11/24/14

Three Ways to Get a Steady Paycheck Long After You’ve Retired

Guaranteed income for life. That was the plan – now the fantasy – during the golden age of American business, when pension plans were the norm. You did your time as a loyal, hard-working employee, retired at 65 and then monthly checks from your former employer rolled in until you died. A modest livelihood was assured without worrying about depleting your savings.

It sounds so quaint. For most Americans, the responsibility to save and manage retirement money is now all theirs. The good news: There are ways for do-it-yourself investors-turned-retirees to create their own simple pension-like plans at age 65. They involve mixing investments ranging from Treasury Inflation-Protected Securities (TIPS) to annuities to equity funds. None of them can eliminate risk entirely, but they do help minimize the chance that you’ll outlive your money.

Below are three approaches to generating lifetime income for retirees:

Stephen Sexauer: Climb the TIPS Ladder, Then Annuitize

The lowest-risk way retirees can create lifetime income is to put around 85 percent of their savings in TIPS, says Stephen Sexauer, chief investment officer of U.S. multi-asset management at Allianz Global Investors. TIPS are U.S. government-backed bonds that increase in value as inflation rises. After putting that money into TIPS of different maturities, Sexauer’s strategy allocates the remaining 15 percent to a deferred Life annuity that kicks in when a retiree is 85.

TIPS help protect money’s purchasing power, and there’s no credit risk. A TIPS portfolio is actually better than a defined benefit pension plan, Sexauer argues: “The ‘golden era’ of pension plans wasn’t such a golden era – a lot of companies went out of business and quit writing checks.” Also, the payouts weren’t adjusted for inflation.

Buying TIPS maturing in different years – “laddering” – lets retirees live on the expiring TIPS’ liquidated value, as well as the portfolio’s overall income. It also helps investors because part of a TIPS’ “payout” is its twice-yearly inflation adjustment. Unlike a normal bond, TIPS not only pay income to shareholders but add value to the bond’s principal based on changes in the Consumer Price Index. To realize the total return of a TIPS portfolio the bonds must mature or be sold.

You can buy TIPS at TreasuryDirect’s web site only in increments of five or 10 years, however. For a fee, a broker can buy you bonds with in-between maturities that are already trading. A recent call to TD Ameritrade found it charging 0.125 percent to 0.25 percent of a TIPS order, depending on the bonds’ yields. More yield equals more fee.

Rather than go farther than 20 years out in TIPS, Sexauer recommends a deferred life annuity. These insurance products pay a fixed level of income if you’re still alive at a predetermined future date. If you don’t live to that date, you get nothing. These don’t adjust for inflation. Because about half of all people who reach 65 don’t live past 85, insurers are willing to sell such annuities fairly cheaply to retirees.

Of course, there are wrinkles to this strategy. A big one: With inflation expected to rise, TIPS are expensive, so much so that a 10-year TIPS pays only half a percentage point above the inflation rate. An all-TIPS portfolio for 30 years with no annuity would cost 30 percent to 40 percent more than the TIPS-plus-annuity strategy, according to Laurence Siegel, Sexauer’s co-author on an article about do-it-yourself pensions and research director of the CFA Institute, a group of Chartered Financial Analysts.

More on Do-It-Yourself Investing:

  • An Investor’s Guide to Fees and Expenses 2014
  • Slay the Little Beasties of ETF Investing
  • You’re Not a Piñata. Find a Financial Adviser Who Knows It
  • Mr. Risk’s Rules of Enrichment: Oaktree’s Marks Speaks Out

 

William Bernstein: TIPS? Definitely. Deferred Annuities? No.

A TIPS-heavy strategy makes sense to William Bernstein, founder of money manager Efficient Frontier. It’s the annuity part of Sexauer’s plan that bugs him. Annuities have too much credit risk, he says, because issuers could go bankrupt. There are state insurance guarantee funds meant to help financially troubled insurers. But Bernstein thinks there’s too much systemic risk in the financial markets today to rule out a major implosion that would leave annuity holders hanging.

Instead of an annuity, Bernstein would use a Total Stock Market Index Fund. While not touching it for 20 years might be hard, over the long run stocks are very good inflation hedges. That’s because stocks are a claim on real assets, says Bernstein. If you buy $1,000 worth of Proctor & Gamble stock, you’re buying a company that has pricing power. If inflation comes along, you’ll almost certainly have a positive rate of return as the company adjusts its pricing, he figures.

There is one kind of deferred annuity Bernstein likes, and it’s even inflation-adjusted: Waiting to take social security. You get a 30 percent bump in income if you wait from age 62 to 66, and another 30 percent if you wait from 66 to 70, he says.

While Bernstein thinks an all TIPS portfolio would be ideal, few people could afford it. Typically, a traditional pension would replace about 70 percent of your working income, and with today’s skimpy yields, you’d have to invest a lot up front to reach retirement income goals.

