Managing Money in Retirement A Guide to Retiree Financial Strategies
Managing Money in Retirement
Managing Money in Retirement QUICK REFERENCE 2 A New Era of Retirement 3 Identifying Your Retirement Needs 6 Sources of Retirement Income 9 Your Retirement Investment Strategy 10 Retirement Asset Allocation Worksheet 15 Cracking Your Retirement Nest Egg: Withdrawal Strategies 17 Don t Make Uncle Sam Your Heir 20 Retirement Resources This guide is not intended to be tax advice and should not be treated as such. Each individual s tax situation is different. You should contact your tax professional to discuss your personal situation.
A NEW ERA OF RETIREMENT Fifty years ago, the average American could expect to live only 68 years. 1 Social Security provided the lion s share of retirement income, supplemented by fixed-payment pension plans. Many retirees lived with their families, and retirement community life was largely a thing of the future. So were IRAs, 401(k) plans, and HMOs. But times have changed. The average American can now expect to live to age 78, and the average 65-year-old can now look forward to 19 more years. 1 People are working longer and are much more likely to live independently, leading healthier, more active lives. At the same time, retirees have less financial security. Social Security now provides less than 35% of the aggregate income for seniors, and the program itself faces future funding deficits. Fixed pensions, once the mainstay of a retiree s income, are now on the decline, and many companies no longer even offer them. The result? Increasingly, retirees must depend on income from savings plans and their personal investments making effective money management during retirement a priority. This guide can help you pursue a solid retirement financial strategy. It provides guidance on what you need to consider to successfully manage your assets after you ve retired. It also includes valuable information on how to best manage tax-advantaged investments such as IRAs and 401(k) plan assets once you begin taking distributions. Keep in mind that this information is educational and not financial advice. You should meet with a financial professional to discuss your retirement investment strategy. 1 Source: National Center for Health Statistics, 2013 (data used is for year 2011). 2
RETIREMENT NEEDS How Long Can You Expect to Live in Retirement? Age 55 60 65 70 75 80 85 Life Expectancy 25.5 21.5 17.8 14.3 11.3 8.6 6.3 Increased life expectancy means that your money will have to work longer once you ve retired. Identifying Your Retirement Needs Before mapping your retirement financial strategy, it s important to figure out how much retirement income you may need. A typical guideline is to plan on spending 60% to 80% of the last year of your preretirement income during each year of retirement. However, this percentage can vary, depending on your personal circumstances and lifestyle choices. As the first step in determining your needs, ask yourself the following questions. Will you continue to work? By 2022, an estimated 23% of those aged 65 and older are expected to remain in the workforce, up from 18.5% in 2012. 2 If you continue to work, what will be your estimated annual earnings? Where will you live? Do you intend to remain in your current home? If so, when will your mortgage be paid? If moving, will you stay with a family member, sell your current home for one of lesser value, or trade up by purchasing a more expensive residence or a vacation home? How long will you spend in retirement? The average 65-year-old man can expect to live about 17 more years and the average 65-year-old woman can look forward to living 20 more years, according to the National Center for Health Statistics. As the average life expectancy continues to rise, be aware that you may spend 20 years or more in retirement. 2 Source: U.S. Department of Labor, Bureau of Labor Statistics, December 2013. 2012 data is latest available. 3
REVIEW YOUR SHORT-TERM GOALS What will be your retirement lifestyle? The lifestyle choices that you make will help determine how much of your preretirement income you ll need to support yourself in retirement. See where you might fit into these three hypothetical financial scenarios: 60% of preretirement income: You have little interest in traveling and eating out, no expensive hobbies, and are debt free. 80% of preretirement income: You occasionally travel, eat out, or participate in moderately expensive leisure activities. You ve incurred minimal to moderate debt. 100% or more of preretirement income: You plan to travel extensively, eat out regularly, and participate in one or more expensive hobbies. You may want to begin a new business. You ve incurred a moderate to high amount of debt. Health Care Considerations Retirees often underestimate the expense of health care. Americans are not eligible for Medicare until age 65, but Medicare doesn t cover many health costs. In 2014, a newly retired man would have needed $116,000 in savings to be statistically confident he could fund health care expenses not covered by Medicare. A woman would have needed $131,000. 3 As you determine your retirement income needs, expect to spend more on medical costs as you age. In 2013, those aged 65 to 74 spent an average of $5,183 per year on health care and those aged 75 or older spent an average of $4,898. 4 Also plan how you ll pay for long-term care costs. More than 70% of 65-year-olds are likely to need long-term care. 5 The average nursing home cost for a semi-private room is $77,380 a year. 6 Rather than deplete your retirement savings Medicare doesn t pay for long-term nursing 3 Source: Employee Benefit Research Institute Research Note Vol. 35, No. 10, October 2014. 4 Source: U.S. Department of Labor, 2013 Consumer Expenditure Survey, September 2014. 4
