By ,
Published January 13, 2015
Dear Friends-
Guess what some of the richest families in America are worried about? Not having enough income in retirement.
A 2005 survey by PNC Bank found that among households with at least $10 million in “investable” assets, (i.e. excluding real estate) 1 in 5 said they were concerned they won’t have the income they’ll need to live the lifestyle they’re looking forward to when they retire.
OK, OK. I’m not exactly pulling out the crying towels. The point is, sweating out the cost of a retirement that’s likely to last 30 years or more is clearly an issue that spans the entire wealth spectrum. Just because someone has what most of us would consider a ton of money, doesn’t make him or her immune.
In addition, the amount of income you’re going to need in retirement is relative. You might be worried about whether you’ll be able to pay your Medicare premiums and put gas in your car when you’re 65, whereas those who are affluent may be worried about replacing the family yacht every three years.
When you think about it, “retirement” is the last financial frontier an individual faces. What makes it particularly thorny is that, unlike other financial goals you might have over your lifetime-like saving for a child’s college education, a new home, etc.- it’s impossible to know with any precision how much you need to save to finance your retirement years. One of the biggest wildcards is your health, since medical bills can eat up a big portion of your income.
In addition, “retirement” is the only financial goal you have that doesn’t have a time horizon attached to it. For instance, if your child is 6 years old, you know college tuition bills will be popping up in 12 years. Unless you’ve got a standing date with Dr. Kevorkian, you don’t know how long your money will need to last in retirement.
According to the Society of Actuaries, a 65-year-old man in 2000 has a 50% chance of reaching age 85; for a woman, it’s 88. Another way of looking at this is that each has a 50% chance of living longer than the “average” life expectancy age (85/88). Furthermore, if both members of a couple were 65 in 2000, there’s a 25% probability that one of them will celebrate their 97th birthday!
As medical care advances continue to increase longevity, tomorrow’s retirees need to think long and hard about how quickly they draw down their savings so they don’t run the risk of outliving their money. Research by Franklin Templeton Investments found that a key factor in determining the “safe” withdrawal rate is your “asset allocation:” how your money is invested among different types of investments- stocks, bonds, cash, and so forth.
Most financial advisors recommend planning for your retirement to last at least 30 years. In essence, this means you’re responsible for providing three decades worth of paychecks for yourself. With this kind of a long-term investment horizon, the worst thing you can do is go ultra-conservative and put too much of your money in fixed income investments such as bonds, certificates of deposit, money market funds, etc. Inflation will eat you alive if you invest ultra-conservatively.
If the inflation rate simply averages 3% a year, one dollar at age 66 will buy the equivalent of 50 cents 24 years later. If the income from your nest egg is the same as it was when you retired, your standard of living will be cut in half. To overcome this, retirees need a significant amount of their assets invested in stocks. Although that might give you the jitters when we go through a tumultuous period like we did this past summer, historically, the return on stocks has out-paced inflation.
Numerous studies have been conducted over the past 10 years in an effort to determine the “safe” withdrawal rate, the percentage of your nest egg that you can withdraw each year while also minimizing the risk of exhausting your savings. But since it’s impossible to know for certain what kind of returns your portfolio will earn in the future, the best these studies can do is offer probabilities based on how the markets have performed in the past.
Fidelity Investments has just launched two products that aim to address both aspects of the retirement income conundrum: a mutual fund that automatically figures out how much you can draw down over a certain period, and a variable annuity that guarantees to pay a minimum income for as long as you (or your spouse) lives without requiring you to annuitize the contract. In designing both, Fidelity says it took into consideration the two main concerns retirees have with regard to their money: flexibility and liquidity.
Boyce Greer, president of Fidelity’s fixed-income and asset allocation division, says the firm’s new “Income Replacement” mutual funds eliminate the need for a retiree to decide how to invest his/her money or figure out how much income can realistically be withdrawn. Instead, Fidelity sets the asset allocation, gradually moving the portfolio from a “balanced” mix of stocks and bonds to one primarily invested in short-term bonds and cash as the timeframe for drawing income winds down. The firm also determines the amount of money you can withdraw.
“We put the asset allocation on auto pilot and we manage the drawdown because we manage the payout rate,” explains Boyce. The income you receive is “based on paying out a certain percentage of the account value,” which is around 5% in the first year. In the last year of your account’s term Fidelity’s drawdown strategy pays you “all remaining principal and interest,” that is, 100% of the assets left.
Boyce admits that an investor could easily replicate this process on his/her own, but says it is difficult to implement. While we might have the best of intentions, most of us are simply not disciplined enough to rebalance our portfolios every year or adhere to a strict withdrawal plan.
Since it’s based on the value of your account, the payout from an Income Replacement mutual fund will vary and can go up, or down, based on how well the fund performs. However, while most annuities lock in your money, a mutual fund can be redeemed any time you want access to your cash. You can also add more money to the fund whenever you wish.
“The beauty of these portfolios is if something changes... such as an unexpected medical expense,” says Boyce. “You can buy or sell [shares] to respond to whatever situation arises.”
He imagines a baby boomer who retires at age 56 using a 10-year Income Replacement fund to bridge the gap until he/she becomes eligible to receive a full Social Security benefit. Or, consider a couple who are in their 70s and one is very ill and wants to be sure the surviving spouse will have a stream of income. In this case, they might invest in the 20-year Income Replacement fund.
As attractive as they sound, it’s critically important that investors understand the difference between this new category of mutual fund and the ones we’re all familiar with is: they are designed to run out of money.
“At the end of the timeframe,” says Boyce, “you’ve consumed all of your principal and interest.” In contrast, if a traditional mutual fund generates 6% a year and you withdraw only the earnings, you are not liquidating the shares that you own. Unless the markets suffer a catastrophic collapse, your mutual fund account will be worth something- perhaps considerably more.
Fidelity’s response to concerns about not outliving one’s income is a deferred variable annuity (VA) that, like similar products on the market, pays a guaranteed amount each year no matter how long you live and does not require you to annuitize the contract. This means you continue to have access to your principal.
However, like the firm’s new mutual fund offering, there are key differences between Fidelity’s annuity and most of those currently on the market. Many contracts say that if the investments in your account increase in value, your income “may” increase; Fidelity’s new product does this automatically, without any action required on the part of the account owner. Once the annual payout goes up, it can never go down.
Perhaps the biggest surprise is that Fidelity’s new VA does not have a guaranteed death benefit. However, Jon Skillman, president of Fidelity’s life insurance arm, says “any residual value is available for heirs.”
Skillman sees Fidelity’s new annuity and Income Replacement mutual funds as complimentary: While the VA offers income for as long as you live, the payout period for the latter is a specific number of years. “Different customers have different types of needs for income depending on which phase of life they’re in,” he says. “For instance, maybe you want a Social Security bridge today, but you’re also concerned about outliving your assets later in life.”
Like California, Fidelity often sets the trend for new products that other companies in the financial services industry emulate. As tomorrow’s retirees demand income solutions for their longer lives, we’ll see more and more innovations along these lines.
Just be sure to read the really fine print.
Hope this helps,
Gail
(1) Until you reach age 85.
If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.
https://www.foxnews.com/story/how-to-make-sure-youll-have-enough-money-for-retirement