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Retirement Decision-Making Issues

Barbara O’Neill, Ph.D., CFP

Interim Extension Specialist in Financial Resource Management

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Topics To Be Covered

Retirement savings need analyses

Retirement investment withdrawals

Strategies to stretch your assets

Special planning considerations

Q and A

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Retirement Savings Analyses: Five Key Variables Age at retirement

Amount of money currently saved

Amount of annual income needed (% of pre-retirement income)

Rate of return on investments

Number of years in retirement (life expectancy)

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Amount of Annual Income Needed in Retirement 50%? 100%? Each case is different!

Active phase of retirement is expensive

Replacement % depends on retirees’

– goals (e.g., travel)

– lifestyle choices (e.g., smaller home, work)

– resources (e.g., employer-provided health insurance, inheritances)

It is dangerous to generalize

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Growth Rate on Retirement Assets Large company stock compound annual

return (1925-2000): 11%

Mistake to assume 10% or 11% return- few investors have 100% stock

$1.5 trillion in passbook accounts

Half of U.S. households have no equity investment exposure

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Retirement Age

Early retirement is increasingly popular Lose the tremendous resource of time Rule of 72: only takes 8 more years for

$250,000 to double to $500,000 at 9% Lower SS and pension benefits Big factor: post retirement health

insurance (gap until age 65 and requirements for employer-paid coverage)

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Resources For Making Estimates

Ballpark Estimate: www.asec.org

Cooperative Extension fact sheets

Investment firm worksheets & software

Web sites (e.g., www.financenter.com)

Monte Carlo analysis: run thousands of possible scenarios for asset class combinations to determine probability of achieving financial goal (e.g., www.financialengines.com)

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Retirement Scenario I:Your Savings Provide “the Extras” Tap taxable savings first for “extras”

Take as little as you can from tax-deferred accounts (until age 70 1/2)

Monitor your annual cash flow

If continuing to work part-time, consider a Roth IRA

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Live on a Pension -- Live It Up on Your Savings Direct Social Security and pension

checks to checking account.

Allot an annual sum from taxable savings and direct it to a money market fund with check-writing.

Preserve tax-deferred savings until age 70 1/2 or as a resource of last resort

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Give Yourself a Raise

Increase what you supplement by the inflation rate

Understand “the Rule of 72”

At 3.5% inflation -- buying power reduced 50% in 20 years.

Lean toward living for today with discretionary funds.

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Retirement Scenario II:Your Savings Pay the Bills Be realistic about the amount you withdraw

monthly to insure income for 20-30 years from now.

Make “payday” a convenient process

IRS Section 72(t): “substantially equal periodic payments” to avoid tax penalty

– SEPPs for later of 5 years or until 59 1/2

– Example: Begin at 52 1/2; withdraw 7 yrs

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Withdrawal Rate Consensus

Somewhere between 4% and 5%

What you should do depends on:

– Your expected investment returns

– Whether or not you to leave money to heirs

– Whose statistics you believe the most

To help with withdrawal decisions, consider T. Rowe Price’s Retirement Income Manager ($500) 1-800-566-5611

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Review Your Portfolio Allocation Be more conservative in retirement

Consider 50/50 split; perhaps 60/40 in first 10 years of retirement

Remember, the portfolio has to pay for your retirement in real-time

Keep a minimum of 20% in stock to attempt to keep up with inflation

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Create a Separate Retirement Spending Account

Don’t mix investment and spending accounts

Don’t simply sweep all dividends and interest $$ into spending accounts

Don’t treat yourself to a spending spree in an up market year.

Do take annual raises to keep up with inflation.

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Set aside enough $$ to pay uncovered “excess” expenses for 3 to 5 years in a money market mutual fund

Remainder grows in stock and bond mutual funds. Sell shares annually and add to MMF balance

If stock market tumbles -- hang tough. Wait for markets to recover

Retirement Distribution Strategies

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Strategies To Stretch Your Assets

Involve lifestyle decisions and/or planning

TANSTAAFL

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Invest More Aggressively

Over long time periods, the more stock in portfolio, the higher average return

Constant risk of market volatility

Aggressive portfolio: 60-80% stocks before and after retirement

Lower risk: G&I, equity-income funds

TRADEOFF: increased investment risk

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Maximize Tax Advantages

Compound interest works best when taxes are eliminated, reduced, or deferred

Tax-free: municipal bonds, Roth IRAs Reduced tax: 20% LTCG tax rate Tax deferral: employer plans, traditional

IRAs, and variable annuities TRADEOFF: Lack of flexibility (penalty &

tax: withdrawals before age 59 1/2)

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Trade Down to a Smaller Home

Example: $250,000 house to a $100,000 condo or a rental property

Proceeds are available to invest Maintenance, utilities, taxes decrease No longer any age requirements Generous CG tax exclusions TRADEOFF: less square footage and

storage space & moving hassles

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Move to a Less Expensive Location “Geographic Arbitrage”: Take

advantage of housing cost differences across the country

Could keep same size home; it just costs less (no downsizing needed)

TRADEOFFS: proximity to family and friends & moving hassles

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Delay Retirement Date

Provides additional income to invest and postpones asset withdrawals so money can grow

May also increase pension & SS benefits (based on years of employment and income)

TRADEOFFS: less control over one’s time & continued daily job hassles

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Work After Retirement

“Semi-Retirement”: work 2-3 days/week Provides income, sense of fulfillment,

social contact, daily time structure Current job, new job, or self-employed Reduces the amount needed to be

withdrawn from investments Don’t jeopardize pension benefits! TRADEOFF: reduced control over time

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Consider a Reverse Mortgage

Good for persons 62 and older who are “house rich and cash poor”

Provides lump sum, monthly payments, or line of credit for any purpose

Loan is repaid from equity after owner(s) move, sell, or die

TRADEOFFS: less home equity to distribute to heirs and high up-front costs and complexity

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Make Tax-Efficient Asset Withdrawals Generally, tap taxable accounts & muni

bonds first (taxes already been paid) Then after-tax $ tax-deferred accounts Then before-tax $ tax-deferred accounts Minimum withdrawals required at 70 1/2 Exception: high net worth retirees TRADEOFF: complexity that may require

professional advice; planning

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Consider Combining Strategies

Investing more aggressively AND moving to a less expensive home

Reverse mortgage and AND working after retirement

Try different planning scenarios

All choices involve trade-offs

There are no “perfect” or “one size fits all” answers

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Special Consideration #1: Poor or Uncertain Health May want to push up retirement date

Prepare realistic longevity projections

Prepare estate planning documents

Make adequate provisions for ill person’s spouse

About 25% of Americans don’t live to 65

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Special Consideration #2: Sudden or Forced Retirement “Early out” incentives and pink slips May be psychologically and/or financially ill-

prepared A sense of loss is common May affect spouse’s retirement plans

– Spouse retires earlier than intended– Spouse remains employed for income or benefits– Issues of “togetherness”

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Questions, Comments, Issues? Experiences?