Retirement - Will I Run Out of Money?

Will I run out of money in Retirement?

Most likely, our greatest fear as we are nearing or in retirement can be stated in 8 simple words; "Will I run out of money in retirement?" I can see the wrinkled nose and sweaty palms start to kick in as the stress levels rise after someone asks that question. Moreover, it's not an easy quantifiable answer. It's better addressed as "it depends" since it is dependant on various moving parts such as interest rates, inflation, withdrawals, etc. that muddies the income and savings waters.

As a Retirement Counselor, I have to sit back, take a deep breath, and then start to outline the events and circumstances that "could" result in a shortfall of money during your retirement. In this blog post, I will explain a few of these, along with some 'traps' and 'potholes' to look out for on the road to (and in) retirement.

First off, "running out of money in retirement" needs a proper definition. Do you mean running your investments and savings plans to zero? Or do you mean running out of INCOME that those investments can produce? Or is the better question still, "will my current lifestyle be reduced in future years by my choice of investments today", or "how can my current plan to live in retirement be re-worked so I increase my odds of not running our of money" You have to be specific with your question to allow your advisor to give you a more specific answer based on the economic assumptions and historical outcomes.

Once your question is framed in an succinct manner, next you must consider what you are comfortable doing. What is your experience, temperament and willing risk level? Follow me here. If you're a saver and like bonds and CD's, and think stocks are risky, then say that. If your retirement plan owned mutual funds and they worked out, then you can stomach some risk of owning stock-based investments . Where I find most investors get side-tracked is when they do things that are really against their nature or experience, and they allow emotions to color their thinking, often to their detriment. Also, they don't think things through money-wise or they think too much and change their strategy so often that no undertaking has a chance at success. Let's look at some numbers and options that could help you with your retirement planning.

Consider a retirement portfolio (IRA, brokerage account, etc.) that contains $50,000 in bonds and $50,000 in stocks. The stocks are high quality and pay dividends equal to 2% per year. The bond portion pays 5% in interest income. So that's $1,000 from stock dividends plus $2,500 in bond dividends totalling $3,500 income per year. Not bad; that's close to $300/month in income. If the bonds and stocks continue to pay, then it's fairly safe that your income will stay level, or even rise over time as the stock companies increase their dividends if business does well.

Appreciation vs. Income: Where investors go awry is when they confuse 'appreciation' with 'income'. Appreciation is the rise in value of a stock, bond or mutual fund. Income is the earning of dividends or interest from a stock or bond or mutual fund. From my example, what could happen to de-rail your efforts and lead you to running out of money prematurely? Answer: Spending more than you earn.

Suppose your stocks go up in value 25%, to $62,500, and the bonds stay at $50,000. Now you have $112,500 total, right? You may think - OK, now I'll take $1,000 more from my account each year since I've made some money in my stocks - you now take $4,500, or
$375 a month. Whoa there big spender! Where are you getting the extra $1,000? You have to sell some stock(s) or bond(s) to get it ... you are now spending your principal, since your dividends and interest are still $3,500 per year. Spending beyond what your portfolio
earns is spending your principal. For every $1,000 in stock you sell, you are reducing your future income by $20/year (2% of $1,000, and $50/yr. for every $1,000 in bonds sold). It's emotionally warm to think that way in a bull market, but how 'bout when the 25%+ bear
market hits, (we just had one) and your account is now down to $87,500 ($50,000 bonds + $37,500 stocks). De-rail your retirement pothole #1: you will never run out of principal if you don't spend any. Rule: 1a: If you decide to spend principal in the good times, be
prepared to stop spending principal in the bad times. Remember: income from dividends and interest is fairly stable. Appreciation from stocks and bonds is not stable, and cannot be relied upon year to year. Better idea: when stocks rise, move some of that appreciation (gain) to the bonds; now you will earn more income - 5% from the bonds vs. 2% from the stocks.

Taxes and Inflation: The second area of real imporance ignored by most investors, the media and and to some extent by the investment companies, is the effects of inflation and taxes on your retirement money. It's what you keep that counts. We all hate taxes and the darn tax code is changed so often by Congress that hardly anyone can keep up with it. Inflation is a bit easier to figure out. To keep the example easy, say you are earning 5% on your combined stock
and bond portfolio. Taking 15% in taxes away, you now earn 4.25%. Now subtract 3% inflation, and you're left with 1.25% - not much of a gain now, is it? De-rail your retirement pothole #2: be aware of the inflation and tax hits that will occur when you design your retirement income plan.

Maximum withdrawal rates. Multiple studies on this topic have been penned in the last 25 years, and the consensus is a 4% to 4.5% rate of withdrawal would prevent running out of money during a 30 year retirement time frame using 50% stocks/50% bonds. This plan does not consider principal vs. income like above. You take your starting account value and withdraw 4 -4.50% year after year. Another plan I have seen put forth is to withdraw your portfolio's total return (appreciation + income) after subtracting the inflation rate. For instance, your portfolio gains 10% for the year (8% appreciation + 2% income); you can withdraw 7% that year. Why? Because if you earn 10% and inflation is 3%, then you are leaving that 3% gain in the portfolio to offset inflation in the portfolio that you will need next year. That would take some mental math on your part, because you would adjust your income each year depending on your portfolio value and the cost of living (inflation) from the prior year. Where this plan could backfire is when your portfolio loses money, such as last year, so that no withdrawals would be taken. Can you put your retirement income on hold and await better times-probably not. De-rail your retirement pothole #3: Be flexible; work out more than one plan for your retirement income, using more than one portfolio or investment.

