What is the Best Way to Take Retirement Withdrawals?

If you are looking to retire in the near future or are recently retired, you may be interested to learn that how you take withdrawals from your portfolio may have a dramatic impact on the success of your retirement plan. Here’s a summary of a recent article in the Journal of Financial Planning.

Researchers considered a 60/40 portfolio with 4% withdrawals for retirement to examine different withdrawal strategies. They used historical equity returns since 1970, an assumed 2% rate of return for bonds, 1% in fees, 3% annual inflation increases, and a 30 year retirement horizon. They tested four different ways of withdrawing funds from a $1 million portfolio and calculated the percentage of success of each approach as well as the median portfolio value that was left over at the end of 30 years.

Strategy Success Percent Median Ending Value
Spend Stocks First 72% $912,593
Annual Rebalancing 80% $730,302
Simple Guardrail 94% $1,390,418
Spend Bonds First 97% $4,222,468

Most advisors suggest annual rebalancing. This approach keeps your portfolio pegged at a 60/40 allocation even as 4% annual withdrawals are taken. Note the success rate here was 80%, which means that in 1 out of 5 trials, the strategy failed to provide 30 years of inflation adjusted withdrawals. Annual Rebalancing also had the lowest Median Ending Value, which is important for a cushion if you or your spouse should live longer than 30 years, or if you would like to leave assets to heirs or charity.

The best result was obtained by Spending Bonds First. That means that a retiree would not touch their stocks at all while they spent down their entire 40% in bonds. At 4% withdrawals, it would take about 11 years until you had depleted your bonds and for the following 19 years, you would have a 100% equity portfolio. This type of strategy is sometimes called a “Rising Equity Glidepath” by Michael Kitces and other researchers.

Spending Bonds First might provide the best return because it begins with more than a decade of stock growth, with no withdrawals, which in most periods would have been a significant rate of return. However, this approach is controversial, because most practitioners (and regulators) believe that the typical retiree in their seventies or eighties does not have the risk tolerance to be 100% in equities. But, if you did have the stomach for this type of approach, there is evidence from this article and several others that validates the potential benefits of spending bonds first.

The Simple Guardrail may be easier for most retirees to tolerate and for advisors to adopt because it does not require moving to a 100% equity portfolio. The guardrail is simply this: no withdrawals are taken from stocks following a down year to give them a chance to rebound. The portfolio is also rebalanced back to 60/40 annually. While it doesn’t have the dramatically higher median ending value of Spending Bonds First, the guardrail still offers a noticeable improvement in success versus standard rebalancing, from 80% to 94%.

While Spending Bonds First may offer the best hypothetical results, it may be too aggressive for most retirees. The Simple Guardrail improves results on a more basic premise of giving equities an opportunity to rebound after a down year. In our next down year in equities, we will be talking with clients who are taking distributions about this idea.

The study is interesting, but it assumes one account and does not consider the real world complexities of taxes, multiple types of accounts, or Required Minimum Distributions. We look very thoroughly at each client’s withdrawal strategy to fulfill their income needs in the most efficient manner possible.

Source: Determinants of Retirement Portfolio Sustainability and Their Relative Impacts, DeJong and Robinson, Journal of Financial Planning, April 2017, pp. 54-62.

The Future of Social Security

It seems like the Internet Age has helped create a culture of instant gratification, short attention spans, and sound bites. There is less interest and patience for detailed discussions, long-form journalism, or acknowledging the complex trade-offs of decisions. We have moved into a post-factual world where the truth gets less airplay than spin. Politically, everything is black and white, right or wrong.

Frequently, I see people posting political comments or memes on Facebook about Social Security. These posts are meant to make the other party look like villains, but are often factually incorrect, incomplete, and short-sighted. I avoid getting sucked into these unproductive conversations, but many people could use a better understanding of the numbers and reality of our situation.

We should be having a real, adult conversation about Social Security. It is the future of not only retirement planning, but of our country’s prosperity and debt. I hope this primer below will make the case for why we need to reform Social Security and the challenges we face.

First, it is a myth that Social Security saves your contributions. Social Security is and always has been an entitlement program, like Welfare or Food Stamps. Current taxes are used to pay current benefits. The Social Security taxes you paid in 2015 were paid out to Social Security Beneficiaries in 2015. None of that money was saved for you.

Because of post-WWII demographics, there was for a very long time, a Social Security surplus. They took in more payroll taxes than they paid out in benefits. That annual surplus was invested in the Social Security Trust Fund, to pay a portion of future benefits. It was never the intent or expectation that the Trust Fund would cover all future expenses.

For decades, the Trust Fund saved this surplus. However, in the 1970’s politicians looked for a way to close the budget gap and decided to spend the Trust Fund and replace those assets with IOU’s in the form of Treasury Bonds.