care costs consider purchasing long-term care insurance. Keep in mind, however, that the expense of a long-term care policy increases with age. Factoring In Inflation When evaluating how much income you ll need during retirement, don t disregard the effect of inflation. Although the inflation rate can be relatively tame, remember that it can also surge; while the Consumer Price Index (CPI) averaged under 3% during the last decade, it soared into the double digits at times during the 1970s and 1980s. 4 When determining your retirement income needs, it s a good idea to tack on an additional 4% each year to help compensate for inflation. The Impact of Inflation Over Time 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 YEARS Assuming a 4% inflation rate, a car currently costing $20,000 would cost almost $44,000 in 20 years. Because inflation slowly eats away at the purchasing power of a dollar, it s important to factor inflation into your annual retirement expenses. 5 Source: U.S. Department of Health and Human Services, National Clearinghouse for Long-Term Care Information, December 2013. 6 Source: Genworth, Cost of Care Survey 2014, March 2014. 5
RETIREMENT INCOME Sources of Retirement Income Picture this: The average American s retirement income rests on a three-legged stool, and each leg is composed of a different income source Social Security, pensions, and personal investments/earnings. Unfortunately, that stool is becoming increasingly lopsided. Personal Investments/ Earnings 45% Social Security Benefits 35% Source: Social Security Administration, Fast Facts & Figures About Social Security, 2014. Pensions/ Other 20% Social Security: How Will It Benefit You? Your monthly Social Security benefit is based on the number of years you worked and your average earnings over your lifetime. Your nonworking spouse (aged 62 or older) may also receive a benefit based on your earnings. Several years ago, the Social Security Administration increased the age threshold for receiving full benefits. Only those born in 1937 or earlier are fully eligible at age 65. For those born between 1938 and 1960, the full benefit age rises gradually, finally reaching age 67 for those born after 1960. Be aware that if you choose to begin receiving benefits before reaching your full retirement age, your benefits will be permanently reduced, in some cases up to 30%. Your nonworking spouse s benefit would be reduced as well. Additionally, if you plan on working even after applying for early retirement, your benefit amount could be further reduced. In 2015, retired persons under their full retirement age can earn $15,720 a year before triggering a wage cap penalty. This amount is adjusted annually for inflation. 6
Pensions: A Diminishing Role Do you receive a pension from your employer? If so, what type do you have? Does your pension pay survivor benefits after your death? Defined benefit plans usually offer a fixed regular payment for life, while defined contribution plans tend to pay out a lump sum benefit when an eligible worker retires. In 1990, 42% of U.S. households participated in a defined benefit plan, compared with a 38% participation rate for defined contribution plans. By 2010, defined contribution plans were the primary retirement plan for more than 70% of workers, while only 22% of workers had a defined benefit plan as their primary retirement plan. 7 The bottom line? Increasingly, the burden for managing pension income is shifting from the employer to the retiree. Personal Investments: The Bulk of Your Retirement Nest Egg Assets and earnings account for the largest percentage of most Americans retirement income. Which of the following assets can you count on for retirement income? 401(k), 403(b), 457, and other employer-sponsored plans. You may have one or multiple employer-sponsored, tax-deferred plans. IRAs. With a traditional IRA, you can make contributions until age 70½ if you have earned income and all or part of your contribution may be tax deductible. With a Roth IRA, you may continue contributing after age 70½ if you have earned income and meet certain guidelines. Although contributions to Roth IRAs are not tax deductible, qualified distributions are tax free. Annuities. Often, retirees invest in an immediate life annuity, of which there are two types. A fixed annuity pays a specific amount of income for life. A variable annuity also pays income for life, but the income varies based on the return of your chosen investment portfolio. 7 Source: Employee Benefit Research Institute, August 2012. 7