Finally, remember - I've used one example of a 50%-50% portfolio mix today. You may own other investments that guarantee your income, such as a pension, social security or an income annuity. The safer the guarantee, the more choices you will generally have with your remaining investments.

Bonus questions & FREE Retirement Calculator. If you earn 5% each year on your portfolio, and withdraw 7% of your principal each year, plus a 4% increase each year to offset
inflation, in what year will your account reach zero? Answer: 15 years.
Reply to this blog by clicking on the comment link below, or send me an e-mail to: barry@stetsonwealthmanagement.com and I'll send your paper retirement planning calculator by mail or pdf file.

I hope you've gleaned some useful information today.

Barry Unterbrink
Chartered Retirement Planning Counselor; Portfolio Manager
(954) 719-1151

60 Minutes' 401k Recession broadcast analysis

Dear clients and friends:

Last Sunday's (4/19) broadcast of CBS's 60 minutes included a segment on the 401k plans that many americans have relied upon to help fund their retirement needs in later years. If you missed the broadcast, you can replay it on the network's web site at: http://www.cbsnews.com/stories/2009/04/17/60minutes/main4951968.shtml

I feel the journalistic message delivered was helpful, raising important questions that should alert you if you own a 401k or retirement plan. Coincident with the above, the tone by the participants and interviewers was very dour and pessimistic. CBS News Steve Kroft was the reporter, who chased down financial friend and foe that had interests in the 401k plans. The parties included investors, retirement plan designers, and politicians trying to help with some new legislation.

More than one investor's story was told about losing money in their retirement plans. Kathleen Coleman was the headliner interviewee at age 54. Her 401k plan balance declined from $88,000 to $50,000; "I don't deserve this" she says. Worker Alan Weir opened his 401k statement on-air; he lost half his money in a number of months and expects never to see it come back. Hold the story: Alan, open your statement when you get it, take some action! What are these workers thinking? They are all old enough to remember the dot-com meltdown, the subsequent 100% stock market gains from 2002-2007, and the great bull market run of the 1990's. If you are loaded to the gills with stocks or stock mutual funds, you will get mauled in a bear market. Some will get hurt less than others. Suggestion: learn some tactics that will preserve your retirement money when the markets turn ugly. From the performance shown by these investors, I gather they had 70% or more of their plans in stock-based funds. Did they seek outside advice? Attend the 401k employee investment meetings? Consider other options? Ask lots of questions? Look at a chart?

I wonder when these interviews took place? The stock market has gained about 25% since early March. CBS should do a follow-up in a year with the same investors to see how they fared, but that will never happen.

David Ray, President of the 401k Council of America told it fairly correctly - the plans did not let people down - the investments and stock prices let people down. The plan participants (employees) were not aware of the risk of owning ABC or XYZ mutual fund. Consider: Last year, 373 stocks on the New York Stock Exchange gained in value; that's just 1 in 12; in 2007 it was 1 in 3. You can't make decent money as a stock investor with these odds against you in a crappy market, and most mutual funds will follow the direction and velocity of stock indices. You can lose big time if you don't have a game plan. Mr. Ray ended the interview paraphrased 'the realities are the you cannot count on it coming back; do not have unrealistic expectations'. He did look foolish at the end of the segment and danced around the legislative jam on getting disclosure with the fees. Being a lobbyist for the industry tells us all where his allegiences stand. He ended by chiming that we need to be truth-tellers to investor's; they can't count on the money come back, but maybe it will. Why not end on a positive note? I wonder how many people sold their 401k stock funds the next day or since then based on this reporting?

Virtually all retirement plans offer offer safer non-stock based options: money market funds; stable value funds; US Government Bond Funds to name a few.

Concerning 401k plan fees, this was an eye opener for most and good reporting. True, the fees in the plan prospectus are confusing, and I would support legislation that presents full disclosure. For now, it's a call by you to pick those funds with lower fees. I would select from the lower cost stock index funds if they are offered. Some plans that I have seen offer only one fund in each category; that's just not right. You need some selection since that fund can be a real 'dog' and not perform well. Also, I suggest comparing your 401k mutual fund with the same fund outside of your plan to see how much higher the fees are inside your plan. True, fees can be a drag on your performance, but it looks much worse in down markets, when you're not getting any return on your money and still paying the fees.

The 401(k) Plan Escape Hatch

Did you know that retirement laws allow employers to offer options to "move your money" from the plan to another investment account (I.R.A.), etc. while still working? It requires adding a provision to the plan that allows this (write this down), IN-SERVICE, NON-HARDSHIP WITHDRAWALS. Ask your human resource office if that is allowed in your plan today. If it is, get the paperwork to get it started if you're not happy; if it's not, ask them to check with the plan administrator to see if they can adopt it. I've been told mistruths and run around on this, so you must be persistant. Call me if you want me to help you through this.

FREE REPORT ... Tapping Into Your 401k Money Before Retirement
This report, by a noted retirement planning expert I use, details the ways to go about your quest to be "401k free" with all or a portion of your money. It's about a 20 page read. Ask me for a copy and I will e-mail you the *pdf file. What could be more important financial-wise than your future and retirement goals. e-mail me at: Unterbrink@usa.net and ask for the 401k Escape Hatch Report.

Thanks for reading.
~Barry Unterbrink