Several years ago, the annual Social Security surplus disappeared and became negative. Today, there is a short-fall where current OASDI taxes are insufficient to cover benefits paid. The short-fall is presently being covered by the Trust Fund through cashing in their Treasury Bonds. This is where all the Facebookers get things wrong – Social Security does have an impact on the deficit. Benefits which are paid from the Trust Fund are now part of our national debt, as new bonds are issued to replace those cashed by the Trust Fund.

Once the Trust Fund reaches zero, the Social Security Administration will be able to cover only 77% of their promised benefits. Every year, the Social Security trustees project when this will occur, presently thought to be 2035. This is the date that Social Security will be insolvent, or “bankrupt”.

People say, But I paid into Social Security, I am OWED those benefits! Unfortunately, the Social Security System is broken and the numbers are simply not going to work. When the program began, there were 16 workers for every retiree. Today, there are 3 workers for every retiree, and that ratio is expected to continue to fall to 2 to 1, before the mid-century.

There are a couple of reasons why this has happened. Demographically, the Baby Boomer generation is enormous and there are thousands of people who are starting benefits every day for the next two decades. When Social Security began, the life expectancy at birth was only 65. Today, if you are already 65, the typical beneficiary will probably live another two decades. The retirement period being funded by Social Security has swelled from a couple of years to 20, 30, or more years because of our increasing longevity.

What originally worked in 1935 isn’t possible with today’s population. Every year, the Trustees tell Congress exactly how to fix Social Security. There are only two options: increase taxes or decrease benefits. There is no magic unicorn of preserving promised benefits and not raising taxes. That’s not how Math works. So when a politician promises that they will not lower benefits, they are either in favor of higher taxes or they are just blowing smoke. If they ignore the issue for long enough, it will become their successor’s problem.

Seniors vote and turn out better than any other age group. Politicians and candidates know this. The easiest attack in politics is to say that your opponent wants to “take away your Social Security check”. Up to this point, that war cry has silenced every politician who has proposed Social Security reform, including the bi-partisan Simpson-Bowles commission which came up with comprehensive solutions.

The present approach from politicians is the worst for America: kick the can down the road and let someone else fix it. Parties are too concerned with maintaining their seats over the next two years (or taking them back), to be willing to think longer-term than the next election cycle. The longer we wait to address the short-fall, the more drastic steps will be required.

Simpson-Bowles proposed increasing the Full Retirement Age from 67 to 69 over several decades. This would have had zero impact on current retirees and gave 20 years notice to future retirees. But even this small change brought the full opposition of the AARP, and ultimately none of the commission’s proposals were ever enacted.

Presently, workers and employers pay OASDI taxes on the first $127,200 of earnings (2017). Raising the income ceiling on Social Security taxes will not be sufficient to fully fund benefits, even if we were to eliminate it entirely. There will probably need to be some reduction in benefits if we are to avoid increasing taxes significantly on all workers. But that doesn’t mean that everyone will see their benefits plummet. Ways to reduce benefits include:

  • Increasing the Full Retirement Age gradually from 67 to 70
  • Changing how SS calculates cost of living adjustments (COLAs)
  • Means-testing benefits
  • Creating a cap on benefits, say to the first $75,000 in income
  • Adjusting mortality calculations for today’s increased longevity
  • Lowering the payout formulas and tying them to future increases in longevity

By the way, increasing immigration and the population of younger people would help retirement programs like Social Security. Look at a country like Japan, which has an even higher percentage of retirees than the US, to see the challenges of financially supporting a large segment of the population. The money that is spent on retirement programs, or to finance the debt of those programs, crowds out other government spending which might be better for economic development.

There is no quick fix or easy solution to save Social Security, but it’s time we expect more from our politicians. Fixing Social Security and Medicare will not be easy or painless, but we need to be thinking now about how we can preserve these programs and ensure their viability for younger workers and future generations. Become an informed voter and be on the lookout for when politicians are using issues as ammunition to lob at their opponents, rather than looking at solutions for America.

Social Security Planning: Marriage, Divorce, and Survivors

The Social Security Statement you receive is often incomplete if you are married, were married, or are a widow or widower. Your statement shows your own earnings history and a projection of your individual benefits, but never shows your eligible benefits as a spouse, ex-spouse, or survivor.

In general, when someone is eligible for more than one type of Social Security benefit, they will receive the larger benefit, not both. But how are you supposed to know if the spousal benefit is the larger option? Social Security is helpful with applying for benefits, but they don’t exactly go out of their way to let you know in advance about what benefits you might receive or when you should file for these benefits.

The rules for claiming spousal benefits, divorced spouse benefits, and survivor benefits are poorly understood by the public. And unfortunately, many financial advisors don’t understand these rules either, even though Social Security is the cornerstone of retirement planning for most Americans. Today we are giving you the basics of what you need to know. With this information, you may want to delay or accelerate benefits. The timing of when you take Social Security is a big decision, one which has a major impact on the total lifetime benefits you will receive.

