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Retirement Risks Threaten Financial Success

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As retirement approaches, the investor contemplates how to eventually convert savings into an income stream without the benefit of continuous earnings from a full time job. There is a good chance that interest and dividend income will not be sufficient to support cash flow needs in retirement and that a withdrawal strategy that includes a reduction in principal will be required.

To that end, an additional set of risks such as inflation risk, longevity risk and sequence-of-returns risk appear on the horizon for the investor and threaten the chances of financial success in retirement. 

Overall, consumers ages 55 to 75 see great value in having guaranteed lifetime income in addition to Social Security.  Most retirees say they receive far more income from guaranteed income sources than from non-guaranteed sources.  According to consumers, the two leading benefits that guaranteed lifetime income products provide are peace of mind and making it easier to know how much to spend. 

Building up enough retirement income to live comfortably until the end of your days isn’t as difficult as it might seem, so long as you start saving and investing early and understand that the process evolves throughout your lifetime. Continuing to throw your hat in the ring over the long term will give your portfolio a chance to outperform and last throughout your lifetime.

Families will have a greater degree of financial security by making retirement decisions earlier rather than later.  But it’s never too late to plan for the future even for those retirees with a solid nest egg and keen planning.  The increasing lifespan and the likelihood of needing significant physical assistance and even long-term-care placement for many years prior to death may significantly undermine financial projections.

The key is to start saving/investing early in life and be consistent (save with every paycheck). The power of compounding is lost on many people. Also maxing out contributions when possible, eliminating debt, avoiding risks with your nest egg, planning for multiple streams of income once retired (pensions, dividends, part time work, etc.) should all be part of everyone’s plan.

Financial experts’ rule of thumb is that retirees need 70 percent of the income that they earned during their working years. If there’s a gap between your savings and the amount you think you’ll need in retirement, you can either work longer, scale back on your retirement plans, consider a part-time job to help cover the shortfall, or buying an annuity can help create the steady and guaranteed income that can give retirees peace of mind.

By purchasing an annuity that, combined with Social Security and possibly a pension, will cover just the fixed costs they’ll face in retirement. That way, they have the confidence of knowing that we don’t have to draw from investments to cover those costs, and regardless of what happens, those costs are covered

Retirement planners have touted the “4 percent rule” for years. Under it, they say retirees can safely withdraw 4 percent of their total assets in their first year of retirement, and withdraw that amount, adjusted for inflation, thereafter. The problem with that, as many new retirees learned in 2008, is that if the market crashes early on in your retirement, your assets could suffer irreparable damage.

The fix, is having a cash cushion to see you through the next market crunch. It is recommended that retirees keep at least two to three years’ worth of expenses in an emergency account, so they can avoid pulling money out of the market when it’s falling. Or have a guaranteed income account.

What happens when one spouse unexpectedly predeceases the other?  Planning for such a contingency need not be overwhelming, but it is vital to fold this concept into your retirement planning as early as possible. The choices you and your spouse make before retiring can make the difference between a surviving spouse living comfortably or one being left with little financial support.

It’s important to think about this issue early on, because once you make a decision regarding the administration of your pension, it’s permanent. If your spouse will need your pension in the event that you die first, then crunch some numbers to decide which option will work best for you.

Guaranteed lifetime income products make it easier to manage a budget and provide more long-term security than other financial product.  A deferred income annuity is similar to an immediate income annuity, however guaranteed income payments typically start anywhere between 5 to 20 years after purchase.

The longer the time between purchase and the start of income, the higher the amount of guaranteed lifetime payment. Many deferred income annuities guarantee payments for 10 years even if you do not live that long. Like any insurance, the benefits received from an annuity contract can be tied to either the lifetime of one person (a Single Life contract) or two people (a Joint Life contract).

An annuity is an insurance contract that provides protection in the event of someone living too long (in the form of a sustainable income stream), whereas a life insurance policy provides protection in the event of someone dying too soon (in the form of a lump sum payment to the estate). Both forms of insurance are based on a mortality table (i.e., a “probability of death” table) managed by actuaries at the insurance carrier.

Deferred income annuities typically make the highest monthly income payments among sources of retirement income and there are no additional costs or fees associated, but you cannot withdraw the cash value of the account beyond these monthly payments. For example, if you deposited $100,000 into a contract at age 55 and waited until age 65 to receive payments, you can expect to receive approximately $9,300 per year for the rest of your life.

Income Annuities are used in situations where the investor needs to create – and specifically define – a source of guaranteed and predictable income.  There are no explicit fees associated with an Income Annuity. Like a Bank CD, these expenses are embedded in the rate you are given.

When withdrawals are made from a retirement savings account, the investment performance or return of the account can be negatively impacted in a significant way, especially during a down market. On the other hand, if withdrawals take place during an up market, the account is not as severely impacted.

The timing of market returns is important and is an additional risk that needs to be addressed. As an individual, one does not get to choose retirement based on what market sequence will materialize. Sequence-of-Returns risk may force the individual to adjust his/her standard of living in retirement and, in extreme cases, can cause a dependency on social programs, friends, and family.

By allocating retirement savings across investment and insurance-based products in proper proportions, one can effectively combat the additional risks found in retirement (inflation risk, longevity risk, and sequence of returns risk).

The impact of longevity and the risk of outliving one’s investments are real. Rather than trying to predict the future for inflation, longevity, and sequence-of-returns in the market, an investor should consider insuring against potentially adverse outcomes by adopting a product allocation strategy that aligns different types of annuities combined with investment accounts that can balance and fine-tune the sustainability and legacy trade-off throughout retirement.

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Monday, October 20th, 2014 Wealth Management

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