Managing Your Retirement Income

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1 Managing Your Retirement Income Developed by: 2006, National Association of Foundation for Retirement Education. All rights reserved. This presentation may not to be used without permission by NAVA or InFRE True or false? During retirement You could spend more than 1/3 of your lifetime Your expenses might triple or quadruple what they were in the first year You might spend more than $200,000 in out-of-pocket health care expenses 1 You more than likely will spend more on lifestyle expenses than you think One prolonged illness could wipe out your retirement savings Negative returns on your investments in the early years could mean returning to work 1 Fidelity Consulting, 2006 All rights reserved. 1

The retirement income management process Maintain and Update the Plan

Step 5 Plan for retirement risks Identify retirement income needs and

4 Step 1 Step 1: Identify your definition of retirement success What are you

2 The retirement income management process Maintain and Update the Plan Determine your retirement income strategy Step 6 Plan for Taxes & Bequests Step 5 Plan for retirement risks Identify retirement income needs and resources Identify your definition of retirement success Step 2 Step 3 Step 4 Step 1 Step 1: Identify your definition of retirement success What are you retiring to? In other words, are you ready for a month of Saturdays? All rights reserved. 2

3 What it takes to be retirement ready* Retirement readiness consists of being prepared: Financially Geographically Biologically Medically Psychologically Socially Engagement (Happiness) Wealth Health (Prosperity) *The InFRE Retirement Readiness Profile, Step 2: Identify retirement income needs and resources Essential Expenses Discretionary Spending Total Retirement Income Need Where saving has the most impact on building your nest egg, how you spend it has the most impact on how long it will last. All rights reserved. 3

Beware of overspending early in retirement $$$ CURRENT

RETIREMENT SPENDING -8% $ Number of observations: Not

and Actual Declines in Spending at Retirement, the RAND

Changing Priorities Increased spending ( go go ) $ -

4 Beware of overspending early in retirement $$$ CURRENT SPENDING PROJECTED RETIREMENT SPENDING - 22% ACTUAL RETIREMENT SPENDING -8% $ Number of observations: Not retired: ; Retired: Singles and Couples. Wealth and income quartiles calculated by marital status and retirement status. Source: The Retirement-Consumption Puzzle: Anticipated and Actual Declines in Spending at Retirement, the RAND Land and population Program, March 2003 Money Stages & Changing Priorities Increased spending ( go go ) $ - Spending in Retirement Slower spending ( slow go ) What spending? ( no go ) Early retirement Mid retirement Late retirement All rights reserved. 4

5 Retirement Income Sources 1. Social Security - When to start? 2. Employer-sponsored retirement plans - How to take distributions? - When to begin pension? - Joint or single life? 3. Personal savings - Where to invest? 4. Work (wage income) - Availability of work? - Ability to work? - Desire to work? When to start Social Security benefits Key factors to consider are health and longevity risks Impact on surviving spouse benefits Up to an 8% increase each year between FRA and age 70 Potential reductions due to employment and taxation of benefits Age Annual benefit* $11,388 $13,512 $16,068 $22,380 *Source: - Social Security Quick Calculator estimate based on earnings of $50,000 at age 62. All rights reserved. 5

6 Step 3: Plan for retirement risks A retirement of uncertain length 1. Longevity Risk Expenses increasing faster than your retirement income over time 2. Inflation Risk You need a plan to help you make sure your retirement assets last a lifetime! Step 3: Plan for retirement risks Skyrocketing and unknown health and long-term care costs 3. Health Care Cost Risks Stock market and interest rate volatility 4. Investing Risks You need a plan to help you make sure your retirement assets last a lifetime! All rights reserved. 6

7 1. Longevity Risk % of actual deaths 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Annual Percentage of Deaths Population of 65 Year Olds Average Life Expectancy Source: 2000 Individual Annuity Mortality table Age Life probabilities at age Age % Male Female 1 Member of a Couple Source: Society of Actuaries RP-2000 Table All rights reserved. 7

2. Inflation Risk Compounded inflation 72 4% = 18 years for expenses to double Age Expenses 55 $50,000 73 $100,000 91 $200,000 3.