1) Spousal Benefits. If you are married, you are eligible for a benefit based on your spouse’s earnings, once your spouse has filed to receive those benefits. If you are at Full Retirement Age (FRA) of 66 or 67, your spousal benefit is equal to 50% of your spouse’s Primary Insurance Amount (PIA). If you start benefits before your FRA, the benefit is reduced. You could start as early as age 62, which would provide a benefit of 32.5% of your spouse’s PIA. Calculate your benefit reduction here.

If your own benefit is already more than 50% of your spouse’s benefit, you would not receive an additional the spousal benefit. When you file for Social Security benefits, the administration will automatically calculate your eligibility for a spousal benefit and pay you whichever amount is higher. A quick check is to compare both spouse’s Social Security statements; if one of your benefits is more than double the other person’s benefit, you are a potential candidate for spousal benefits.

If your spouse is receiving benefits and you have a qualifying child under age 16 or who receives Social Security disability benefits, your spousal benefit is not reduced from the 50% level regardless of age.

Please note that spousal benefits are based on PIA and do not receive increases for Deferred Retirement Credits (DRCs), which occur after FRA until age 70. While the higher-earning spouse will receive DRCs for delaying his or her benefits past FRA, the spousal benefit does not increase. Furthermore, the spousal benefit does not increase after the spouse’s FRA; it is never more than one-half of the PIA. If you are going to receive a spousal benefit, do not wait past your age 66, doing so will not increase your benefit!

2) Divorced Spouse Benefits. If you were married for at least 10 years, you are eligible for a spousal benefit based on your ex-spouse’s earnings. You are eligible for this benefit if you are age 62 or older, unmarried, and your own benefit is less than the spousal benefit. A lot of divorced women, who may have spent years out of the workforce raising a family, are unaware of this benefit.

Unlike regular spousal benefits, your ex-spouse does not have to start receiving Social Security benefits for you to be eligible for a benefit as an ex-spouse, as long as you have been divorced for at least two years.The ex-spouse benefit has no impact on the former spouse or on their subsequent spouses. See Social Security: If You Are Divorced.

If you remarry, you are no longer eligible for a benefit from your first marriage, unless your second marriage also ends by divorce, death, or annulment.

A couple of hypothetical scenarios, below. Please note that the gender in these examples is irrelevant. It could be reversed. The same rules also apply for same-sex marriages now.

a) A man is married four times. The first marriage lasted 11 years, the second lasted 10 years, the third lasted 8 years, and his current (fourth) marriage started three years ago. The current spouse is eligible for a spousal benefit. The first two spouses are eligible for an ex-spouse benefit, but the third is not because that marriage lasted less than 10 years. A person can have multiple ex-spouses, and all marriages which lasted 10+ years qualify for an ex-spouse benefit!

b) A woman was married for 27 years to a high-wage earner, and they divorced years ago. She did not work outside of the home and does not have an earnings record to qualify for her own benefit. She is 66 and unmarried, so she would qualify for a benefit based on her ex-spouse’s record.

However, if she were to marry her current partner, she would no longer be eligible for her ex-spousal benefits. If the new spouse was not receiving benefits, she could not claim spousal benefits until he or she filed for benefits. Additionally, if the new partner is not a high wage earner, her “old” benefit based on the ex-spouse may be higher! Some retirees today are actually not remarrying because of the complexity it adds to their retirement and estate planning. And in some cases, there is an actual reduction in benefits by remarrying.

3) Survivor Benefits. If a spouse has already started their Social Security benefits and then passes away, the surviving spouse may continue to receive that amount or their own, whichever is higher. The survivor’s benefit can never be more than what they would receive if the spouse was still alive.

If the deceased spouse had not yet started benefits, the widow or widower can start survivor benefits as early as age 60, but this amount is reduced based on their age (See Chart). Widows or widowers who remarry after they reach age 60 do not have their survivorship eligibility withdrawn or reduced.

One way to look at the survivorship benefit: which ever spouse has the higher earnings history, that benefit will apply for both spouse’s lifetimes. The higher benefit is essentially a joint benefit. For this reason, it may make sense for the higher earner to delay until age 70 to maximize their benefit. If their spouse is younger, is in terrific health, and has a family history of substantial longevity, it may be profitable to think of the benefit in terms of joint lifetimes.

Additionally, Social Security offers a one-time $255 death benefit and also has benefits for survivors who are disabled or have children under age 16 or who are disabled.

The challenge for planning is that none of these three benefits – spousal, ex-spouse, or survivor – are indicated on your Social Security statement. So it is very easy to make a mistake and not apply for a benefit. I like for my clients to send me a copy of their Social Security statements, and I have to say that more than half of the clients I have met don’t understand how these benefits work, even if they are aware that they are eligible.

Social Security Administration: it’s time to fix your statements. You can do better.

Can You Be Too Conservative?

As you approach retirement, you are probably thinking quite a bit about making your investment portfolio more conservative. We generally recommend that investors start dialing back their risk five years before retirement.