Personal investments. These might include mutual funds, stocks, bonds, money market accounts, and other non-taxdeferred investments. Home equity. Do you know how much equity you have in your home? If you choose to sell your home and it s currently your principal residence, you may receive tax-free gains of up to $250,000 per individual ($500,000 for a married couple filing jointly). If you want to remain in your home, a reverse mortgage produces steady income and doesn t need to be repaid until you die, sell, or move. However, these loans can be complex. Evaluate your options carefully before deciding whether this option is right for you. Other sources of income. Do you have cash-value life insurance? Income from trusts? Do you own incomeproducing real estate? Once you ve identified your potential sources of income, you ll need to prioritize and match your income sources with your anticipated needs. But first, you should determine an investment strategy for your personal savings in order to maximize your retirement income. 8
RETIREMENT INVESTMENT PLAN Your Retirement Investment Strategy Just because you stop working doesn t mean that your investment portfolio should stop working for you. In fact, converting all your investments to low-risk cash securities carries its own risks: losing out to inflation and not providing enough income for an extended time period. Remember, you may be living in retirement for a long time, so you need to invest for the future as well as for today. As with preretirement investing, a crucial element in your retirement investment strategy is your asset allocation. Asset allocation is the process of dividing your money among different types of investments stocks, bonds, and cash to pursue a specific investment goal in the most effective way possible. It helps you pursue returns while managing risk. Your asset allocation should take into consideration your age, your objectives, your investment time horizon, and your comfort level with risk. You should also factor in your retirement income needs. The worksheet that follows will help you determine an asset allocation that s right for you. Keep in mind that there are many factors to take into consideration when determining your asset allocation, and this worksheet is only a summary of the points you should consider. You should speak with a financial advisor before making any decision. 9
RETIREMENT ASSET ALLOCATION WORKSHEET Retirement Asset Allocation Worksheet The questions below apply to an individual in or at retirement. They do not take into consideration spousal income, benefits, or investments. The worksheet is meant to give you an idea of what retirement asset allocation may suit you best, but should not be construed as investment advice. Answer the following questions. Then add your total points to find which retirement portfolio may suit you best. Your Time Frame Points 1. What is your age bracket? 55-59 8 60-64 7 65-69 6 70-74 4 75 and over 2 Your Income Sources 2. How much of your total retirement income is provided by Social Security and pension benefits? Under 10% 6 10% to 24% 5 25% to 39% 4 40% to 59% 3 60% and over 2 3. How much of your total retirement income do you expect to fund from your investments? Under 10% 8 10% to 24% 7 25% to 39% 5 40% to 59% 3 60% and over 1 10
4. Do you plan to tap into your home equity (provided you have over 30% equity in your home s value) to supplement your retirement income? Yes 2 No 0 Your Risk Profile 5. Which best describes your feelings? I would never take a chance losing what I ve saved, even if it meant potentially earning less. 0 I would take a chance with some of my savings, provided it meant earning potentially higher returns. 3 I need to aggressively grow my savings, so I would accept higher risk for potentially higher returns. 5 6. If the stock market declined 15%, you would: Cash out immediately to avoid further losses. 0 Reduce stock and stock fund investments. 2 Probably do nothing. 3 Purchase more shares. 6 7. Which best describes your investment objectives? Preserve savings and earn a moderate return. 1 Generate potentially higher returns with a little risk. 2 Grow my savings assuming moderate risk. 3 Aggressively grow my savings despite the risk. 5 11
RETIREMENT ASSET ALLOCATION WORKSHEET 8. Your emergency savings would ideally cover what period of time? None 5 A few weeks 3 A few months 2 Six months or more 1 Total Scoring Key Conservative Retirement Portfolio Moderate Retirement Portfolio Aggressive Retirement Portfolio Total points 20 points 21-40 points 41 and up This worksheet should not be construed as investment advice. See your financial advisor before making any decision as to your asset allocation. 12