8 2. Inflation Risk Compounded inflation 72 4% = 18 years for expenses to double Age Expenses 55 $50, $100, $200, Health Care Cost Risk Lack of Insurance Can Wipe Out Even the Best-Laid Plans: Assisted living facility base rates 1 : Average: $30,288/year Home health care 2 : Average: $18/hour Long-term care 2 : Average semi-private room cost: $61,685/year Out-of-pocket expenses 3 : $200,000 for Medicare premiums/cost sharing & prescription drug expenses 1 MetLife Mature Market Survey of Assisted Living Costs, MetLife Market Survey of Nursing Home and Home Care Costs, Fidelity Consulting, All rights reserved. 8

9 Long-Term Care Costs Annual nursing home costs by region 1 West** $39,785 to $101,470 Midwest $33,580 to $146,000 Northeast $40,150 to $164,250 Southwest $30,660 to $88,330 Southeast $29,200 to $153,300 Annual Cost for Long-Term Care Coverage 2 Age 45 Age 50 Age 55 Age 60 Age 65 Age 70 Age 75 $1,361 $1,399 $1,512 $2,117 $3,062 $5,027 $8,883 1 Source:General Electric Capital Assurance Company, The costs shown are for non-inflation-adjusted coverage and assume the couple qualifies for standard health rates. Policy coverage is assumed to be a lifetime benefit covering up to $75,600 per year in costs, and includes a 180-day elimination period. Where nursing home costs exceed $75,600, long-term care insurance will not cover all costs of a nursing home stay. Source:General Electric Capital Assurance Company, ** Excludes HI, AK 4. Investing Risks a. Interest Rate Risk Annualized income on $50,000 invested during: Month, Year May, 1981 March,1989 June, 1995 Jan., 2004 Treasury Bill Annual Rate 16.2% 8.8% 5.8% 0.9% Income Per Month $675 $367 $242 $37 Source: Stocks, bonds, bills and inflation, U.S. treasury Bills Total Returns, Ibbotson Associates All rights reserved. 9

10 4. Investing Risks b. Volatility Risk 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Reduced Over Time Large company stocks 10.4% Long term government bonds This is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results. 4/1/2006. For the period year holding periods 5-year holding periods 10-year holding periods 20-year holding periods Compound annual return 5.5% 4.5% Treasury bills Each bar shows the range of compound annual returns for each asset class over the period Source: AdviceAmerica Used with permission. 4c. Point-in-Time Risk Q. If you had $100,000 averaging 6% per year, and you withdrew 6% per year, what would your balance be at the end of 10 years? A. Depends on two factors: 1. Are there any years with negative returns? 2. When do the losses occur? All rights reserved. 10

$100,000 hypothetical investment with loss in the early years Year Rate of Return Withdrawal Ending Balance 1 2-15% -10% $6,000 6,000 $79,900 66,510 3

11 $100,000 hypothetical investment with loss in the early years Year Rate of Return Withdrawal Ending Balance % -10% $6,000 6,000 $79,900 66, % 10.63% 10.63% 6,000 6,000 6,000 66,939 67,414 67, % 10.63% 10.63% 10.63% 10.63% 6,000 6,000 6,000 6,000 6,000 68,520 69,163 69,874 70,661 71,531 Average ROR 6% Ways to Manage Risks Plan beyond average life expectancy (self and spouse) Preserve purchasing power - vs - conserve capital Transfer health care risks Diversify investments and invest for the long-term Expect the unexpected in the early years All rights reserved. 11