However, it is possible to be too conservative. Retirement is not an single date, but a long period of sustained withdrawals. We typically think in terms of a 30-year time horizon, which is not unrealistic for a 60 to 65-year old couple, given increasing longevity today.

The old rule of thumb was to subtract your age from 100 to determine your allocation to stocks. For example, a 65-year old would have 35% in stocks and 65% in bonds. Unfortunately, this old rule of thumb doesn’t work for today’s longer life expectancies.

Researchers analyzing the “4% rule” used for retirement income planning, typically find that optimal allocation for surviving a 30-year distribution period has been roughly 50 to 60 percent stocks. For most new retirees, we generally suggest dialing back only to 50/50 or 60/40 in recognition that the portfolio still needs to grow.

We still need growth in a retirement portfolio to help you preserve purchasing power as inflation erodes the value of your money. At 3% inflation, your cost of living will double every 24 years. So if you are retiring today and thinking that you just need $40,000 a year, you should be expecting that need to increase to $80,000 or more, to maintain your standard of living.

Another reason retirees should not be overly conservative: interest rates are very low today. Bonds had a much better return over the past 30 years than they will over the next 30 years. That’s not even a prediction, it’s just a fact. When we use projected returns rather than historical returns in our Monte Carlo simulations, it suggests that bond-heavy allocations are not as likely to succeed as they were for previous retirees. See: What Do Low Interest Rates Mean For Your Retirement?

The other side of today’s low interest rates is that some investors are reaching for yield and investing in much lower-quality junk bonds. While retirees often focus heavily on income producing investments, financial planners and academic researchers prefer a “total return” approach, looking at both income and capital gains.

We don’t want to take high risks with the bond portion of our portfolios, because we want bonds to provide stability in the years when the stock market is down. High Yield bonds have a high correlation to equities and can have significant drops at exactly the same time as equities.

We manage to a specific, target asset allocation and rebalance annually to stay at that level of risk. That gets our focus away from stock picking and looking at the primary source of risk: your overall asset allocation of stocks, bonds, and other investments. While no one can predict the future, a disciplined approach can help avoid mistakes that will compound your losses when market volatility does occur.

Don’t Miss Out on a Roth IRA

I am a big fan of the Roth IRA and think it is an underutilized tool for investors. There are many people who are eligible for a Roth and are not participating. If you have a chance to put money into an account where it grows tax-free, why would you not want to contribute?

If you have a 401(k) at work, your first goal should be to maximize contributions to that account. For 2017, you can invest $18,000 into a 401(k), or $24,000 if you are age 50 or older. Your 401(k) contribution is tax deductible.

But whether or not you max out your 401(k) contributions, many families are missing the opportunity to also contribute to a Roth IRA. YES, you can be eligible for a Roth even if you participate in a retirement plan at work. More people should be trying to do both. Even if you do invest $18,000 a year into a 401(k), who says that will be enough to retire?

For the 2016 tax year, you can contribute $5,500 to a Roth IRA if your modified adjusted gross income (MAGI) is below $117,000 (single) or $184,000 (married). If you are over age 50, you can contribute $6,500. Contributions must be made by April 15, 2017 to count as a 2016 contribution.

Many investors are contributing to their 401(k) plan and say they don’t have additional income to contribute to an IRA. But if you have a taxable investment account, you could use money from that account to fund your Roth. If you aren’t planning to touch that money, don’t leave it in a taxable account, put it into an account that grows tax-free!

Here are a couple of important points to know about the Roth IRA:

  • With a Roth IRA, if you need to access your money before age 59 1/2, you can withdraw your principal (your original investment amount) without taxes or penalty. It is only if you withdraw earnings, would you be subject to a penalty and taxes before age 59 1/2, and even then only on the earnings portion.
  • If you’re married, as long as your income is below the $184,000 threshold, both or either spouse can contribute to the Roth IRA. It doesn’t matter if one spouse doesn’t work outside the home, you’re both eligible.
  • If you make too much to contribute to a Roth IRA, AND you do not have any Traditional IRAs, you may be a candidate to make a “Back-door Roth Contribution”. Read how here.
  • For investors who are over age 70 1/2, you are allowed to contribute to a Roth IRA but not a Traditional IRA. Again, put your money into the tax-free account if you are eligible!

The biggest problem with the Roth IRA is that the contribution limit is so low. When you miss a year of contributions, you can’t get that opportunity back later. So don’t miss out. If you are eligible for a Roth for 2016 and haven’t funded it, don’t delay. Call me today.

The Boomer’s Guide to Surviving a Lay-Off

Most people in their fifties and sixties have a very specific vision of their retirement. But if you find yourself unexpectedly getting laid off at age 55, or 63, you are probably feeling extremely stressed about your plans being thrown off course. The reality is that many people retire earlier than they had originally intended due to being laid off, or because of health or family reasons.

