Big Threats to a Secure Retirement

Transcription

1 5 Big Threats to a Secure Retirement As your career winds down, consider incorporating a proven wealth preservation strategy to protect your nest egg and generate income for life.

2 Welcome to the New Planning Reality The days of the gold watch and generous company pension are gone. Today, most private companies no longer provide traditional retirement plans but instead offer 401(k)s or similar plans funded largely by the employee. As the costs associated with employerprovided retirement plans have gone through the roof, even government pensions are being called into question thanks to ever-tightening resources. Not even Social Security is immune from this trend, given that the ratio of contributing workers to claiming beneficiaries continues to decrease due to baby boomers retiring in record numbers. In fact, many question how long Social Security benefits can remain at current levels. If you are recently retired or rapidly approaching retirement, what does all this mean? It means you will need to assume responsibility for what s at stake and take more of a DIY approach to planning for your financial future. You must not only find ways to preserve the assets you have accumulated but also identify opportunities to generate income that lasts a lifetime, no matter how many years you spend in retirement. The Challenge with Traditional Approaches to Investing Before we get started, it s important to note that there are many ways to invest your retirement assets. The most common asset accumulation and growth strategies involve a combination of stocks, bonds and cash, as shown in Figure 1. Your retirement portfolio most likely contains some mix of these types of assets. Stocks Bonds Cash 20% 20% Figure 1: A Typical Example of Traditional Asset Allocation Model While the traditional asset allocation models may be appropriate during your working years, they do not address the pervasive wealth preservation problem, nor do they guarantee consistent monthly income in retirement. Traditional models are also not immune to the most common risk factors that threaten the effectiveness of your personal retirement plan. Let s now examine those five big threats in detail. 60% Figure 1: This model is hypothetical and does not reflect any particular investment portfolio. Asset Allocation is a method used to help manage investment risk. It does not ensure a profit and does not protect against losses in a declining market. 2

3 1Beware of the Bear Market Traditional asset allocation can be majorly affected by an environment in which we experience a bear market, defined as a as a downturn of 20% or more lasting at least 60 days. A bear market can eat away at the stock and bond portion of your retirement portfolio. History shows us that since 1929, the U.S. stock market has experienced 25 bear markets, an average of one every years. Depending on how your assets are invested, it could take years for your portfolio to recover! Suppose your portfolio declined 35% from $100,000 to $65,000. At a 4% annual return, it would take 11 years for your portfolio to recover to its initial value of $100, At a 6% annual return, it will take 8 years to recover, and at 8%, it will take 6 years before you are back to where you started. If a bear market occurs mid-career, you may have enough time to recover from the loss. However, the situation becomes much more dire if you are at or near retirement. Once retired, you will likely begin withdrawing money regularly to cover your living expenses. What if a bear market occurs in your first year of retirement? Assuming you withdraw 5% from your portfolio each year and your investments grow at 8%, it will take 15 years for your portfolio to recover to its original value. If the annual return is 6%, it will take you 44 years. If the bear market recovery is really poor, generating an annual return of 4% or less, your portfolio may never fully rebound! Figure 2: Years to Recover from a Bear Market 2 Figure 2 compares two sets of data: the average number of years it takes to recover from bear markets during your working years while you are still accumulating assets, and the number of years it takes during retirement when you are withdrawing money at 5% per year. As you can see in this hypothetical example, a bear market experienced late in life can be a major threat to your financial future Figure 2: Example assumes an initial portfolio value of $100,000. Results based on calculations from Ativa Interactive % Return Pre-Retirement (No Withdraw) 6% Return 8% Return In-Retirement (Withdraw)

