How to Avoid Outliving Your Money
Running out of cash in retirement is a common fear, but don't let it scare you to death. Here's how to stay in the money.
Chris Farrell is senior economics contributor for American Public Media's Marketplace and author of the forthcoming Unretirement: How Baby Boomers Are Changing the Way We Think About Work, Community, and The Good Life.
Yes, for years you’ve been diligently socking it away in your 401(k), 403(b), IRA or a similar retirement savings plan. But the stash may look paltry after two bear markets and two recessions in less than a decade.
Then, maybe, you come across sobering calculations like those by Jonathan Skinner, a Dartmouth College economics professor, in his article "Are You Sure You’re Saving Enough for Retirement?" Skinner figures that a married couple with two children, an income of $136,000, and a mortgage-free home should have about $850,000 in savings when they retire at age 65 if they plan on maintaining their standard of living in retirement. At age 55, this same couple would be on target if they’ve amassed a shade over $500,000. But in reality, according to the Employee Benefits Research Institute, a boomer in his 50s who has worked at the same employer for 20 to 30 years has saved an average of just $180,000 in his or her 401(k).
Little wonder that you may be haunted by the dreaded thought that you’ll outlive your savings, eking out an existence in the latter stages of life reminiscent of William Butler Yeats’ bleak picture of old age as a “battered kettle at the heel.”
Wall Street rocket scientists, finance scholars, benefit consultants and retirement savings product designers are well aware of the worry. They’re devising so-called longevity investment products sold by financial advisers — many of them hybrids combining elements of annuities (monthly checks for the rest of your life), life insurance and perhaps long-term care insurance — to ease the fear of a financial shortfall in retirement. Pension mavens on Capitol Hill and in the executive branch are also working on new rules that would encourage savers to embrace longevity products or at least make it easier for them to participate in employer-sponsored savings plans.
These innovations are heading in the right direction. But the early generation of new financial products is usually better suited for a well-heeled niche than the average household. The risks generally are not well known yet and the investments are often expensive. If history is any guide, however, the experience of niche buyers will eventually lead to mass-market versions.
So what should typical workers in their 50s and 60s do in the meantime?
For one thing, continue to save. That advice is obvious, but it’s worth repeating.
Most people should also plan on working longer.
And anyone approaching retirement should become familiar with one of the oldest type of longevity product — an immediate annuity (more on this in a bit).
Surprisingly, when it comes to outliving your money, asset allocation doesn't matter as much as most people think. Despite all the expert exhortations about proper diversification, it turns out that tweaking the mix of stocks, bonds and cash in your retirement portfolio won't substantially increase the average boomer's future wealth.
The reason: Most people set aside only modest sums in their 401(k)s, 403(b)s and IRAs. So even if they manage to increase returns by embracing stocks, the amount of extra money generated by this strategy probably won’t add up to much.
In their recent article, "How Important is Asset Allocation to Financial Security in Retirement?," scholars Alicia H. Munnell, Natalia Sergeyevna Orlova and Anthony Webb at the Center for Retirement Research at Boston College looked at a typical 57-year-old approaching retirement.
In one simulation, they assumed the pre-retiree had a $62,600 income and $60,500 in a 401(k)-type account invested 57 percent in equities. The gain from putting 100 percent of that portfolio in stocks instead — earning the historical average annual return of 6.5 percent — would be an extra $25,700 at age 66, just over four months' salary. That isn’t much to justify the gamble inherent in picking stocks. The impact of asset allocation is greater for wealthier households.
Still, the authors say, “The typical 401(k)/IRA balance of households approaching retirement is less than $100,000, which suggests that the net benefits of portfolio reallocation have to be modest for the typical household.”
A more powerful approach to avoid outliving your money, the authors say, is to work beyond age 62. Delaying retirement until 70 reduces the required savings rate for an adequate retirement income by roughly two-thirds, they estimate, for someone with a median income and a retirement savings plan.
The payoff for working longer is evident in several other ways: Social Security benefits are more than 75 percent higher at age 70 than at 62; earning some income well into the traditional retirement years lets you make additional contributions into a retirement savings plan; and when you finally quit working, you’ll have already shortened the amount of time you'll be relying on income generated by your savings. (Mandatory withdrawals from most retirement plans don't start until 70½.)
The results of the center’s study and others like it show that our definition of planning for retirement is too Wall Street-centric. Too many retirement-planning tools focus on coming up with an “optimal” asset allocation.
As I mentioned earlier, I think you would be wiser to consider putting some money into an immediate annuity, also known as a life annuity or an income annuity, when you retire.
In essence, an immediate annuity lets you invest a sum of money with an insurer and, in return, receive a predictable income stream for the rest of your life. The checks come either monthly, quarterly or annually, depending on the payout option you choose. (Next Avenue has an article from the National Endowment for Financial Education with a detailed explanation of immediate annuities.)
Immediate annuities aren’t for everyone — far from it. They’re complex products, so you’ll want to investigate the advantages and the disadvantages before deciding whether to buy. A few tips:
Make sure the insurance company has been around for many years and has a strong balance sheet. This will increase the chances that the insurer will be able to keep making its annuity payouts. The simplest way to check on an insurer's financial soundness is to look for top financial-soundness grades from the major rating services: A.M. Best, Moody’s Investor Services (you’ll need to register), Standard & Poor's, and Fitch (you’ll need to register).
Decide which type of annuity you want. The stream of income will depend on how much money you invest, your age at the time of purchase and other factors.
Among the most important questions you’ll need to answer: Do you want a single or joint policy? In other words, do you want an annuity that will make payments over just your lifetime or over your spouse’s, too?
Another critical question: Do you want to receive the annuity payments for the rest of your life or for a fixed term of, say, 10 years?
I think it’s smart to get inflation protection with the annuity. A rise in consumer prices erodes the value of your savings over time. Even though inflation is relatively tame today, it’s a big risk for many retirees over the long run.
There’s a tradeoff for receiving the inflation-protection feature: Your initial payouts will be lower than they would be with a standard immediate annuity contract. If inflation flares up sometime over the next few decades, though, the payout will rise and more than compensate for lower initial payments.
Keep in mind the two drawbacks to buying an immediate annuity today: Interest rates are currently so low that you won’t get much of an income from this investment. One way to mitigate the low rate is to create an immediate annuity ladder, purchasing annuities at different interest rates over a couple of years. This way, you can buy the first annuity now, when you'll need income initially, then buy other annuities later, as rates rise (which they’re likely to do).
Another drawback is that you’ll lose control over the money when you give it to the insurer. That’s why you don’t want to annuitize all of your savings. Buy an annuity to cover your anticipated expenses and make sure you have some money set aside for unexpected ones.
The website analyzenow.com has several terrific programs that can help you decide whether an immediate annuity fits your household budget.
Some people decide, after running the numbers and analyzing buying an immediate annuity, to forgo the purchase and rely instead on Social Security to provide, in effect, an inflation-adjusted annuity. After all, you know you won’t outlive your Social Security checks.
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