Avoiding running out of retirement income

Doug Horn

With the investment markets behaving as they are, the likelihood of running out of retirement income may appear to be a real possibility. Throw in the murky future of the Social Security Administration and the huge future demands on its assets to meet the promises to the baby boomers, and retirement may not be looking all that rosy.

Short of becoming a lone lost child of Warren Buffett, there are steps that can be taken to improve the chances that existing retirement assets will suffice to provide income throughout retirement. First, there are facts that should be known and applied to avoid running out of assets. Many retirees expect the performance on their retirement assets to perform at similar levels as their preretirement rates or they apply a rate based upon recent results and not long term averages. Another common mistake is applying an average return rate, even if it a reasonable 7 percent, and believing the portfolios will last forever when withdrawing 5 percent. A third error that is often made is the allocation mix of the retirement assets. Now that retirement has started, many believe the production of income is the main focus and the majority of the assets should be certificates of deposit or bonds.

The first step must be met with the understanding that a successful retirement in today’s world will rely more on the retiree’s own assets than an income stream from the U.S. Government or a former employer. Thus, a retirement portfolio must be built through annual and monthly contributions into an employer’s 401-k plan, personal retirement plans such as IRAs, or into taxable investment accounts. Expecting to build a sufficient retirement portfolio just two to ten years before retirement is only setting oneself up for a stressful retirement.

Retirement also changes the performance of the assets. There will no longer be additions to the portfolios to take advantage of market dips, but rather withdrawals are now occurring during what could be bear markets. Once funds are taken out to be spent, they obviously are not there to assist in rebuilding the account value when the markets recover. This change in portfolio status, in addition to withdrawals, will reduce the average portfolio returns.

Preparing assumptions based upon average returns is also very dangerous. While a portfolio may average 8 percent per year, it is unlikely that every year in its history it made 8 percent. The actual returns are made up of a host of both positive and negative returns. There is a phenomenon referred to as “sequence of returns” that can play havoc on a portfolio. The sequence of when the good and bad years occur will impact whether a portfolio will last or not. Using a portfolio with bonds and stocks based upon the indexes, a retiree taking a 5 percent income, which is adjusted for inflation, will have a portfolio that has grown to 8 times its original value from 1979 through 2008. But had the retiree experienced the same returns in reverse order, the portfolio would have been exhausted before the completion of the 24th year. Since the average turn for the period is the same whether you add them from the top down or the bottom up, using an average can provide a false sense of security.

Additionally, many retirees may start their rate of withdrawal from retirement assets at a reasonable 5 or 6 percent, but after adjusting for inflation and additional one time withdrawals for the new car or anniversary vacation, the annual amount climbs. As long as the portfolio has grown as well, the percentage may not be too different. But, once a correction occurs, the 6 percent withdrawal rate could become an 8 or 9 percent withdrawal rate based upon the now lower portfolio value. Failure to react to this change could cause the account to start a downward spiral.

Lastly, the belief that equities should no longer have a role in the portfolio allocation can lead to premature portfolio declines. Studies have shown for a 25 year retirement that an 80/20 percent stock/bond portfolio has a 61 percent chance of providing 6 percent annual income adjusted for inflation. Whereby, a portfolio with 20/80 percent stock/bond portfolio only has a 33 percent chance of avoiding running out of assets within the 25 year period.

Understanding the rules and setting realistic expectations are major ingredients to avoiding running out of retirement assets.

For assistance with insurance, estate planning, and managing investments, contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.

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