Retirement

Don't outlive your money

Feb. 24, 2014 at 3:23 PM ET

As you transition from collecting a paycheck to living off your savings, which for most occurs in their 60s and early 70s, all those years of retirement planning get put to the test. 

You'll need to determine how much you can safely withdraw from your portfolio so you don't deplete your principal, convert your collection of taxable and tax-deferred accounts into a stable income stream and adjust your asset mix to minimize market shocks. 

"The transition from accumulation to deaccumulation poses a psychological as well as a financial challenge," said Bob Adams, a certified financial planner with Armstrong Retirement Planning. "It requires financial planning, as well as some key choices and trade-offs for the retirees around their own goals and objectives."

Longevity risk, or the chance you'll outlive your money, is by far the biggest threat to a secure retirement. The best defense on that front is a good offense, he explained.

Before you call it quits on your career, Adams advises crunching the numbers to ensure your savings are sufficient to maintain your standard of living.

Evaluate your assets and project your retirement income. Include pensions and Social Security, along with your living expenses — mortgage, car payments and travel — to determine whether you can comfortably cover your bills.

"Too many blindly and arbitrarily retire at a certain age without regard to the financial ramifications," Adams said.

Delaying retirement by even a year or two, he noted, can improve your future cash flow significantly. Not only does extra time in the workforce allow you to continue contributing to your individual retirement account (IRA) or 401(k) plan, but it also gives your nest egg the chance to deliver compounded returns longer. 

Consider postponing Social Security. This can greatly increase the size of your benefit checks and is one of the most effective strategies for boosting your retirement income if you've undersaved.

If your full retirement age is 65 years and six months, for example, you'll receive 100 percent of your benefit by retiring on time. If you wait until age 70, you'll get 131.5 percent.

Give your income stream a test drive, said Elliot Herman, a certified financial planner and certified public accountant with PRW Wealth Management. Try living off your projected income for several months to see how it feels.

Regardless of how much you have set aside, the key factor that determines whether your savings will last as long as you do is how much you withdraw each year.

Watch your withdrawal rate. Gil Armour, a certified financial planner with SagePoint Financial, recommended that retirees use an initial withdraw rate of between 4 percent and 5 percent, adjusting that figure higher annually to account for inflation.

"Any higher and you risk irreversible damage to the balance if you encounter a nasty bear market early in your retirement and deplete too much of your nest egg," said Armour, noting those with considerable wealth or guaranteed income may be able to take more.

Armour suggests maintaining an emergency fund in a liquid account that covers six months of living expenses, ensuring they won't have to sell into a down market. Locking up much more presents costs to the investor, who could be earning 7 percent or more in the stock market.

Balance stocks and bonds. During your golden years, your investment strategy shifts from capital appreciation to wealth preservation. Your asset allocation should now reflect a more balanced mix, Adams stressed.

More conservative investors should have roughly 60 percent of their portfolio in fixed-income securities — including bonds, tax-exempt bond funds, real-estate investment trusts and certificates of deposit — with the remaining 40 percent in equities, such as mutual funds and individual stocks, he noted.

The inverse allocation would be appropriate for an aggressive investor or one who needs to pursue growth.

Just be sure you're not too conservative with your portfolio, warned Adams.

"It might intuitively feel right to keep the money 'safe,' such as putting a lot in a money market fund for years at a time, but the opposite is true because inflation, higher medical costs and longevity require solid growth to overcome," he said.

Protect your assets. Given the rising cost of health care, SagePoint Financial's Armour recommended that middle-income retirees also consider long-term-care insurance, which covers in-home and facility-based assisted-living services.

A 2013 survey by Genworth Financial found at least 70 percent of people over 65 will need long-term-care services and support at some point in their lifetime. The median annual rate for a private nursing-home room was $83,950 in 2013, up from $67,525 in 2008.

Tap tax-free accounts last. Most retirees have a mixed bag of tax-deferred IRAs, tax-free Roths, taxable brokerage accounts and personal savings from which to draw.

As a general rule, retirees should tap their brokerage accounts first, since the capital-gains tax rate may be more favorable than the ordinary income-tax rate you'll pay when withdrawing from tax-favored accounts, such as a traditional IRA or 401(k). That strategy also enables your IRA and 401(k) to deliver tax-deferred growth longer.

Once your taxable accounts are drained, move to your tax-deferred accounts, including 401(k)s and traditional IRAs. Leave your tax-free accounts, such as your Roth IRA, for last, Adams said.

There is no required minimum distribution for a Roth IRA, as there is for some annuities, traditional IRAs, 401(k)s and other retirement accounts, so it can continue delivering compounded returns. Any unused money left in the account when you die can be passed along to your heirs, who can then withdraw the money tax-free.

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