To show how much money you’d need to invest in order to get the income you want from TIPS, Sexauer and Siegel created a website, DCDBBenchmark.com. It provides a table of current payouts for $100,000 invested in the 85 percent TIPS/15 percent deferred annuity strategy. This September, a 65-year-old putting $100,000 in the strategy would get just $4,486 in the first year of retirement. If inflation stays at 2.1 percent, that payout would rise to $6,728 when year 20 ends and the annuity begins. (The website projects inflation out 20 years based on long-term averages.) So to have a payout of about $45,000 this year you’d need to invest $1 million. Sexauer says it’s not as bleak as it sounds because Social Security would augment the income from TIPS.

Phil Blancato: Forget TIPS. Take some credit risk. 

A better strategy than buying overpriced TIPS is to create buckets of income-producing assets during retirement, says Phil Blancato, chief executive officer of Ladenburg Thalmann Asset Management. He suggests a laddered portfolio with high-quality corporate bonds for one bucket, a junk bond mutual fund for another and perhaps income-producing equities or preferred stock for the third. “We’re in the lowest default cycle in probably 50 years,” he says, so investors should take some credit risk. For someone with a 20-year horizon, Blancato thinks the risk of default is worth taking as opposed to the other risk — not having enough income to live on.

Blancato uses an example of a 65-year-old retiree who wants her 500,000 portfolio to generate about 5 percent in average annual income. To get that, he’d take $300,000 and buy individual corporate bonds, and maybe some Treasuries and municipal bonds. The other $200,000 would go into a widely diversified portfolio that might include a high-yield bond fund, some master-limited partnerships and alternative income-producing products, maybe even preferred stock. Just know, he says, that these are your speculative investments and you’ll need to weather some periods of temporary loss.

That won’t have the same certainty as a pension, he says. But over time, he thinks it will provide a retiree the income they need. It’s undoubtedly a much more expensive strategy that that of Bernstein or Sexauer, and not exactly a do-it-yourself solution, though.

A cheaper way to take some risk in the bond portion of a do-it-yourself pension: Build a portfolio of exchange-traded funds that hold corporate or high-yield bonds of varying maturities. Guggenheim Investments offers a slew of “BulletShares”, ETFs that each invest in corporate bonds maturing in a specific year. Just remember that it’s the guaranteed part of an income-for-life strategy you give up when you take on credit risk.

 

To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 

11/17/14

How Best to Generate Lifetime Retirement Income

One of the most important retirement planning decisions you’ll need to make is how you’ll use your 401(k), IRA or other retirement savings to generate a lifetime retirement paycheck. This task is particularly critical if you haven’t earned a significant lifetime pension from your employer, a situation many people are in these days.

Here are two different approaches for viable retirement income generators (RIGs):

  • Systematic withdrawals: You invest a portion of your savings and use a withdrawal method to generate a paycheck intended to last the rest of your life. But it may not last if you live a long time or suffer poor investment returns.
  • Immediate annuities: You give a portion of your savings to an insurance company, and it guarantees to send you a monthly check for the rest of your life, no matter how long you live and no matter what happens in the economy.

You’ll find many opinions about these two approaches, some based on facts and some based on misperceptions. You’ll also find that the people with the strongest opinions are often the ones who have a financial stake in your decision (meaning they want to invest your money for you or sell you an annuity).

With both approaches, you can find high-cost, poor-performing solutions or low-cost, efficient solutions. Your task is to first decide which approach, or combination of them, best meets your needs, then seek the most efficient version of each type of RIG.

Here is one important difference between systematic withdrawals and annuities that’s relevant to this analysis. With most immediate annuities, the income stops at your death, and no further benefits will be paid (unless you elect a joint and survivor benefit – then the income will stop when both you and your spouse or partner die). With systematic withdrawals, any money left in your account when you die is available as a legacy unless, of course, you exhaust all your savings before you die. In that case, you experience “money death” before physical death.

One way to compare systematic withdrawals with immediate annuities is to consider the circumstances where one approach would beat the other, meaning the circumstances under which you’d receive more retirement income or have money left over for a legacy. With annuities, you “win” if you live a long time or would have experienced poor investment returns if you had invested your money instead. With systematic withdrawals, you “win” if you experience good investment returns or die well before your life expectancy.

Let’s look at an analysis that digs deeper into this comparison. First, let’s consider a 65-year-old single woman who has $100,000 in retirement savings that she’ll use to generate a regular paycheck. (Later we’ll look at other situations.)

If our retiree uses an annuity bidding service such as Income Solutions - one cost-effective way to buy an immediate annuity – she could have bought a monthly annuity that would generate about $562 per month for the rest of her life.