4 Ride the Market Volatility Rollercoaster 2Even if your portfolio is not bitten by a bear market in your late working years or while taking distributions, a traditional asset allocation would mean that your retirement income depends on stock performance. As we all know, the markets are inherently volatile. This presents a challenge in and of itself in planning for a comfortable lifestyle in retirement. Figure 3 shows annualized returns of the S&P from 2005 to Referencing the graph, you can see that although the broader market is recovering from the 2008 financial crisis, the impact of social and economic factors both in the United States and abroad continue to result in unpredictable returns and high levels of market fluctuation. Therefore, assets you have invested in the market result in putting your income at risk. Figure 3: Annualized S&P 500 Returns As a younger investor still working and accumulating assets, you re likely to weather the markets ups and downs over time. On the flipside, these fluctuations can keep you awake at night when you are retired and make it nearly impossible to achieve a consistent flow of income over time. The last thing you want to spend time in retirement doing is obsessing over the stock ticker when you should be enjoying friends and family or mastering your favorite hobby % 30.00% 20.00% 10.00% 0.00% % % % % % Figure 3: Annualized S&P 500 Returns The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading industries of the U.S. economy. 4 S&P 500 monthly and annual returns as of July 1, 2016, available online at 4

5 Experience that Sinking Feeling of Low Interest Rates 3While we ve discussed the potential pitfalls of investing in the market, it may lead you to believe that the easiest way to protect your hardearned assets from downside risk is to leverage a safe-money vehicle like a bank CD 5. Though a bank CD does indeed protect you from market declines, these assets provide risks of their own. Figure 4 shows average CD performance throughout the last 20 years, indicating that rates have decreased precipitously throughout this time. In fact, six-month and one-year rates have been hovering near zero for the past five years, as you ve likely noticed on recent bank or money market statements. While stocking away a portion of your assets in a bank CD may have been a good idea in the 1980s or even 90s, that is currently not the case. Speculators continue to follow the market and try to predict when interest rates will rise, but there is certainly no guarantee of if or when this will happen. With rates as low as they are, money currently placed in a bank CD would actually be decreasing in value because it is not keeping pace with inflation. Plus, you would need over $500,000 in the bank to generate just $9,000 per year in income! This certainly isn t the most efficient way to maintain the lifestyle you likely desire in your golden years. Figure 4: Historical CD Rates ( ) 6 5 Certificates of Deposit (CDs) are time deposit accounts that entitle the CD owner to a specified annual interest rate over a specified period of time. CDs are FDIC insured up to $250,000. Conditions and restrictions apply. 6 Bankrate.com, available at 35

6 Travel the Longevity and Winding Income Road 4When thinking about life in retirement, it may be easy to envision yourself traveling the globe, enjoying time with loved ones or volunteering for a favorite cause. Yet when you picture this, at what age are you seeing yourself? Are you 70, 80, 90 or older? While living longer is a blessing, it can pose a major threat to your retirement security if you don t plan for it accordingly. In 1950, the average age 65 retiree could expect to live another 13 to 15 years 7. These days, about one out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age While you are working and accumulating assets, time is your ally. However, once you are retired you may need steady retirement income for 30 years or more. Figure 5 shows the life expectancy for individuals living in the United States. By contrast, Figure 6 shows the value of a hypothetical retirement portfolio. This illustration assumes an individual has $250,000 upon entering retirement and withdraws $20,000 per year. It also assumes an average return of 2.5% per year from a bank CD or similar low-risk investment. Unfortunately, in this typical scenario, you would run out of savings in just 15 years at age 81. Therefore, you need a strategy that can ensure your retirement savings will support your lifestyle even after you begin taking distributions, no longer how many years you may live. At Birth Both Sexes Male Female At age 64 Both Sexes Male Female Figure 5: Life Expectancy in the United States at Selected Ages, by Sex Life expectancy (in years)

7 Figure 6: Depleting Savings in Retirement This example is intended for illustrative purposes only and is hypothetical in nature. It is not intended to illustrate any specific individual s financial situation. Your actual circumstances could vary significantly from the illustrated example. $300,000 $250,000 Remaining Retirement Assets $200,000 $150,000 $100,000 $50,000 $ Years in Retirement Assumptions:»» Individual enters retirement with $250,000 and withdraws $20,000 per year.»» Asset is a CD or low-risk investment with a 2.5% annual rate of return. 7 Growing Older in America: The Health and Retirement Study. National Institute on Aging, issued March Calculators: Life Expectancy provided by the Social Security Administration. Available at 9 CDC/NCHS, National Vital Statistics System, Mortality. Available at 7

