living. Or to put it another way, you may want to take extra care that you’ll have at least enough income to meet your basic living needs the rest of your life.

That’s another way of talking about “liability-based investing.” The writer mentions Social Security, of course, and then an immediate annuity. The annuity may work but it will cost you a bunch extra to index the annuity payments to inflation. If you don’t, you have not eliminated the risk that you can maintain a minimum retirement living standard.

Thus, the writer could also have mentioned building a portfolio of bonds (I-Bonds) and/or TIPS to provide that baseline retirement income, with inflation protection.

The bottom line for me is that you should attempt to isolate part of your retirement income – the essential needs part – from investment risk and spending risk.  Fooling around with a stocks/bonds ratio will not accomplish that.

Here is a link to the full article: Low-risk retirement

Related posts:

1. Another Retirement Income Strategy to Avoid “Money Death”

My favored approach is to use sources of guaranteed retirement income to meet basic living needs, then increase risk from there. Others have proposed a modified version of the 4% rule. To explain one such version, let’s first review the basics of the 4% rule. It postulates that in your first year of withdrawals, you take 4% of the total value of your retirement portfolio. For each year during the remainder of  your retired life, you  withdraw that same dollar amount, adjusted by the prior year’s rate of inflation.

The 4% rule has been popular for several reasons. First, it helps manage the longevity and inflation risks in retirement. Second, it is simple to use.  Third, it provides retirees a steady amount of spending money each year.

But the 4% rule has serious problems. For one, the rule attempts to combine a rigid spending plan with an investment portfolio that can (and probably will) experience substantial changes in value every year. If the markets are strong, a retiree may end with a large stash of money to leave to his or her children. If the markets are weak, that same retiree could easily run out of money halfway through retirement. In the words of Laurence Kotlikoff, economics professor at Boston University: ”This is a prescription for getting people into serious trouble.”

Now here is an explanation of an alternative to the 4% rule – an alternative that is more likely to succeed in providing a lifetime of investment income: Each year the retiree withdraws a fixed percentage of the current value of the retirement portfolio.

Unlike the 4% rule which permanently establishes a fixed dollar amount plus inflation, the fixed percentage approach causes the retiree to adjust spending in response to market performance. Thus, if the size of the investment portfolio grows from the prior year, the withdrawal amount also grows.  If the portfolio declines, so does the amount of the withdrawal.  Using this technique, the retiree will never run completelyout of money.

The obvious downside to the fixed percentage withdrawal strategy is that there can be significant fluctuations in spending power from year to year. Your standard of living may not be “fixed” the way you would like.

To minimize the risk of extreme fluctuations in spending, you can adopt a more flexible version of this strategy. You do this by placing upper and lower limits on the changes in the dollar amount of your annual withdrawals, based on your prior year spending.

As one example, a retiree may determine to withdraw a fixed 4% of his retirement portfolio each year. That same retiree doesn’t want his spending power to change more than 5% from one year to the next. Assume that a retiree withdraws $40,000 (4%) from a $1 million portfolio balance in year one, and in year two a strong market boosted the portfolio to $1.1 million. A strict 4% withdrawal rule would allow that retiree to withdraw $44,000 in year two. However, by creating a 5% “spending band”, that retiree will limit the withdrawal to $42,000. This is a more balanced approach because spending can remain relatively steady from year to year while also responding to changes in investment performance in a way that will help the retirement investment portfolio to last throughout retirement.

In a further improvement to this fixed percentage withdrawal strategy, you can create spending bands or caps that are not symmetrical. In other words, you allow for more variability on the spending downside compared to the upside. For example, a retiree might might adopt a 3% cap on a yearly increase in the withdrawal amount but allow a larger 5-10% drop if the portfolio experiences a major down year.

I think the fixed percentage yearly withdrawals with spending bands has merit as a strategy for providing a lifetime of retirement income. What do you think?

Related posts:

1. Another Retirement Income Strategy to Avoid “Money Death”
2. Can there be a No Risk Retirement?

Western & Southern is a Fortune 500 insurance company and financial services firm based in Cincinnati, with $34 billion in assets. This morning it announced that as of January 1, 2011, it was cutting retiree payments from its defined-benefit retirement plan (a/k/a pension plan) by more than 30%.

Other changes include elimination of a temporary annuity that’s available to employees who retire between the ages of 55 and 62, and a policy that allowed employees to retire with full pension benefits at age 60.

Western & Southern has been studying their plan for 18 months and concluded that it was underfunded. Unlike government pension providers, a private business cannot print money or raise taxes to solve a problem like this.

Western & Southern retirees now can expect their private pension to cover only about 32% of their final salary.

What is the takeaway for us?  We cannot assume that all of the retirement benefits promised to us by private business will be there when we retire.  That is another loss contingency that needs to be introduced into our planning.

Sad but true.