But what are the circumstances where she could have realized a higher retirement income with systematic withdrawals? One way to answer this question is to determine the rate of return she would need to earn so she could withdraw $562 per month over various lengths of time she might live.

For example, if she lives 10 years then passes away, she could have withdrawn $562 per month, earned no interest at all and money would still be left when she dies. This means she could have withdrawn more than $562 per month, or she could have withdrawn that amount and leave a legacy upon her death. If she lives only 10 years, clearly she’d be better off using systematic withdrawals than purchasing an annuity to generate a retirement paycheck.

But what if she lives longer than 10 years?

  • If she lives 15 years, then passes away, she will need to earn at least 0.15 percent per year for 15 years to have any money left over when she passes away. Certainly, that’s possible even at today’s low-interest rates. So, if she lives for only 15 years, she’ll most likely still be better off using systematic withdrawals to generate a retirement paycheck.
  • If she lives 20 years, then passes away, she will need to earn at least 3.1 percent per year for 20 years to have any money left over when she passes away. There’s a good chance she could invest in bonds and earn that rate, although she would need to be a knowledgeable investor to do so. If she invests in the stock market, she could earn 3.1 percent per year or more, but she would need to accept the risk that she could lose money. Even if she lives for only 20 years, she will also most likely be better off using systematic withdrawals to generate a retirement paycheck.
  • Using this same logic, if our retiree lives 25 years, then passes away, she will need to earn 4.6 percent per year for 25 years for systematic withdrawals to beat the income of an annuity. While that’s possible if she invests in stocks, there’s no guarantee and she could lose money if the stock market tanks. Now the comparative advantage of systematic withdrawals over annuities isn’t as clear.
  • If she lives 30 years, then passes away, the break-even rate of return is 5.4 percent per year. Again, it is possible to achieve this return, but our retiree would need to assume significant stock market risk to have a chance to earn that rate of return consistently for 30 years.

We can also apply this logic to a single man age 65 and to a married couple both age 65 who are considering buying a 100 percent joint and survivor annuity. In this last case, the retirement income continues as long as one person is alive. The following table summarizes the results of this analysis for the single woman, single man and married couple.

11-17 blog chartThis table shows that if the single man lived for 25 years, he’d need to earn at least 5 percent per year for 25 years for systematic withdrawals to beat an immediate annuity. The married couple electing the 100 percent joint and survivor annuity would need to earn 3.4 percent per year for 25 years for systematic withdrawals to beat the annuity.

Note that these returns are net of investment expenses and fees paid to financial advisors. If your advisor charges 1 percent of assets, you’ll need to add those charges to the target rates of return as well. In this case, the single man who lives 25 years would need to earn 6 percent per year because he’s paying 1 percent per year to his advisor. And if he’s investing in mutual funds, the 6 percent return target is net of mutual fund investment expenses.

This analysis offers one way to compare systematic withdrawals with an annuity and helps you focus on the key differences between these two methods of generating retirement income. The annuity protects you if you live a long time or if you’re worried about poor investment results. Systematic withdrawals provide access to your savings and the ability to use untapped funds to leave a legacy, and you “win” if you experience favorable investment returns.

The advantages and disadvantages of each approach tend to complement each other, which is one argument for diversifying your sources of retirement income and dividing your savings between both approaches. You’ll be best served if you learn about the pros and cons of each approach and consider which approach, or combination of approaches, best suits your goals and circumstances.

To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 

11/11/14

Should boomers give millennials money advice?

blog graphA new survey contains some mixed news about the savings habits of the 20- and 30-somethings in the so-called millennial generation—along with a wake-up call for their boomer parents.

According to a survey Fidelity Investments released on Wednesday, 47% of individuals ages 25 to 34 are saving for retirement. Overall, 43% are putting money into a 401(k) plan, while 23% have individual retirement accounts (IRAs).

But about half of millennials aren’t saving for retirement at all. Aside from short-changing their retirements, they are “potentially leaving (free) money on the table” in the form of employer matching contributions, says Kristen Robinson, senior vice president at Fidelity Investments.

Fidelity believes one way to motivate those who aren’t saving is to enlist the aid of their parents. In part, that’s because the Fidelity survey echoes previous findings—from the Pew Research Center, among others—that indicate the millennials and their parents share tighter bonds than previous generations did.

Overall, 60% of respondents say their parents are good financial role models—a high vote of confidence, given the challenges many families encountered during the recent deep recession. Perhaps as a result, when asked who they trust as a source of financial advice, 33% of millennials put one or both parents at the top of the list. (More specifically, 14% said they trusted their parents the most, 11% said they trusted their mother the most, and 8% trusted their father the most.)

There’s certainly a vacuum for the parents to fill: Only 13% of the millennials surveyed say they trust financial professionals the most for money advice, and 25% say they trust no one.