8 5Pay the Price of Unpredictable Inflation Rates While we ve discussed some of the most obvious risk factors you may face in retirement, one threat that often goes overlooked when planning is the impact of inflation. Inflation is the gradual increase in the cost of goods and services over time. During the last decade, the inflation rate has increased an average of about 2% each year but was consistently higher the previous decade 10. Though we may not be able to predict how inflation will rise, we can expect it to impact how far our dollar will go in retirement. Many of the items affected by inflation are things you cannot live without, such as food, fuel and medical care. Therefore, planning in today s numbers can be an inaccurate forecast of what you can buy tomorrow. For example, an individual who retired in 1980 would currently have to shell out $58.50 to purchase what he could have bought with just a $20 bill when he entered retirement! Figure 7 illustrates how inflation might devastate your ability to meet basic living requirements. Even if the inflation rate is only 3%, it will erode your purchasing power from $15,000 to $6,179 in 30 years. Figure 7: How Inflation Erodes Purchasing Power When working and accumulating retirement savings, inflation may not present a huge problem if your salary rises over time and you can increase your retirement contributions as it does. While taking distributions in retirement on the other hand, inflation can deplete what you ve accumulated even faster. Because traditional investment strategies may not offer a secure hedge against inflation, it s important you find an alternative solution that will. Today $15, In 10 Years $11,161,41 In 15 Years $9, In 25 Years $8, In 30 Years $6, Table of Historical Inflation Rates by Month and Year ( in %). Available at 8

9 The Flip Side: Taking an Approach in Line with Your Objectives As you ve learned, traditional planning strategies may not be structured in a way that can help you preserve assets and generate lasting retirement income. Stocks and mutual funds can be an important part of your portfolio, particularly during your working years while you are accumulating assets and have plenty of time to rebound from market downturns. Yet as your working years come to a close, you ll want to consider working with a professional who is wellversed in helping clients prepare for the transition into retirement. There are several different types of agents and advisors who are trained to accomplish specific objectives when helping manage your finances. Some are focused primarily on managing investments, and they will help you make stock and bond purchases or invest in mutual funds that are appropriate for your station in life. Others take a different approach and are trained to help you create a stable source of income during your retirement years to protect you from running out of money too soon. Just as you would seek advice from a cardiologist for a heart condition, rather than some other type of specialist, it s critical you find an advisor who focuses on long-term income planning, rather than just growing an asset base through investments. Strategies for Retirement Income: Now for the Good News! Once you ve selected a professional who understands your current financial situation, as well as your goals and objectives for retirement, he or she can help you identify strategies that put your dreams within reach. In particular, there are solutions available that offer upside potential with protection from market risk, as well as the ability to turn that asset into guaranteed 11 income for life, no matter how many years you live. How might this type of vehicle help simplify your income and distribution planning? There are many planning options your advisor can utilize, depending on your retirement income needs. You can begin receiving income right away or you can defer income until a later date, depending on your financial situation. Deferral, for example, is a good option if you are near retirement but still want to work for a few more years. These income payments can be designed for a single life or joint lives to take care of just you if you re single, or you and your spouse if married. 11 Guarantees are subject to the claims-paying ability of the issuing Insurance company. 9