Conservative Retirement Asset Allocation Stocks Bonds Cash 30% 40% 30% Best for older investors well into retirement, or for those who have not accumulated significant savings for retirement and rely heavily on Social Security. Also good for risk-averse investors. Note, however, that a stock component is still an important allocation if the portfolio is to grow and outpace inflation.* Moderate Retirement Asset Allocation Stocks 20% Bonds Cash 40% This portfolio could suit a broad range of retirees of varied age and risk comfort levels. Good for investors who retire when eligible for full Social Security benefits, who have accumulated a moderate retirement portfolio through IRAs and 401(k) 40% plan participation, and who may supplement their retirement income through part-time work and by cashing in on home equity.* Aggressive Retirement Asset Allocation Stocks Bonds Cash 20% 30% 50% Best for those who retire early and anticipate many years in retirement. Also appropriate for those with a sizeable nest egg who do not rely heavily on Social Security as a retirement income source. Also suited for more aggressive investors.* *These examples should not be construed as investment advice. See your financial advisor before making any decision as to your asset allocation. 13
Component Investment Options Once you ve determined an appropriate asset allocation, you ll need to select specific investments for each asset class. The choice of investments within each class can be daunting; stock investments, for instance, can be broken down into many subcategories based on company size, industry sector, or geographic location. And within each of these categories, there are thousands of companies and funds to choose from. A financial advisor can help you choose the individual investments. When selecting investments, keep in mind that it s a good idea to diversify your holdings whenever possible to reduce your exposure to the risks of concentrating your assets in a particular company, sector, or investment type. Mutual funds can help you reduce this risk by diversifying among many different securities. They also carry the advantage of professional management and can be matched to fit specific asset classes. 14
WITHDRAWAL STRATEGIES Cracking Your Retirement Nest Egg: Withdrawal Strategies A big issue facing many retirees is which assets to tap into first. There s a good chance that you ve accumulated a variety of retirement investments 401(k) plan assets, traditional IRAs, Roth IRAs, annuities, and numerous other personal investments. While some of these investments may pay interest or dividends, others will need to be liquidated in order to generate current income. Different investment vehicles can have different tax implications. That s why it s important to formulate a withdrawal strategy that best suits your circumstances. The Big Picture: Balancing Needs With Means Depending on how much you ve saved, you should first figure out how much you can afford to draw down your retirement nest egg each year. One traditional approach is to liquidate 5% each year of your principal at the time of retirement, leaving a hypothetical payout of 20 years. While this rule of thumb may be a useful guideline, you should adjust your payout rate to your specific circumstances. Also keep in mind that health care costs often escalate later in life and assisted care, if necessary, can be costly. Special Considerations for Tax-Advantaged Investments Among the first decisions you may face is when to tap into your tax-deferred assets (traditional IRAs, 401(k) plan assets, and annuities), when to draw down tax-exempt investments (Roth IRAs), and when to liquidate other taxable investments. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts. However, traditional IRAs and employer-sponsored retirement plan assets have minimum distribution rules. The following are some points you ll need to consider when liquidating or drawing down different types of tax-advantaged investments. 15
Traditional IRAs, 401(k)s, and other tax-deferred plans require that you begin taking distributions no earlier than age 59½* and no later than April 1 of the year following the year in which you reach age 70½, and that such distributions adhere to a uniform table from the IRS, which takes into consideration the participant s and survivor s lifetimes, based on the participant s age. Failure to take the required distribution can result in a tax penalty equal to 50% of the required amount. So it pays to make sure that you take the required minimum distribution. For more information on minimum distribution requirements and how they apply to your situation, call the IRS at 1-800-829-3676 or visit www.irs.gov. Roth IRA distribution rules differ from traditional IRA distribution rules. Contributions to Roth IRAs are made after tax and therefore can be withdrawn at any time. In most cases, you can only withdraw earnings from a Roth IRA after age 59½ without paying a 10% additional federal tax.* Unlike traditional IRAs, Roth IRAs do not require you to begin taking distributions after age 70½, and minimum distribution rules do not apply. In fact, you re never required to take distributions from your own Roth IRA. However, your beneficiaries will be required to take distributions after your death. Annuities also restrict distributions until after age 59½, and early withdrawals are usually subject to a surrender charge to the issuing company in addition to a 10% additional federal tax on earnings. Although annuities are not subject to IRS-mandated minimum distribution rules, they may be subject to a wide variety of distribution requirements and options, depending on the particular annuity contract. *Certain exceptions may apply. 16