We build detailed retirement analysis packages looking at when you can retire, how much you can spend, and how long your money will last. As much science and math goes into those calculations, we should recognize that things don’t always go as planned and that we may have to adjust our plans. If you find yourself unexpectedly out of a job, I want you to know that things will be okay and we can help give you a more informed dissection of what to do next. Here are five steps to get started:

1) Address immediate needs

  • Figure out your health insurance. COBRA may be very expensive, so take the time to compare COBRA to an individual plan. A lay-off is a qualifying event, so you may be eligible to join your spouse’s health plan without waiting until the next open enrollment period. Avoid gaps in your coverage. Researching your health insurance will likely take more hours than you want to spend, but it’s important to get it right.
  • Please note that if you are over 65 and did not sign up for Medicare because you had employer group coverage, that post-employment, you have an 8-month Special Enrollment Period to sign up for Medicare without incurring the lifetime surcharge. COBRA is not considered group coverage and will not delay the start of this 8-month window.
  • File for unemployment benefits so you can receive benefits as soon as you are eligible. You should never quit a job in advance of a layoff; doing so could jeopardize your eligibility for unemployment.

2) Create your household budget

  • Are you burning cash? How much money will you have left in 6, 12, or 24 months? Making a budget is how you will know. Uncertainty creates fear; planning creates clarity.
  • Can you live off one spouse’s income? Can you cut expenses? This is often not that difficult to do, but we resent it, because it was unplanned and forced upon us against our wishes. But we cannot stick our heads in the sand and ignore a new financial reality. If you are going to make changes, make them without delay.

3) Start your job search immediately

  • You have to document weekly job search activity to receive unemployment benefits, so you might as well get started!
  • It may take you much longer than expected to get your next job. Some of this may unfortunately be due to age discrimination, so I would not discount that consideration. However, many veteran employees have a skill set that was unique to one employer. You may need other skills for what the marketplace requires today. Lay-offs typically occur in jobs where there is a reduction in demand. Your next job may need to be very different.
  • Be careful of anchoring to your past income. If you are holding out that your next job will be the same work at the same pay as your old job, that may not be a realistic expectation.
  • Polish your resume and application; consider getting professional help with these materials. Most applications are done online today, so your words represent you. Practice your interview skills and be prepared to answer any question. Network with colleagues and meet with someone every week to chat about your next steps.

4) Consider retiring early

  • Maybe you are 63 and were planning to retire at 65. The layoff could be a blessing in disguise and will allow you to retire now. Make your budget and let’s take a look at your retirement plan. If you can afford it, why not go for it?
  • You may realize that you don’t enjoy your work as much as you used to and have other interests now. If you used to make $100,000, you might not be willing to work 50 hours a week for $65,000. Or you may decide that starting a new career isn’t going to be very fulfilling, if all you are doing is marking time for 2-3 years. Consider all your options.

5) Delay spending your nest egg

  • Can you hold off on withdrawals for a few years and get by on a spouse’s income or from existing cash and unemployment benefits? Postponing withdrawals by even two or three years can have a significant impact on the longevity of your portfolio.
  • Try to avoid dipping into your IRA and 401(k) at age 60, if you were not planning to touch those monies until age 66. The best withdrawal strategy remains to wait until age 70 1/2 and then take only your Required Minimum Distributions.
  • Lay-offs are one of the most common reasons people start Social Security benefits early. If you have longevity concerns – and most people should – you want to delay those benefits for as long as you can, even to age 70. You get an 8% increase in benefits by delaying for each year past full retirement age. Patience pays.
  • Take a part-time or seasonal job if it means you can avoid tapping your retirement accounts. Unemployment benefits are based on weekly income, so you would be better off working 40 hours in one week and zero the following week, versus working 20 hours both weeks.

Bonus: 6) Take care of your emotional needs

  • It’s easy to focus on the financial aspects of a lay-off, but the emotional impacts are even greater. If you are not yet financially ready for retirement, a very real concern is running out of money in your seventies or later. We need to address those fears with a revised financial plan.
  • It’s natural to feel resentment and even betrayal when you were planning on giving a company the rest of your working years, and they decide instead to kick you to the curb. It’s important to not take this personally. A lay-off does not have anything to do with your value as a human being, a parent, or even as an employee. If you still feel enthusiasm, optimism, and joy in your work, then your positive attitude will be as valuable to your next employer as your experience!
  • We need to have a sense of identity, self-worth, and purpose that is not tied to our job. We are more than just an accountant, teacher, or engineer. Many people who are laid off go through the same work withdrawal they would have experienced at retirement. They don’t have their old routine, colleagues, or sense of belonging. Can you fulfill those needs in another way, such as through part-time work, free-lancing, or volunteering? What exactly is it that you miss?

While you can do all these steps on your own, what may give you the most confidence to move forward is to meet with me and prepare a new financial plan. I’ve met a lot of folks in the same situation and can help. We will put together a detailed analysis reflecting your new situation, evaluate all your options, and chart a new course.

Sometimes we choose change and sometimes it is thrust upon us. Change isn’t always easy or what we would have preferred, but ultimately, it’s our attitude that determines how successfully we can adapt.