12 Step 4: Plan for Taxes & Bequests To minimize taxes, where should income come from first, second, third etc? Will you be in a lower tax bracket in retirement? When does it make sense to convert into and take money out of a ROTH IRA? How much of your Social Security benefits can you spend? How will you plan for required minimum withdrawals starting at 70 ½? Who will inherit your legacy and how? How much of your Social Security can you really spend? Full Retirement Age Earnings Limit Reduction in Benefits Before $12,480 in 2006 $1 for every $2 of excess earnings Actual year $33,240 in 2006 $1 for every $3 of excess earnings After No reduction All rights reserved. 12

Taxation of Social Security benefits Filing Status Married couples filing jointly Single taxpayers 50% of benefit taxable after threshold of $32,000 $25,000 85% of benefit

Step 5: Determine your retirement income strategy Assume you are 65 and just won $100,000 in the lottery. You are given the choice of taking: A. Lump sum of $100,000 B.

13 Taxation of Social Security benefits Filing Status Married couples filing jointly Single taxpayers 50% of benefit taxable after threshold of $32,000 $25,000 85% of benefit taxable after threshold $44,000 of $34, Social Security Manual, The National Underwriter Company 2 And who lived together at any time during the year. Step 5: Determine your retirement income strategy Assume you are 65 and just won $100,000 in the lottery. You are given the choice of taking: A. Lump sum of $100,000 B. $698 a month for life 1 Which would you choose? Why? 1. Source: Assumptions: $100,000 single life annuity for male Illinois resident. All rights reserved. 13

14 How to manage your retirement income Essential Expenses Discretionary Spending Fill Income Gap (A) Fill Income Gap (B) Lifetime Income Sources (assets not under your control, but income is guaranteed for life) Social Security Pensions Annuities Other lifetime income sources Managed Income Sources (assets under your control but income is not guaranteed for life) Taxable assets Personal retirement accounts Employment income Other variable sources Which retirement income Method is best for you? All rights reserved. 14

Ways to create an income stream from your savings 1. Preserve principal & live off the earnings (Income only plan) 2. Spend investment earnings and principal (systematic withdrawal plan - SWP) 3.

15 Ways to create an income stream from your savings 1. Preserve principal & live off the earnings (Income only plan) 2. Spend investment earnings and principal (systematic withdrawal plan - SWP) 3. Create lifetime income for essential needs (Additional lifetime income plan) 4. Combinations of 1, 2 & 3 = diversified asset & income allocation Retirement income option #1: Income (earnings) only plan Long-term bond interest Laddered certificates of deposit Dividend income Rental income Real Estate Investment Trusts (REITs) Risk: under-consumption, or living beneath means, and limited growth potential All rights reserved. 15

16 Retirement income option #2: Systematic withdrawal plan (SWP) How it works Regular distributions (i.e. quarterly or monthly) of investment earnings and principal throughout retirement. A withdrawal amount based on a percentage of savings at the time of retirement determines the first year income. Withdrawals are increased each year to account for the effect of inflation on expenses. Why it works Research indicates that a initial withdrawal rate of 4% - 5% of the portfolio in the first year is safe over a 30 to 40 year retirement. (i.e. 5% on $100,000 = $416.67/month or $5,000 annually in first year) How long will your savings last? Retirement Savings $$$ Retirement # 1 Retirement # 2 Retirement # 3 $ Age Spending? Longevity? Inflation? Return on Investments? All rights reserved. 16

17 Retirement income option #2: Systematic withdrawal plan (SWP) Pros - Full asset ownership and control - Distributions can increase with inflation - Withdrawal flexibility Cons - No guarantee of lifetime income - Assumption of Market Risk Divide your assets into phases of retirement buckets (asset allocation) Need $ $ $ Resources Yr. 1 of retirement to age 70 ½ Retirement income investments $ Resources Age 70 ½ - 80 Income and growth Investments Resources Age 80 plus Growth Investments Phase 1 Phase 2 Phase 3 All rights reserved. 17

