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Predictible Stream of Retirement Income

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The market has been volatile and there is talk of another drastic drop in the stock market. Many on Wall Street had expected an easy ride for stocks into the end of the year, with a Santa rally capping a year of gains. But the mood has soured this week.  Just several days ago, the market was buzzing with talk about Dow 18,000. The Dow lost 1.5 percent to 17,533 Thursday.

You may be labeled as “pre-retirees,” which means we can see the sun beginning to set on our working years.  Retirement planning has a lot of moving parts, factor in things like taxes, inflation, distribution strategy and uncertain investment returns.  In order to retire financially secure, you need to have a plan.

Although boomers are optimistic about retirement, many are concerned about meeting their financial needs in retirement. Are you nearing retirement and fretting about what income you can pull out of your 401(k) or IRA? We have a recipe for you. It’s a way of converting a lump sum into a very predictable stream of cash payouts. It won’t give you a huge return, but it may succeed in taking some of the financial worry out of old age.

You may be looking for a sustainable investment and making a sustainable distribution strategy requires a long-haul approach.  Once you reach retirement, you must rely on the wealth you accumulated to pay the bills as you probably do not work. In this state, you use money generated from your portfolio or you make withdrawals.

There can always be the question of whether or not you and/or your spouse will outlive the money.  Life expectancy of a 65-year-old has grown by 37 percent since 1950. The amount of money needed to fund a secure retirement has grown as well. A 2013 Government Accountability Office report stating “middle-class retirees should convert at least half of their retirement savings into a lifetime income annuity”.

It is difficult for the average person contemplating retirement to determine how to drawdown his/her wealth.  Choosing a wealth decumulation and consumption strategy that maximizes lifetime income is a source of uncertainty.

  • Number one you need to answer the question, what are your expenses?  You need to include your mortgage payment, your annual insurance payments, your property taxes, income taxes, vacations, entertainment, tithing, charitable giving, even the money you spend on your children.
  • Number two, find the difference between your expenses and your income. Multiply that number by 25, and then multiply that sum times 12. Why?  25 is 4%, which is the suggested withdrawal amount. 12 is the number of months in a year. By doing this calculation you have just learned how much money you will probably need to live on. You will also know if you have work to do or if you are there already.
  • You’ve probably heard people say you can’t take out 4% any more. With so much volatility in the market, you can only withdraw 2%. If you don’t have a sell strategy that helps to protect you from bear markets, that could be true. You’ll need to go back to Step No. 2 and recalculate, multiplying the difference between your expenses and your income by 50 and then again by 12. And when you look at your new total, you may decide you can’t retire.
  • Number Three, Dedicate an emergency account that would cover several months’ worth of expenses.
  • Number four, Asset allocation — or how assets are divided among different classes, such as cash, stocks, bonds, real estate and so on — plays an important role in both the risk and return of your portfolio. The longer you have until retirement, the more aggressive you can afford to be. The closer you get, the more important it becomes to have a balanced portfolio with both stocks and bonds.
  • Number five, Seriously consider getting long-term care coverage. It will help cover costs like home health services, assisted living, skilled nursing care and specialized memory care. Those types of care can be expensive — the median cost of one year in a nursing home is about $77,000 — and can quickly deplete your nest egg.

Having more than 80 percent of your portfolio allocated toward stocks could open you up to significant losses that might force you to delay retirement if we have another major downturn like we experienced in 2002 or 2008.  A common rule of thumb is to take 100 minus your age and put that percentage in equities, but that guideline looks dated for a few important reasons.

First, people are living longer now, which means their assets need to last longer too. Being too conservative can mean not keeping pace with inflation and running out of money too soon. Second, interest rates are at historic lows, which will affect the risk and return of bond portfolios. So for those looking for a simple guide, it’s probably better to take 110 or 120 minus your age and put that in equities.

People often misunderstand the rules about drawing down their assets in retirement. People forget that they need to start taking required minimum distributions from their individual retirement accounts and 401(k)s after age 70 ½. For those nearing age 70, an important milestone that affects all of their tax-deferred retirement funds is approaching. By April 1 of the calendar year after reaching 70, minimum withdrawals based on age must begin if the annuity option has not been chosen.

Prior to the issuance of regulations announced by the U.S. Department of Treasury (Treasury) and the Internal Revenue Service (IRS) in July 2014, longevity annuities were, as a practical matter, not accessible to DC and IRA investors due to Internal Revenue Code rules that require distributions from a DC or IRA account to begin by age 70 ½, which is prior to the age longevity annuities are designed to begin income payments. With these new regulations, qualifying longevity annuity contracts (QLACs) are exempt from required minimum distribution (RMD) rules within prescribed parameters.

An annuity is the flip side of life insurance. Life insurance protects your loved ones if you die too soon. Annuities protect you if you live too long. With a classic annuity, you are essentially buying a pension for yourself. That design is very much in line with what people had in their traditional pensions. The value of their benefits grows over the years, and the only thing they have to do, at some point in the future, is turn on the income stream.

Don’t think of annuities as a type of investment. They are a way to convert savings to guaranteed income. Investments involve calculated risk. Annuities involve minimal risk. The whole point is that you know how much monthly income you can count on. Do consider buying an inflation-protected annuity, which increases the payments each year to keep up with the cost of living.

Whatever is going to happen with your annuity can be found in the policy that is issued by the carrier. There are no surprises, secrets, or hidden gotchas in the contract. Nothing is over hyped or bullet pointed in the policy. There are no hypothetical, theoretical, projected, back-tested, or hopeful return scenarios in the annuity contract. It is what it is.

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Thursday, December 11th, 2014 Wealth Management, Wealth Preservation

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