Avoiding Another 2008 for Pre-Retirees

In 2008, the S&P 500 Index was down a whopping 37%. Other stock indices and many mutual funds did even worse. Perhaps the worst part of the 2008 crash was that diversification didn’t work. Correlations went to 1. You couldn’t hide out in international stocks, or small cap, or high yield bonds. They all went down. With today’s global economy, if the US catches a cold, the rest of the world becomes very sick. This is bad news for investors who thought they were safe by diversifying globally.

Since 2009, the market has been up. Just like Autumn turns to Winter, there will undoubtedly be another recession and bear market for investors in the future. On average, bear markets occur every 5-6 years, so many argue that we are already overdue. While we don’t know when this will ultimately occur, it’s not a matter of “predicting” a bear market, but being prepared.

If you’re a long-term investor, you can recover from years like 2008. In fact, it’s an opportunity to buy more shares while they are on sale. All that matters to you is that the returns are strong over the next decade or longer. However, if you were planning to retire in 2009, a year like 2008 can potentially derail your plans. Whether your retirement strategy involves a 4% withdrawal rate, buying an annuity, or investing for income, taking a 37% hit to your principal will certainly impact the amount of retirement income you can generate from your portfolio.

Even worse off were the people who retired in 2007, because they didn’t have the option of delaying retirement. If you retired with $1 million on January 1, 2007, and took withdrawals of 4% ($40,000 a year), you would have ended 2008 with less than $600,000 if you had invested in an S&P 500 Index fund.

There is a crucial window from 5 years before retirement to 5 years into retirement, when a large drop could have a major impact on your retirement success. Even if the market later rebounds, as it always has historically, retirees have the risk that their withdrawals could deplete their shares and they are still unable to recover. Financial planners call this sequence of returns risk.

We are starting a new portfolio model specifically to address sequence of returns risk by investing in a portfolio with significantly lower volatility. Our new Defensive Managers Select portfolio uses institutional funds with a disciplined quantitative or fundamental process to invest with less risk. Our aim is to approximate the return of a 60/40 portfolio, but with with much lower price fluctuation, as measured by standard deviation. We use funds which have a demonstrated track record of delivering low volatility, smaller magnitude of losses, and consistent positive returns.

The portfolio can include active managers, low volatility ETFs, alternative strategies, and cash. Portfolios will typically own 4-8 different funds, which gives us diversification of manager and style, in addition to stock and bond diversification. How did these funds do in 2008? While the S&P 500 Index was down 37%, three of our allocation funds were down 9.8%, 4.6%, and 0.5%. Although past performance is no guarantee of future results, we believe that having a disciplined risk strategy is better than not having any strategy and simply taking market results.

Defensive Managers Select takes a different approach than our traditional Premier Wealth Management portfolios. The Premier Wealth Management portfolios remain our recommended solution for accumulation and for investors who do not require withdrawals within five years. These portfolios use passive strategies, which are very low cost, tax efficient, and I believe will deliver superior long-term results for investors. Implicit in being invested in a passive strategy is that you have the time and resources to remain invested if the market ever takes another 37% plunge.

The Defensive Managers Select portfolio is not designed to beat the market. Most managers do not beat the market over time, and track records have no predictive accuracy as to which funds will beat the market going forward. What is more consistent is volatility. We are buying those funds with a style, process, and track record of low volatility. Pre-retirees don’t need to hit home runs, they just need to make sure that they aren’t going to be wiped out in the next bear market.

No one wants to think about another downturn, but there’s old saying that “the best time to fix the roof is when the sun is shining”. If you are within 5 years of retirement, don’t wait until there is a big drop to decide to shift your portfolio strategy to a more conservative posture. If you wait, you are just locking in your losses and diminishing your chances of recovery. The market is up this year, and the sun is shining. Now is the right time to adopt a defensive strategy.

Let’s schedule a call to talk about your income requirements and retirement goals. I don’t see a lot of other firms offering truly defensive retirement strategies, or making any distinction between accumulation and retirement objectives. This is a unique approach and one which I am happy to compare to what you are doing today. If the possibility of a bear market, or God forbid, another 2008, would hurt your retirement, let’s address that risk before it occurs.

Please note that the objective of this investment strategy is growth and not preservation of capital. While our goal is low volatility, that is no guarantee that losses will not occur.

6 Steps at Age 60

The sixties are a decade of financial change. Are you prepared? Here’s my checklist to confirm if your finances are in good order at age 60.

1) 12.5X annual income. At this point, you should have saved at least 12.5 times your annual income in your investment and retirement accounts. Why 12.5 times? When you retire, we will recommend an initial 4% withdrawal rate. To replace one-half your income from investments, you would need 12.5X. For example, if your income is $100,000, we’d want at least $1,250,000 in investments to provide $50,000 a year in distributions.