ESTATE PLANNING Don t Make Uncle Sam Your Heir A carefully crafted retirement financial strategy will also take into consideration your estate plan. A large variety of estate planning tools is available to help you maximize current income while minimizing the tax bite to you and your heirs. Although the variety and complexity of estate planning tools is beyond the scope of this guide, there are several points you should keep in mind when formulating a retirement financial strategy. Using Trusts to Hand Down Assets For 2014, the first $5.34 million in the value of an estate is exempt from federal estate tax. If your assets exceed this amount, you may want to consider transferring them into a trust. Trusts can be used to transfer assets to beneficiaries without incurring estate taxes. They can also be used to help maintain control of assets while you re alive and medically competent, and to indirectly maintain control of the disposition of assets if you are medically unable to do so or in the event of death. Trusts come in many varieties designed to meet different needs and objectives. Below are several you may wish to consider when formulating your retirement financial strategy. Keep in mind that trusts vary considerably in their legal and tax consequences. An estate planner can help you evaluate a certain type of trust to determine if it may be appropriate for your circumstances. A living trust allows you to remain both the trustee and the beneficiary of the trust while you re alive. You maintain control of the assets and receive all income and benefits. Upon your death, a designated executor distributes the remaining assets according to the terms set in the trust. 17
An irrevocable life insurance trust is often used as an estate tax funding mechanism. Under this trust, you make gifts to an irrevocable trust, which, in turn, uses those gifts to purchase a life insurance policy on you. Upon your death, the policy s death benefit proceeds are payable to the trust, which, in turn, provides tax-free cash to help beneficiaries meet estate tax obligations. To help benefit your favorite charity while serving your own trust purposes, you might consider a charitable lead trust. This trust lets you pay a charity income from a particular asset for a designated amount of time, after which the principal goes to the beneficiaries, who receive the property free of estate taxes. Another charitable option, the charitable remainder trust, allows you to receive income and a tax deduction at the same time, and ultimately leave assets to a charity. Highly appreciated assets are typically the funding vehicles of choice. Bequeathing Tax-Deferred Assets Assets held in an IRA, 401(k), or other tax-deferred retirement savings plan warrant special consideration when planning your estate. Such assets are subject to minimum distribution rules for you and your heirs and are taxable to your beneficiaries, regardless of the estate tax-exemption. If you want to take full advantage of the tax-deferral potential offered by retirement plans and IRAs, make sure you name a beneficiary for each of your plans. By naming a beneficiary, you can prolong the distribution and tax deferral of plan assets during your beneficiary s lifetime. Your heirs will still have to meet minimum distribution guidelines and pay ordinary income taxes on withdrawals, but they will be able to stretch out these distributions over a long period of time. 18
In general, it s a good idea to make your spouse the beneficiary of your retirement plan assets and leave non-retirement plan assets to nonspouse heirs. This can reduce estate taxes and stretch out tax deferral for as long as possible. If instead you wish to leave your retirement assets to several younger heirs (such as your children), a Stretch IRA lets you split these assets into several accounts, each with its own beneficiary and with minimum distributions based on each beneficiary s age. As with most areas of estate planning, distribution rules governing beneficiaries are complex and may differ for your particular situation. An estate planner can help you determine which distribution strategy best suits your needs. 19
Retirement Resources For more information about managing your money during retirement, check out these resources. General Retirement Information AARP: 1-800-424-3410; www.aarp.org Administration on Aging: eldercare locator services in communities around the United States: 1-800-677-1116; general information: 202-619-7501; www.aoa.gov Federal Citizen Information Center: 1-888-8-PUEBLO; www.pueblo.gsa.gov Setting Priorities for Retirement Years (SPRY) Foundation: 202-216-0401; www.spry.org USA.gov: www.usa.gov/topics/seniors.shtml Wired Seniors: www.wiredseniors.com Estate Planning Estate Planning Links: www.estateplanninglinks.com Health Care/Long-Term Care Issues Agency for Healthcare Research and Quality: www.ahcpr.gov Long-Term Care Resources: longtermcare.gov Medicaid Consumer Information: www.hcfa.gov/medicaid/mcaicnsm.htm (includes link to toll-free numbers for each state) Medicare: 1-800-633-4227; www.medicare.gov Social Security Social Security Online: 1-800-772-1213; www.ssa.gov 20
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