18 Retirement income option #3: Additional lifetime income plan Payout Annuities: How do they work? Lump sump investment Monthly distribution for fixed period/lifetime Fixed or variable payments depending upon type of annuity selected Why do they work? Some people live longer than others Those who live longer receive the funds of those who died earlier The Lonely Hearts Club, or The Five 95 Year-Olds Banker: $105k/5 = $21k each or 5% return Actuary: $105k/4 = $26.25k each or 31% return Retirement Advisor: $95k/4 = $23.75k each or 19% return Example adapted from Grandma s Longevity Insurance, Moshe A. Milevsky, October, 2004 All rights reserved. 18

Impact of creating additional lifetime income Retirement income option #3: Additional lifetime income plan Payout Annuities: Pros - Provide lifetime income* Cons** - Reduces estate value - Limited

19 Impact of creating additional lifetime income Retirement income option #3: Additional lifetime income plan Payout Annuities: Pros - Provide lifetime income* Cons** - Reduces estate value - Limited withdrawal flexibility - Distributions may not increase with inflation (Fixed Annuity) * Annuities are issued by insurance companies and lifetime income is based on the on-going financial stability of the issuing company **Certain annuities today offer provisions that reduce the impact of the cons above additional expenses may apply All rights reserved. 19

Retirement income option #4: Combine lifetime income and a SWP SWP: 5% initial withdrawal 4% inflation annually Retirement income option #4: Combine lifetime

20 Retirement income option #4: Combine lifetime income and a SWP SWP: 5% initial withdrawal 4% inflation annually Retirement income option #4: Combine lifetime income and a SWP SWP: 5% initial withdrawal 4% inflation annually, Annuity: Life only annuity, male, state of Illinois All rights reserved. 20

Retirement income option #4: Combine lifetime income and a SWP SWP: 5% initial withdrawal 4% inflation annually, Annuity: www.immediateannuities.

21 Retirement income option #4: Combine lifetime income and a SWP SWP: 5% initial withdrawal 4% inflation annually, Annuity: Life only annuity, male, state of Illinois What is the Ultimate Goal in Retirement Income Planning? To create an integrated asset and income allocation strategy Asset Allocation Bonds Cash Stocks Managed Income Sources Lifetime Income Sources Income Allocation All rights reserved. 21

22 How to manage your retirement income Essential Expenses Discretionary Spending Fill Income Gap (A) Fill Income Gap (B) Lifetime Income Sources Social Security Pensions Annuities Other lifetime income sources Managed Income Sources Taxable assets Personal retirement accounts Employment income Other variable sources What are your choices for closing your income gap(s)? Priority Choices for Closing Gaps Essential Gap Discretionary Gap 1. Reposition managed assets 2. Add additional lifetime income 3. Postpone Social Security & Pension 4. Work full-time/part-time (phased) at same or new job 5. Spend less 6. Use home equity Remember that combinations of all the above may be used to close gaps. All rights reserved. 22

Step 6: Maintain and Update the Plan When: Experience point in time risk positively or negatively Market Interest rates Death of a spouse Actual spending Health Going back to work 62 Other reminders

23 Step 6: Maintain and Update the Plan When: Experience point in time risk positively or negatively Market Interest rates Death of a spouse Actual spending Health Going back to work 62 Other reminders Include all retirement assets in your planning Consider combining retirement savings or rollover assets to simplify Evaluate suitability, fees and expenses of investment options Review and monitor your plan at regular intervals Find a qualified advisor All rights reserved. 23

24 The retirement income management process Maintain and Update the Plan Determine your retirement income strategy Step 6 Plan for Taxes & Bequests Step 5 Plan for retirement risks Identify retirement income needs and resources Identify your definition of retirement success Step 2 Step 3 Step 4 Step 1 All rights reserved. 24

INVESTMENT POLICY GUIDANCE REPORT. Living in Retirement. A Successful Foundation

INVESTMENT POLICY GUIDANCE REPORT Living in Retirement A Successful Foundation Developing Your The process for creating a strategy Plan for the Expected Your Retirement Journey It all starts with you.