Why replace only half your income? Won’t that be a significant drop in your standard of living? As an employee today, you are subject to payroll taxes (7.65%) which will not apply to your retirement income. Since you are saving today for retirement, that “expense” will go away in retirement. Plus the 50% is only withdrawals – when we include Social Security, and possibly pension income, your income replacement rate may be 70% or higher.

You may disagree with this, because at age 60, you have no immediate plans to retire. Therefore, you think this does not apply to you. Wrong. The 2016 Retirement Confidence Survey from the Employee Benefits Research Institute finds “a considerable gap exists between workers’ expectations and retirees’ experience about leaving the workforce.” Although 37% of workers expect to work past age 65, only 15% of retirees actually retired at this age. Most reported retiring for reasons beyond their control, such as layoffs, health issues, or family reasons. So, just because you plan to keep working does not guarantee that you will actually be able to do so.

Even if you do not retire for another five years, the market might not be higher over this short time frame. Certainly that was the experience for people who retired in January of 2009. If you already have 12.5X your income by age 60, then you aren’t dependent strong market performance in your last years of work to get you to the finish line.

2) Estate plan. If your will and documents are more than five years old, it’s time to revisit your estate plan for an update. This should include:

  • Checking the beneficiaries on your retirement plans, IRAs, life insurance, and annuities.
  • Updating your Will.
  • Establishing Directives and Powers of Attorney if you should become incapacitated.
  • Considering if you have the potential for an Estate Tax liability; considering whether trusts are needed for asset protection, tax planning, or special needs.

3) Health Care. Modern healthcare is extending the human lifespan. Even more significant than the added years is the high quality active lifestyle that people are leading in their seventies and even eighties today. Many of the miracles of modern medicine are in the early detection, treatment, and cure of common diseases such as cancer and heart disease. If you want to enjoy these life-saving advances, you have to participate and have regular screenings and testing as recommended by your physician. Don’t ignore minor symptoms, bring them to your doctor’s attention as soon as possible.

I think many of us are reluctant to go see a doctor when we feel well or can find an excuse to not go. Without your health, you are not going to be able to enjoy the fruits of your decades of work. Make a small, but essential, investment in your future by taking care of your self.

4) Long-Term Care Plan. Note, this says plan, it does not say insurance. Not everyone needs to have Long-Term Care Insurance, some people can afford to self-insure. No one wants to think of themselves as being in a nursing home. However, as people are living longer, more of us will need assistance. Today, many LTC insurance policies include coverage for home health care and aides, meaning that the policy may actually be the reason why you can stay at home and not have to go to a nursing home.

At age 50, people aren’t interested in buying LTC when it is 30+ years away. At age 70, a policy will be prohibitively expensive, and you won’t want to buy one even if you could afford it. Age 60 is the sweet spot for buying LTC insurance. Here’s what you should do: determine if you can afford long-term care in the future without the insurance. If not, contact me for more information. If leaving money to heirs or charity is a top priority for you, you should actually consider the insurance as it will reduce the possibility of depleting your assets if you should need care.

5) Social Security Statement. Create your account on ssa.gov and download your statement.

  • These estimates assume you continue to work until the age of retirement. Know your Full Retirement Age, and learn about how benefits are reduced for early retirement and increased for delaying up to age 70.
  • The spouse with the higher benefit will provide a benefit for both lives, under the survivorship benefit. Therefore, you should try to maximize the benefit of the higher earning spouse by delaying, if possible, to age 70.
  • Statements do not list spousal benefits, and all amounts are in today’s dollars. Benefits will accrue Cost of Living Adjustments to keep pace with inflation.

6) Health Insurance. Keeping your benefits is essential until age 65, when you become eligible for Medicare. When you do receive Medicare, you will still have to pay premiums for Part B, as well as any Supplement, Advantage, or drug plans. Don’t neglect to include these costs in your retirement budget!

Back in 2008, I realized that many of my clients had similar questions once they were within five years of retirement. This is a crucial final period of preparation for your decades ahead. To help educate pre-retirees about these issues, I wrote Your Last 5 Years: Making the Transition From Work to Retirement as your guidebook. Email me for a copy or order one from Amazon!

To Roth or Not to Roth?

The question of “Roth or Traditional” has become even more complicated today with the advent of the Roth 401(k). Which should you choose for your 401(k)? Like many financial questions, the answer is “it depends”.

In asking the same question for an IRA, investors often look at their eligibility for the Roth versus their ability to deduct the Traditional IRA contribution. For the 401(k), that’s not an issue – there are no income restrictions or eligibility rules for a Traditional 401(k) or a Roth 401(k). You should also know that while you may choose Roth or Traditional contributions, any company match will always go in the Traditional bucket.

How to choose, then? Here are five considerations to making the decision:

1) If you are going to be in a lower tax bracket in retirement, it’s preferable to defer taxes today and pay taxes later. If this describes your situation, then you are likely better off in the Traditional 401(k). A majority of people should have an expectation of lower taxes in retirement.