Read more: Western & Southern to trim rich retirement plan

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1. Can there be a No Risk Retirement?

The presenter was Bryan Olson, a senior vice-president at Schwab’s Center for Financial Research. His talk was jam-packed with high-value statistics and guidance, all delivered with an engaging and confident style. Actually, he had too much content and too little time to present it. But he did a yeoman’s job in the time allotted and even spoke to me after (more about that below).

A lot of the material will be familiar to some of you but it can’t hurt to have it refreshed. So here are some points that I found important.

Only 40% of retirees have actually calculated how much money they will need to retire. This, according to Olson (and everyone else), is an essential exercise no matter how painful the answer might be to your psyche. To start, the two key questions are:

• How much money will I spend each year when I retire?
• How long will I need to spend it?

The longevity part cannot be underestimated. For couples now at age 65, there is a 60% chance that one of you will live to age 95.

Yes, you read that correctly: 95 years old. That’s a lot of life to plan for.

For Social Security, Schwab’s “rule of thumb” recommendation is to wait to claim it and even consider using other retirement assets in the early years to allow that to happen. Indeed, they suggest that if you want to retire at age 62 but cannot make ends meet without Social Security, you should delay your retirement if possible.

On the other hand, don’t count on working longer as a substitute for proper planning: 41% of folks now in retirement were forced there by layoff or health.

For a typical Social Security beneficiary, the break-even point for claiming benefits at age 62 vs. 66 is age 77.  For age 62 vs. age 70, the break-even point is age 79.5.

Now you know why that “living to age 95″ statistic is so significant.

For the de-cumulation phase, Schwab also uses the 4% withdrawal rule over 30 years. It bases many of its calculations on a portfolio with a 60%/40% equity ratio with 8% assumed returns.

I say good luck with 8% returns as an assumption.

Olson had a simple warning for investment yield chasers: Yield is the market’s way of pricing risk.

Turning to inflation, Olson observed that the Fed’s current monetary policy is to push money into the system to prevent deflation. The problem right now is that the money-multiplier effect on which this strategy is based is not operating as expected. Instead, the money system is stagnant.

However, Olson warned that things could reverse course in a hurry, with inflation spikes to follow. Thus, he characterized inflation as a “sleeping giant.”

To counter-act inflation, Olson rejected gold for two reasons. First, gold prices show a poor correlation to inflation. Second, right now more  gold is being bought by speculators than by gold users.

Olson discussed TIPS as an option which pleased me. He noted that the current price of 10-year TIPS indicates a market expectation for a 1.8% inflation rate. He added that if you thought that inflation would exceed that, buy TIPS.

Amen to that.

After the session, I approached Olson and asked him if he was familiar with Prof.  Zvi Bodie’s research and views. I was pleased to find that Olson recognized Bodie’s name immediately. I asked Olson to comment on Bodie’s opinion that the equity markets were not suitable for retirement assets that would be needed to support your basic cost of living.

To my pleasant surprise, Olson said that he agreed that using I Bonds and TIPS (with Social Security) to exclusively fund your essential living expenses in retirement was reasonable approach to the problem. Equities and other investments could then be used to pay for the “wants” in your life, now that your “needs” are taken care of.

Finally, I asked Olson if the Bodie strategy was included in the planning protocols used by Schwab advisors.  It was, he said. Good for Schwab.

Thank you Dr. Bodie and now Bryan Olson. Now you know why and how my plan for guaranteed retirement income was born.

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I will by purchasing some of these ten year TIPS inside my 401(k) plan. Buying TIPS at auction is the best way to obtain a more predictable and fair price, compared to the secondary market.

For more on why I am doing this, go back and read my post on creating a plan for guaranteed retirement income.

Here is the link to the Treasury Auction announcement page.

Do any of you own or plan to buy TIPS at auction or on the secondary market?

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It turns out that most retirees are “cautious” spenders. This is the message from Emily Brandon’s post on retirement spending at Planning to Retire. The retirement spending and retiree wealth pattern data is from a study conducted by the Urban Institute. The study is titled How Quickly Do Older Americans Spend Their Wealth?

Although the study concludes that retirees spend carefully, the overall wealth patterns of retirees vary dramatically depending on pre-retirement income levels.

For example, retirees in the top income category managed to increase their net worth through age 85. Those in the middle income ranges held on to their net worth generally until age 70, at which point their net worth began a slow decline. For the lower income retirees, they quickly exhausted their meager retirement savings and entered a long period of being totally dependent on Social Security benefits and pension income, if they were lucky.

Take a look at the graphed data in the report – it is telling. Yet another report cited by the study authors states that 87% of surviving spouses die with some wealth left over. That’s good to hear.

The study authors made a prediction that is important to baby boomers. Social Security benefits are likely to change and Medicare premiums will increase. This will decrease the amount of income that retirees can replace with their Social Security benefits.