To instill good savings habits, parents of millennials should have money talks with their children around the time of key life events, such as college graduation and before a first home purchase, says Robinson. Millennials also need their parents’ help to cope with information overload.

At the other end of the spectrum are the 25% who say they don’t trust anyone—including their parents. Amid the recession, “many became skeptical of financial institutions,” says Robinson, who speculates that those in this camp may also have seen their parents prove themselves poor financial role models since 2008. Indeed, the average boomer isn’t in great shape with regard to retirement saving: In 2013, the median household between the ages of 55 and 64 had only $111,000 saved in their 401(k)s and IRAs, according to a recent survey by the Federal Reserve.

Otherwise, the survey indicates the millennials are serious about saving. Their top three financial goals are to: accumulate more savings for retirement (52%); pay off credit card debt (41%) and pay off student loans (28%).

 

To Your Successful Retirement!

Michael Ginsberg, JD, CFP®

 

11/3/14

Your partner’s plan for retirement should agree with yours

Washington Post, by Michelle Singletary

Retirement  is something I’ve increasingly been thinking about. My husband and I have set a goal of retiring once our youngest child finishes college in about eight years.

We’ve talked about whether we might move. We know we eventually want to live close to our children when they start their own families. We want to do full-time ministry work helping people with their financial problems.

If you’re married, I believe you should adopt the “two ‘yeses’ and one ‘no’ ” rule, which means you both have to agree to whatever major decisions you make, from buying a dining-room table to your retirement choices.

Without a mechanism to negotiate and come to a compromise, you’ll end up in the situation in which one wife has found herself.

“My husband is facing a medical issue that will probably mean the loss of his current job,” the woman wrote. “He just told me that he’s planning to retire after his surgery. He has $30,000 in savings, and he’s 56. I’m 43 and had worked out a financial plan based on both of us working until our full retirement ages. Now, I’m stuck trying to pay off a mortgage and make necessary home improvements on one income. Our budget works out on one income as long as we don’t have to fix the roof. Rent would cost more than our mortgage. This is an awfully long time for me to be footing all the bills. I’m already working a side job. Any suggestions?”

The woman said she feels she’s being held hostage to her husband’s retirement plans.

I received the question during a recent online discussion in which my guest was Carrie Schwab-Pomerantz, author of “The Charles Schwab Guide to Finances After Fifty: Answers to Your Most Important Money Questions.” We didn’t get to the question during the chat, but here’s our take on the situation.

Before even addressing the retirement issue, Schwab-Pomerantz recommends that the husband check whether he has any legal protections against losing his job because of the surgery. He should find out if he’s covered by the Family and Medical Leave Act. The federal law entitles eligible employees of covered employers to take unpaid, job-protected leave for specified family and medical reasons. Eligible employees may take up to 12 weeks of leave in a 12-month period.

If the husband can’t work because of a health issue, however, he needs to determine whether he’s eligible for Social Security disability insurance. If he has a private disability insurance policy, he needs to see if he can file a claim, Schwab-Pomerantz said.

“While your husband sounds like he has a serious health issue now, he should think about his recovery and whether he’ll eventually be healthy enough to find another line of work — perhaps something part-time or less physically demanding,” Schwab-Pomerantz said. “Having him bring in some amount of income would be tremendously helpful to your situation.”

If your spouse can’t work and isn’t eligible for financial assistance, you’ll need to look carefully at your new cash-flow situation, Schwab-Pomerantz points out.

“You’re probably going to have to make some significant changes to your lifestyle,” she said.

Ask yourself some tough questions: Which non-essentials can you cut back? Are you sure it is more expensive to rent when you factor in property taxes and maintenance? Can you consider minimizing your housing costs by moving to a less-expensive neighborhood or taking in a renter?

Next, look at the income side of your balance sheet. At age 56, the husband is six years away from being able to collect Social Security. If he elects to take the benefit early, his retirement payments will be reduced by 28 percent compared with waiting until his full retirement age, according to a Social Security table, which you can find at www.ssa.gov by searching for “Benefit Reduction for Early Retirement.”

These are just some of the important issues to factor into the decision to retire. “Unfortunately, there are no magic answers,” Schwab-Pomerantz said.

I recommend that couples read “The Couple’s Retirement Puzzle: 10 Must-Have Conversations for Transitioning to the Second Half of Life” by Roberta K. Taylor and Dorian Mintzer.

If you’re married, you can’t unilaterally decide to retire if you have a choice. It’s unfair to your spouse.

“It is naïve to think that decision-making can be based solely on what you want,” Taylor and Mintzer write. “The realities of living need to be taken into consideration, particularly in an economy where people often have not been able to save adequately for retirement. . . . Ultimately, your goal is to come up with a plan you both can agree to.”

 

To Your Successful Retirement!

Michael Ginsberg, JD, CFP®