Longevity Risk

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Income Generation In Retirement

I think people who are near retirement and/or already retired are fearful of when the next shoe’s going to drop.  In an effort to stimulate economic growth, the Federal Reserve introduced a zero interest-rate policy, which it has maintained.Interest rates have remained at historically low levels for seven years.  This policy is the Fed’s war on seniors and savers, as the artificially low interest rates have pushed yields on traditionally conservative investments so low that it is impossible to exceed the inflation rate of key expenses for retirees.

The Federal Reserve is expected to begin raising interest rates soon, however, even if the Fed decides to begin the process of raising interest rates tomorrow, which would be the first time in almost a decade, their pace will be incredibly slow and methodical.  They have turned savers into financial eunuchs, unable to reproduce and grow their retirement funds to maintain expected future lifestyles.”

Today the overwhelming majority of CDs offer less than one percent.  Being in bonds isn’t an attractive proposition either, because bond prices generally fall as interest rates rise.  The problem is, the market has evolved to the point where these are no longer suitable vehicles to generate income for retirees, and those who refuse to accept this reality and remain over-allocated to cash investments are doing nothing more than “losing money safely.”

The result of all this is many of today’s strategies for income generation require the use of riskier assets, such as equities and other alternative investments. Perhaps the biggest fear we see is the concern that retirees will run out of money before they run out of breath.  The length of your retirement, volatility in the markets and shifts in public policy are all threats that are largely out of our control. All of those threats could jeopardize your long-term financial stability.

Add to the equation the fact that Employers have shifted from traditional defined-benefit plans to defined-contribution plans so workers will have to take responsibility for planning for retirement.  401(k) plans, were originally introduced as a way to supplement the retirement income workers could expect from their defined benefit pensions, but now 401(k)s  are the primary retirement savings program.

When we talk about defined contribution plans in the not-for-profit sector, we’re usually talking about 403(b) plans, as opposed to the 401(k) plans that are widely used among for-profit companies. Both plans share common features, such as retirement savings funded through employer and employee contributions, but there are differences.  The most important distinguishing feature of 403(b) plans is that they were designed to provide lifetime income for people in retirement.

Whether you are saving through a 401(k) or a 403(b), workers love to see account balances grow. But retiring with a large account balance can give a false sense of security. Without knowing how long they will live, there’s a possibility that even with a large nest egg, plan participants will outlive their savings. A better focus for savers is to think about how much monthly income their savings will generate.

While many of the threats to your financial security are outside of your control, strategies that can limit their impact are within your grasp.  Additionally, longer lives are reason to celebrate, for sure, but also reason for workers to ask: “Can I afford to be retired for 30 years or more? We believe that retirees should gradually de-risk portfolios.

People who don’t annuitize can access a number of drawdown products and strategies to try to avoid running out of money in retirement. But even the most prudent drawdown strategy might leave retirees vulnerable to longevity risk and market fluctuations. Only annuities provide guaranteed income for the rest of a retiree’s life.

Buying an annuity that generates lifetime income could very well be a good move for a retiree and their spouse, as a variety of studies show that guaranteed income often makes for a happier retirement. Not surprisingly, people seem to enjoy their post-career lives more knowing that they’ll have income they can count on no matter how long they live and regardless of the ups and downs of the financial markets.

Investment accounts and retirement accounts (especially those that generate significant dividend income) can grow your wealth the fastest, but they can also fall in value if the economy goes through tough times. That risk might keep you at night, and when you’re living off your retirement savings, a market crash can be devastating.  A great benefit of annuity income, like Social Security income, is that once it starts, it can keep paying you for the rest of your life — with little effort on your part.

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Friday, December 4th, 2015 Wealth Management Comments Off on Income Generation In Retirement

Protect Your Retirement Income

Gloom and doom is back in fashion for the American economy. A growing number of economists predict it is heading for another recession sometime soon, and only 1 in 5 Americans believes it’s getting better.  What really happens going into and then during the retirement years. It turns out that actually retiring is just not as easy as it is to define. A key consideration ahead of time is that spending changes around retirement are a crucial part of life.

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?” Outliving retirement savings and having enough income in retirement are real concerns as retirees are living longer and are more active in their retirement years.  However, every rose has its thorn, and longer lives happen to create some problems for retirees.

As people live longer, they spend a larger fraction of their lives in retirement.  It is not uncommon for at least one of a retired couple, if not both to survive into their 90s. If this couple retired in their mid- to late-60s, retirement becomes a 25- to 30-year plan. In a way, this is like a whole another career.

Once you hit retirement, the idea is to de-accumulate the retirement assets in a way that will provide you with a cash flow that will more or less match your spending. Having assets during retirement is a great thing, but if you can’t effectively draw on your wealth to satisfy your spending in retirement, it won’t adequately serve your retirement needs.

Knowing what factors you can’t know, are there things you can do to guard against these uncertainties?  There are two important factors at retirement you can never know for certain. These are:

  • how long will you will live, and
  • how your investments will perform.

