How to Preserve and Enhance Retirement Income

I have worked with many clients throughout their working lifetime assisting them in the accumulation of assets to meet their retirement goals. As they have aged and transitioned to retirement, their primary concern is the fear of outliving their retirement
income.

Much of this focus is the result of expanded life expectancies. The Social Security Administration estimates that a 55-year-old male will live 28 years to age 83 while a woman of the same age should plan to live 31 more years to 86. Furthermore, the Society of Actuaries estimates that a couple both age 65 has a 50% chance that one spouse will live to 93.

A common rule of thumb to determine how much income is required in retirement is 80% of pre-retirement income. However, this formula does not consider the lifestyle and expenses of the retiree or the source of the income. For retirees who largely depend on investment income to live, the distribution rate is of paramount importance. In 1994, Bill Bengen, a retired financial advisor, calculated that a retiree could withdraw funds up to 4% annually from a portfolio comprised of 50-60% in stocks and 40-50% in bonds and never outlive their income. His conclusion was based on the historical sequence of returns over many decades. He later increased the target to 4.7% as the safe withdrawal rate during the first year of retirement after adding alternative investments into the investment mix and taking into consideration the benefits of professional and active management.

There are many steps individuals can take both prior and post-retirement to expand the stream of retirement income. Perhaps the best known step is to delay the onset of social security benefits to age 70 from the Full Retirement Age (FRA) which will increase the benefit by 8% annually. The simplest way to delay social security benefits is to continue to work either full or part time beyond the initial targeted retirement date. This move may also temporarily minimize or eliminate the need for investment income thus preserving it for future use.

One of the largest expenses that individuals often incur during retirement that can derail their financial well-being are unreimbursed medical expenses. The strategy of establishing and fully funding Health Savings Accounts (HSAs) has gained considerable traction to address these concerns. These accounts are available to individuals who do not have Medicare. Unlike retirement accounts, distributions from HSA are triple tax free and can be used to pay for unreimbursed medical expenses anytime in the future without any time restrictions. Maximum annual contributions are currently $4,400 for an individual, $8,750 for a couple with a $1,000 catch up contribution available for individuals 55 years of age and older.

During an individual’s working lifetime, the conversion of IRAs to a Roth IRA or allocating elective 401(k) contributions to a Roth 401(k) eliminates taxes for future distributions from these accounts and thus reduce needed funds. Of course, current income tax ramifications and available cash to pay these taxes need to be considered before adopting this strategy.

From an investment perspective, allocating a portion of retirement assets to an annuity that provides guaranteed lifetime income* can provide certainty for a portion of retirement income. In fact, recent changes in regulation allow 401(k) plans to offer these annuities as an investment option. Also, Registered Index-Linked Annuities (RILAs) have become very attractive as they offer downside protection through buffers from a stock market decline while allowing investors to participate from gains. Other annuity options include Single Premium Immediate Annuities (SPIAs) and variable annuities with lifetime income riders.

Upon retirement, many individuals may choose to take a bucket approach to divide their retirement assets. The purpose of each bucket is to earmark a specific time frame and amount for the distribution of funds. Typically, there are three buckets – cash for immediate living expenses, bonds for intermediate cash flow and stocks for long term growth.

It is never too early to plan for retirement as action can be taken years in advance to increase the likelihood of sustaining lifetime retirement income. There is not one formula that suits everyone, but a well thought out plan that encompasses a number of coordinated strategies can enhance the chances for a smooth retirement.

Sincerely,

Clifford L. Caplan, CFP®, AIF®

* Guarantees are subject to the claims paying ability of the issuing insurance company.

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