On this issue, recent comments from former Senator Alan Simpson are interesting.  Simpson is the co-chair of President Obama’s so-called “Government Debt and Fiscal Responsibility Commission.”

Most observers believe that this Commission should be called the “do something about Social Security and Medicare commission.” Simpson is known to dislike these government programs in general, which is probably why he was appointed.

On Fox News this past week, Simpson claimed that the problems with Social Security could be fixed in a half-day of work. Maybe so, but he added this:

But the thing that is really impossible to believe is that whatever adjustment we make and whatever has been suggested for the last 10 years in Social Security reform, from top to bottom, you know, new dates, more contribution, none of that affects anybody over 57. Where do I get my mail? From these old cats 70 and 80 years old who are not affected in one whiff. People who live in gated communities and drive their Lexus to the Perkins restaurant to get the AARP discount. This is madness.

(Source)

For the sake of many baby boomers, I hope Simpson is sincere about not applying radical changes to those over 57. Even with cautious spending, we need those Social Security retirement benefits to help us maintain a basic standard of living.

I would like to see more historical retiree spending data like that reported by the Urban Institute. I wonder if the millions of baby boomers can dial back their spending habits when the time comes.

Related posts:

1. Can there be a No Risk Retirement?
2. Get a Lifetime Investment Income From Your Retirement Portfolio

According to a Career Builder survey of over-60 workers who have decided to delay retirement, 72% say that the reason is financial. They do not feel they have enough money to support themselves if they stop working.

Also, 27% of business personnel managers report being approached by older workers who want to delay a scheduled retirement.

Reality hurts.

Source: Over 70% of workers delaying retirement cite money woes.

So what does one do to overcome this “too broke to retire” problem? For many, it’s a matter of making up for lost time.

Forbes published a recent article on what to do if you are over-50 and a late starter on retirement saving. The advice is typical and not ground-breaking. It applies also to folks who are older and need ways to save to generate more retirement income.

Having a specific savings goal is important in these situations. Just thinking “I have to wait – I need more money” is not particularly helpful or motivating. It’s actually depressing.

I would first estimate how much more retirement income you need. (See my article on a Simple Way to Determine Retirement Readiness. FYI – this article was a featured selection in the “Best of the Best in Money and Personal Finance #12.“)

As a simple example, let’s assume that you are 62 years old and have created a retirement spending plan. From that, you estimate you will need to find an additional $800 in monthly income to comfortably retire.

Instead of retiring and taking Social Security at age 62 as you had originally planned, you decide to wait until age 66, your full retirement age.  That alone could add another $500 to your monthly income, all from Social Security.

What about the other $300 monthly income shortfall  - where will that come from? How much more savings do you need to provide that?

At current rates, a 66 year-old can purchase an immediate annuity providing $300 in monthly income for life for a lump sum cost of about $45,000. (I’m not saying that you must buy an annuity. Rather, this is an easy way to establish a realistic savings goal.)

To accumulate $45,000 in four years, run the numbers through a simple savings goal calculator. In our simple example, and assuming a 4% return, you would need to find an additional $880 in monthly savings to reach your retirement income goal. That may not be easy to do but it at least gives you a target to shoot for.

There are other options to a delayed retirement forced by financial problems. One of those options is a phased retirement, perhaps including taking a different job with less stress and greater contentment.

The key is doing something. Floundering around or giving up completely – as so many boomers seem to have done – will make things worse.

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According to this article from Investment News, Putnam investments is introducing a new simplified retirement income calculator for its 401(k) plan participants. The most important feature of this new calculator is that every time a plan participant logs in to his or her account, they will see their account balance expressed as retirement income.

In my opinion, every 401(k) plan participant should not only have easy access to that retirement income prediction, they should be forced to look at it regularly. The calculation and display of the retirement income prediction should be automatic. Isn’t seeing the reality of what income your account balance may provide the best way to motivate a baby boomer to save more for retirement?

Watching an account grow (hopefully) is all well and good but not if the end-game leads to an inadequate retirement income, even when combined with Social Security benefits. If you see a 401(k) balance of $100,000 at age 58 you might think “I’m doing great.” If you see that your predicted lifetime income from that plan balance is $350/month, your level of contentment may change.

I receive similar income prediction information now from my 401(k) plan provider, but I have to use an optional retirement planning tool the plan offers to obtain it. Most people don’t take the time to use that tool. It takes work and it can be intimidating.

I hope that Congress amends ERISA or that the Department of Labor adopts rules that require all 401(k) plan providers to deliver realistic retirement income predictions to plan participants. Meanwhile, you should ask about this feature at work and agitate a little to obtain it. I’ve done that in the past for other aspects of our 401(k) plan, including increasing the diversity of investment offerings.

Remember, it’s not the size of the nest egg. It’s the retirement income that nest egg will provide.

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