While most retirees want guaranteed income for life, they are in the dark when it comes to an important retirement solution.  The economic events of the last few years have devastated retirement funds with stock market fluctuations and made it hard to save and more uncertain to invest.

Low yields present retirees with a difficult choice: Accept the lower income offered by safer bank CD’s, and bonds or take the risk of gambling in the stock market for a potentially higher return. Many people are tired of taking risks and gambling in the stock market.

In our society, those who are old and without savings have to make it on their government or company retirement checks, work part time, and live very frugal lifestyles. Boomers who come to their retirement years with few resources or with resources depleted by the economy are finding themselves in the same boat.

Retired and near retiree Investors want to invest in a retirement vehicle that will show a positive growth from now until retirement.  To effectively position your portfolio to address retirement income needs, you should create two sub-portfolios. The first is the floor portfolio, which focuses on providing necessary income. The second is the upside portfolio, which is an investment-oriented portfolio that seeks to capture the gains and positive performance in the stock market.

The key is to refocus your retirement planning efforts with an approach that emphasizes cash flow over account balances.  If you don’t need to convert your whole pension into a secure income for life, using the drawdown method could provide a flexible retirement income. However, income in drawdown is not secure and taking high withdrawals may not be sustainable, jeopardizing your long-term income.

The amount of income you receive is dependent on how long you live and how well your investments perform. Drawdown is a high risk option as income is not secure, if you take too much out or your investments don’t perform well, you could be left short of income.

The so-called “4 percent rule” has been a default planning tool for nearly three decades. But that rule, forged in the previous era of low volatility and high interest rates, is out of date in today’s low interest-rate environment.  In today’s low-return environment, retirees can’t safely take 4 percent annually from their portfolios.

In the current environment of low rates and low returns, a retiree would quickly eat capital by following the 4 percent rule. That’s why those near or in retirement instead to focus on how much money they need to cover basic living expenses, rather than simply expecting to spend 4 percent.  2 percent is a “safer assumption when you are managing long-term market risk.

Annuities can provide a guaranteed stream of income that retirees top off with fluctuating income from an investment portfolio. The idea is to structure guaranteed income using low-cost annuities and should be a ‘bedrock’ for all essential spending in retirement, due to its guaranteed value.

Annuities at least provide a baseline so that “you don’t have to worry about running out of gas on the road to retirement.  By ensuring the guaranteed income can cover the ‘essentials’, the remaining from alternative income methods can be used for enjoying retirement.

Whether you want to solve for income, principal protection, or legacy, annuities should be purchased solely for their contractual guarantees.  Annuities can form an important component of a retirement plan because they provide guaranteed income for life that is protected from stock market volatility.

Annuities are an insurance policy against the unknowns. Once set up, annuities pay the agreed amount even if the markets are falling and they promise to pay for as long as you live (even if that’s for as long as age 120).  Annuities are an ideal solution to help alleviate some of that financial uncertainty and provide peace of mind and financial stability.

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Friday, November 20th, 2015 Wealth Management Comments Off on Protect Your Retirement Income

Buying a Retirement Promise

Making sure you are protected from as many worst-case scenarios as possible is as important a part of retirement planning as saving money.  Ideally, your retirement fund will have multiple sources contributing to it. By this we mean, you’ll have Social Security, private retirement accounts, and maybe even a pension contributing to your overall income during retirement.

The reality is we are all living longer and the increased life expectancy is having an impact on retirement.   Most retirement savings plans have changed from those sponsored by governments or companies (defined benefits) to those where the amount of saving, asset allocation and market returns determine how much cash people have in retirement (defined contribution) that it’s up to the individual to manage “longevity risk — alongside investment and inflation risk — to the individual”.

“Longevity risk”. Put simply, is the term that refers to the chance that you’ll run out of money before you die.  Retirees are living longer and need to plan for advanced age. A couple age 65 faces a 50% chance one will live to age 93 and a 25% chance one will live to age 97.  God forbid, they reach very advanced ages and outlive their savings. For the risk of outliving assets, the focus needs to be on incorporating longevity protection.

Years ago, managing your investment portfolio was pretty simple: Invest in 60% stocks and 40% bonds and rebalance your assets once a year.  In the past 15 years your equity account has had a zero real return. In addition, today, low interest rate policies being run by central banks around the globe have an adverse impact on savers and retirees. This has crushed the returns you can get on money by parking it with a bank.

There’s the historic low-interest-rate environment, but also the fact that people are living dramatically longer. Because of this uncertainty, it’s a good idea to develop reliable sources of retirement income that will last for the rest of your life, no matter how long you live

There have been three rules for people considering retirement: Save well, invest well, and de-accumulate well.  Those were not terribly bad rules a generation ago, but they’re now just outdated with our present economy. For most of us, the hope of one day collecting a pension has faded as pensions have mostly been phased out in the U.S.

As we figure out how to generate the income we’ll need to support ourselves in retirement.  If you want your money to last, solve longevity, and not have a drawdown of principal, then you have to change your asset allocation, radically, to protect the fund from increased market volatility which is when market risk damage the returns of your portfolio.

