Getting to the years of retirement is somehow today not so easy. First you got to get through “all” of life’s challenges and then you got to think about your retirement.
You would think that after decades of saving money for retirement, the hard part of investing would be over. Think again. Devising a plan to turn a heap of cash into a stream of income that can last a lifetime is more art than science, and there is no one magic formula that suits every investor. “We’d all like to find one simple answer, but retirement is not simple,” says Eric Sondergeld, vice-president of Limra, an insurance-industry trade group.
Consider one commonly accepted model: the 4% solution. The rule of thumb is to withdraw 4% from your portfolio to finance your first year in pension, and increase that initial dollar amount in subsequent years to keep pace with inflation. This conservative withdrawal pace virtually assures that you won’t run out of money — one of the most frightening scenarios for retirees. But the meager income it generates — initially $40,000 from a $1-million kitty — may be insufficient for many retirees. Some opt to spend more early on and vow to cut back later.
The Rule of Thumb
Or you could buy an immediate annuity. You hand over cash to an insurance company, and in exchange it promises to send you monthly payments for life. This strategy may be good for someone who doesn’t have a pension and wants a blast of guaranteed income. That is to cover fixed expenses such as mortgage payments and utilities. One of the nice things about this approach is that you can invest the rest of your money more aggressively, knowing that your annuity payments, supplemented by Social Security benefits, will cover many living costs.
But interest rates, which affect immediate-annuity payouts, are near historic lows, and inflation erodes the buying power of fixed-rate investments. As a result, retirees who buy an instantaneous annuity now may have to curtail their spending in the future. Or buy additional annuities to maintain their standard of living.
It’s not what you earn, but what you keep. That old adage is true when saving for retirement and it’s equally important. If not more so – when it comes to withdrawing money from your various accounts earmarked for pension. But the conventional wisdom and advice about the best way to take money out of those accounts just might leave you with less, not more, not, after-tax wealth.
Taxable vs. tax-deferred
As a general rule, it’s usually better to sell long-term investments held in taxable accounts. Instead of taking money from tax-deferred accounts before you have to. According to Rande Spiegelman, a CPA, certified financial planner, and vice president of financial planning for the Schwab Center for Financial Research.
Tax-efficient withdrawal software needed
Unfortunately, crunching the numbers year by year to determine the most tax-efficient withdrawals is easier said than done. Most financial services industry firms and advisers – with some exceptions – are not in a position to determine the most tax-efficient way for their clients to take distributions. What’s more, it gets even more complicated when you add “estate-planning considerations to the decision-making process,” said Seibert.
Ultimately, Seibert said, “User-friendly software needs to be developed that will allow clients to choose from various scenarios and make adjustments when needed because what the advisor/client assumes is going to happen tax-wise over a 30-year retirement and what actually does happen will undoubtedly be different.”
Not surprisingly, such software does exist. LifeYield, Samuelson’s firm, is producing software aimed at helping companies in the financial services industry. They help their clients create tax-efficient retirement withdrawals plans. (LifeYield’s calculation engine suggests the optimal trades to make now to source withdrawals, consistent with higher after tax returns later.) And Coopersmith and Sumutka are fast at work building software too.
The Retirement March
With millions marching toward retirement, there’s one conclusion from the study that’s not in dispute. There’s a great need to help retirees and would-be retirees make the most of their retirement funds.
The next time you are considering making an investment change, take a look at viewing all of your assets as one portfolio. Then ask yourself which assets should be held in your retirement account and which ones should not.