10 These strategies allow individuals to earn interest credits based on the performance of a specific market, like the S&P 500, but do not actually invest in that market. Therefore, they also protect against market losses. In other words, if the market goes up, your asset would be credited a portion of those gains. If the market goes down, you would be protected from a zero floor. Within these strategies, there may also be options to increase your payouts the longer you live, to make your income adjust for inflation or to increase income distribution should you become ill and need expedited care 12. Your advisor can then calculate, based on hypothetical, average performance, how much income that might translate to in retirement. This approach eliminates the risk of having to reduce your standard of living or worse, running out of money. It also protects you from the threat of a bear market and general market volatility, helping you sleep at night even when the market has a bad day, month or year. Take for Example Suppose you are in your late 50s and do not plan to retire for six or seven years. Or, suppose you are retired and in your late 60s. In either case, you may want a portion of your retirement savings tied to one of the major market indices such as the S&P given its recent gains. A traditional advisor might put you in a mutual fund. However, you would be subject to market volatility and the possibility of a bear market, which could wipe out your investment. An advisor focused on generating retirement income, on the other hand, can offer you products and strategies that address this challenge. A strong alternative would protect your principal while enabling you to enjoy gains in the market. Figure 8 is an example of a product that ties increases in your account to a percentage of the gains in the S&P 500. However, if the S&P 500 declines like it did during the 2008 financial crisis, your account will not lose any value (zero loss). The worst you can do is break even! 12 Annuities are long-term retirement savings insurance products. The examples presented herein are for informational purposes only. They are not representative of any specific annuity and do not constitute investment advice. Withdrawal of earning will be subject to ordinary income tax and, if taken prior to age 59 ½, may be subject to a 10% federal tax penalty. Additional fees apply for living-benefits options. Violating the terms and conditions of the annuity contract may void guarantees. 13 An index is a composite of securities that provides a performance benchmark. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is not a guarantee of future results. 14 Annuities are long-term retirement savings insurance products. The examples presented herein are for informational purposes only. They are not representative of any specific annuity and do not constitute investment advice. Withdrawal of earning will be subject to ordinary income tax and, if taken prior to age 59 ½, may be subject to a 10% federal tax penalty. Additional fees apply for living-benefits options. Violating the terms and conditions of the annuity contract may void guarantees. 15 Guarantees are subject to the claims paying ability of the issuing Insurance company. 10

11 Figure 8: S&P 500 vs. S&P 500 with Zero Loss and Percentage of Gains In this example, you would benefit from tax-deferred growth, meaning you do not have to pay income tax until you take money out of the account 14. You also can take flexible withdrawals that allow you to access a portion of your asset should you need it and enjoy the option of turning the account into guaranteed income payments for life 15. Hypothetical Performance»» BLACK Line: S&P 500 returns»» GREEN Line: S&P 500 with zero loss and percentage of gains The Choice Is Yours As you approach retirement, you need to be able to manage the five risks we discussed: 1. Bear markets, which may reduce your savings 2. Market volatility, which may keep you up at night 3. Low interest rates, which may limit your earning potential 4. Longevity, which may cause you to run out of money 5. Inflation, which may reduce your purchasing power While these risks may appear daunting, you should have nothing to fear. By sitting down with a financial advisor who specializes in retirement income planning, you can devise a plan incorporating the right financial strategies to overcome these risks. Take responsibility for your golden years and prepare for a more confident, comfortable future. 11

12 50 Derby Street, Suite 250 Hingham, MA Office: Fax: LEGAL NOTICES No specific product is being offered for sale as part of this document. An annuity is a long-term retirement savings insurance product that can help protect you from outliving your money. It has the potential to grow tax-deferred. Some, but not all annuities, offer optional living benefits to help protect and guarantee your retirement income. Some annuities offer death benefits to protect your beneficiaries. Guarantees are subject to the claims-paying ability of the issuing insurance company. You can decide how you want to fund your annuity, how interest is credited to it and how you take payments from it. This document should not be construed as giving legal, tax, or accounting advice. Clients should consult with their qualified legal, tax, and accounting advisors as appropriate. The S&P 500 Index is a product of S&P Dow Jones Indices LLC ( SPDJI ). Standard & Poor s and S&P are registered trademarks of Standard & Poor s Financial Services LLC ( S&P ).