2) The problem is that we don’t know what future tax rates will be. We do know that we are running massive budget deficits and that the accumulated national debt is a growing problem. While every politician wants to promise lower taxes to get votes, that seems unrealistic as a long-term solution to our budget issues. Retirees are often surprised that their taxes do not in fact vanish in retirement. Pension, Social Security, RMDs, etc. are all taxable income.

Link: Taxes and Retirement

If you believe you will be in the same or higher tax bracket in Retirement, then the advantage goes to the Roth. While you will not realize a tax benefit today from a Roth contribution, your money will grow tax-free. If you are going to pay the same tax rates in the future as today, you would be indifferent, in theory. Except that…

3) When you reach retirement, a $1 million Roth gives you $1 million to spend, whereas $1 million in a Traditional IRA or 401(k) may be worth only $750,000, $600,000, or less after you take out Federal and State income taxes. This means saving $18,000 in a Roth 401(k) is worth more than the same $18,000 in a Traditional 401(k), because the Roth money will be available tax-free.

If you are in a lower tax bracket or can comfortably pay the taxes, then the Roth may be preferable. In retirement, if you have both Roth and Traditional accounts, you can choose where to take withdrawals to best manage your taxes. (We call this tax diversification.)

4) The only caveat to the Roth contribution is that contributing to a Traditional 401(k) can lower your Adjusted Gross Income (AGI). If having a lower AGI would make you eligible for a tax credit, or eligible for an IRA contribution, then it may be beneficial to choose the deductible contribution.

For example: The Saver’s Tax Credit

5) There are no Required Minimum Distributions from a Roth account. If you are in the fortunate position to have plenty of retirement assets, making Roth contributions will add to tax-free assets, rather than creating an RMD liability for when you turn 70 1/2.

Last thought: for the past two decades, I have met people who don’t want to invest in a Roth because they think the government will take away the tax-free benefit in the future. I don’t see this happening. The government actually prefers Roths because it increases current tax revenue rather than the Traditional, which decreases current taxes. And I don’t see Roth accounts being used or abused by Billionaires or corporations – the amounts are so small and used mainly by working families.

How America Saves

Defined Contribution (DC) Plans are the backbone of retirement planning in America. Vanguard manages DC plans for 4 million Americans, with over $800 Billion in assets. So, I am always interested to read their annual report, How America Saves, which offers a window into the state of retirement preparation in America.

Link: How America Saves, 2016 Report

Looking through this year’s report, I see both reasons for optimism as well as concern. On the positive side, 78% of eligible employees participated in their company plan. And the average account balance was $96,288. It’s great that a majority of employees are participating.

However, it is surprising to discover the difference between the average and the median. (As a quick refresher, the median is the data point that is exactly in the middle – with half being higher and half being lower than this point.) The difference between the average and the median scores in Vanguard’s report belies a growing chasm between participants who save the minimum and those who save as much as they can.

While the “average” account balance was $96,288 in Vanguard Retirement Plans, the median participant had only $26,405. That means that half of all accounts have under $26,405, and that the average is skewed higher by very large accounts of $300,000, $400,000 and more.

The problem is that many participants are simply not contributing enough. The average deferral rate is 6.8%, but the median again is lower: 5.9%. Disappointingly, the average deferral rate is down from 7.3% in 2007, which means that most people are saving even less than they were 10 years ago.

People really do need to save 10% or more for their retirement. Instead, many invest only 3% or whatever is the default minimum. That’s because many participants only contribute up to the company match. In fact, when I ran a plan for a small company with a dozen employees, all but two only contributed up to the match. When you contribute the minimum over the course of a career, you are not thinking in term of the outcome. Will I have saved enough to fund a comfortable retirement? Am I on the path to financial independence?

However, there are good savers out there. 20% of the participants in a Vanguard plan are saving more than 10% of their salary into their retirement plan. These are the accounts which are bringing up the median of $26,405 to the average of $96,288. And this is what you want to do -you want to be a savings overachiever!

Over time, compounding makes a huge gap between people who contribute the minimum versus those who save more. To examine this, let’s consider two employees: Minimum Mike and Saver Sally. They both have the same salary of $45,000 and earn 3% raises over the next 35 years. Mike contributes 3% to his 401(k) and gets the company match of 3%. Sally contributes 10% and also receives the 3% match. Both earn a return of 7% compounded annually.

Here are their account balances after 35 years:
Minimum Mike: $567,615
Saver Sally: $1,230,417

Saving 10% really does make a big difference over the length of a career. Although the news media would like for you to believe that your financial future hangs by a thread on the outcome of the Brexit, or the Presidential Election, or whatever new crisis is on that day, the reality is that the biggest determinant of your long-term wealth is likely to be the percentage you contribute.

Being average is still a lot better than being median. If you want to be above average, start by increasing your deferral rate.

There is still time to increase your 401(k) or 403(b) contribution for 2016. The maximum contribution is $18,000 for 2016, with an additional catch-up of $6,000 if you are over age 50.