With the prevailing mindset around retirement planning today being one of accumulation, retirees often are left ill-prepared to shift their focus to generating income. Successfully converting accumulated assets into an efficient lifetime income stream is a very real challenge for retirees.

Retirees that use non-guaranteed products to take systematic withdrawals or interest payments, while this allows the retiree to participate in market appreciation, the lack of longevity protection makes it difficult to know how much it is safe to withdraw each year.  Even among professional money managers and advisers, the “safe” withdrawal rate for retirees is now debated to be 3%.

When the worst happened, insurance could prove the difference between maintaining a reasonable standard of living and losing everything you have worked for. If you want to provide yourself with a safety net, consider using a portion of your retirement savings to establish an income annuity with a guaranteed lifetime withdrawal benefit. This helps you find a balance between the need for guaranteed income and your goal of not over insuring for the future.

Fixed Indexed Annuities are not appropriate for every investor, but they do have their place and can be a nice complement to help create a well-diversified portfolio. In the end, increasingly more investors do not mind locking up some of their safe money to earn potentially above average rates in exchange for no risk to principal assuming you hold the investment to term and avoid taking withdrawal above what the FIA allows “10%”) and significantly less volatility in returns.

Annuities are well-suited to serve as a platform to address retirement income management providing longevity protection that will continue the income stream at the same level after the account value is exhausted.  It’s better to think of it as buying a promise: a promise that if something goes wrong, you’ll be protected.

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Thursday, November 12th, 2015 Wealth Management Comments Off on Buying a Retirement Promise

Bulletproof Retirement Income

If you experience a big downturn early in retirement, you not only have the initial problem of a lower account balance, but you also compound the issue with potential withdrawals.  The effects of the early down years is a result of “sequence risk,” or the effect that timing has on long-term portfolio returns can make a big difference in retirement.

The markets might be efficient in the minds of some, but they certainly aren’t fair. An unlucky sequence of bad investment years at the wrong time can derail retirement savings.  The upshot may be that plans based on average return assumptions understate the risks involved and may cause a disruption in retirement.  Couple inflation risk with increased life expectancies, and the possibility of outliving retirement assets becomes a very real concern.

If you participated in a defined benefit pension plan for most of your working life, your retirement planning has essentially been taken care of.  For everyone else, retirement planning essentially consists of salting away the right amount of money in the right investment vehicles so that you accumulate sufficient wealth by the time you retire.  . Everybody knows that planning for retirement these days is full of uncertainty.

Long ago a lot of companies had pension plans and that kind of made retirement planning easy because it wasn’t necessarily wasn’t something that the individuals had to do alone. Our grandparents had it relatively easy. They could count on the combination of the Social Security and Medicare systems in addition to the many employers who maintained fixed pension plans that, like clockwork, wrote monthly retirement checks to their former employees.  Those simpler times, however, are gone

Changes in our retirement benefit structure play a big role in account balances – especially the sharp decline in the traditional defined benefit pensions.  The first mistake for most is failing to understand that saving for retirement is no longer the responsibility of your employer or union through a defined-benefit pension plan. It often now falls completely on you. Many are not saving enough in defined contribution 401(k) or 403(b) plans to make up for the reduction or absence of that traditional pension.

How do you know if your assets can weather the current — and any future — downturns and storms?  Your nest egg will eventually be your source of income, and it’s important to ensure you can make it last through your golden years.  Retirees who live longer will need their portfolios to last longer.  The current low-interest-rate environment also complicates retirement calculations. Yields are low and equity returns are uncertain.

Retirement planning has been traditionally provided in one dimension, with a focus on financial matters only. But increases in longevity, and ongoing uncertainties about being able to fund your own retirement, require a whole new way of planning for retirement.  You may be retired for nearly as long as you working life.  The so called ‘golden years’ may not be golden for many workers.

Replacing a paycheck and living on a fixed amount may seem intimidating, but making your retirement funds last is crucial. Nobody wants to outlive their money, and everybody wants to know they can meet their core financial needs once they stop getting a paycheck.

Like it or not, today a successful retirement outcome requires a great amount of attention and planning. It’s really on your shoulders to annuitize a portion of 401(k) assets and create guaranteed income streams in retirement.  Income sources that take day-to-day management out of retirees’ hands provides retirees greater peace of mind; it really helps to create pension-like income sources to support you in retirement.

We’re living in an uncanny era of persistently low interest rates, and the odds are strong this will not change meaningfully, despite the likelihood the Federal Reserve will soon start modestly increasing rates. Smart investors, especially retirees, would be wise to come to grips with this and invest accordingly — and that means select people should consider the purchase of an immediate annuity to enhance and help bulletproof their portfolio.

The immediate annuity most typically purchased is called “a life with cash refund,” is fundamentally simple. The buyer receives payments for life. If he or she dies before collecting all of the principal in payouts, the remainder is paid to the beneficiary in a lump sum.  When all is said and done, immediate annuities are one of the best ways to help cope with today’s extraordinary economic vagaries.

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Thursday, November 5th, 2015 Wealth Management Comments Off on Bulletproof Retirement Income

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