It's a retiree's nightmare: outliving the assets in a retirement portfolio.
Between historically low interest rates dragging on fixed-income
yields and uncertainties about taxes, not to mention the threat of
future inflation and volatile markets that send skittish investors
seeking shelter, retirees who are living longer are finding it
challenging to keep their portfolios up to speed.
Recent calculations from the Employee Benefit Research Institute
show that roughly 44% of those born between 1948 and 1978—baby boomers
and Generation X—won't have adequate retirement income, and that is
assuming interest rates go back up in 2014. But the current environment
is weighing even on those heading into retirement with what seems like a
tidy sum.
Retirees need an efficient plan of attack to squeeze all the juice
out of their portfolios, ensuring they have sufficient assets for their
golden years. Here are some strategies:
Retirees
should map out a budget for necessities—include everything from housing
to food, transportation, health expenses and utility bills—and set
aside a chunk of a portfolio for these costs.
Many planners suggest putting funds to cover three to five years'
worth of expenses into safe and liquid vehicles, so the retiree has cash
on hand, even if the market drops.
"That way you don't have to liquidate in a down environment," says
Marty Leclerc, portfolio manager for Barrack Yard Advisors in Bryn Mawr,
Pa.
Even though money-market funds are returning basically nothing,
funds earmarked to be used within three years should go into these
instruments, says Michael Gibney, a financial planner in Riverdale, N.J.
"There is no reason to put money that will be used within a short time
period at risk," he says.
For five-year time frames, look to add in a short-term bond fund or certificate of deposit to gain a little more yield, he says.
With many people living well into their 90s, retirees need to think
carefully about how to protect themselves from running out of money in
their later years.
(Longevity calculators that factor in your family history and current health can be found at websites such as
gosset.wharton.upenn.edu/mortality and
livingto100.com.)
Some financial advisers say retirees should consider long-term-care
insurance as a hedge against the future cost of nursing-home care, which
has the potential to decimate even hefty nest eggs.
With 70% of people over age 65 running into some type of health
problem that could necessitate some form of long-term care, it's a big
expense that many retirees initially forget about in planning, says
Robert Stammers, director of investor education for the nonprofit CFA
Institute.
Critics say long-term-care policies can be pricey and may have limits
on the benefits they pay out, so retirees need to make sure they
understand what they are getting before buying. The average annual cost
of such a policy for a 57-year-old single individual is about $1,900,
while a couple of the same age would pay about $2,500, according to the
American Association for Long-Term Care Insurance, an industry trade
group.
Annuities are another long-term planning tool that can provide a
steady stream of income in later life, and a relatively new type of
annuity known as longevity insurance is gaining in popularity.
Longevity insurance is similar to an immediate annuity in that it
allows holders to take a lump sum and convert it into a lifelong income
stream. It is different in that it requires policyholders to pick a date
in the future to start getting that income, typically at age 85, says
Christopher Jones, chief investment officer at investment adviser
Financial Engines Inc.
This guarantees a retiree won't outlive a portfolio, some advisers
say, plus delayed payments are typically larger than those from
annuities that allow policyholders to start collecting money
immediately.
"It takes a problem that has this uncertain length and turns it into a certain horizon," says Mr. Jones.
Advisers warn against falling victim to traditional wisdom:
Portfolio protection through conservative investing in retirement could
actually do more harm than good.
With bonds not generating enough income, "the math is scary," says
Mr. Leclerc. "Retirees need a lot more money than they ever thought they
would to produce simple income."
Retirees looking to generate more yield may be tempted to buy
long-term bond funds, but advisers warn against locking in an investment
now that could be disastrous when interest rates eventually start to
rise. When rates rise, prices fall, so your principal would take a hit.
"So-called safe assets are paradoxically not safe right now," says Mr. Leclerc.
Some advisers suggest intermediate-term bond funds as a way to help
mitigate interest-rate risk, while still getting more yield than what's
available from short-term bond funds.
See additional numbers from Financial Engines on possible retirement spending amounts, based on an initial $100,000 nest egg.
Keep the duration at about five years, says Mr. Gibney, and look for
low expense ratios and a well-diversified portfolio to keep default
risk low.
As a category, intermediate bond funds returned an average 5.5% in
the first eight months of this year, according to researcher Morningstar
Inc.
Although inflation hasn't strayed far from the historical average of
3.2% annually in recent years, advisers says retirees can't ignore this
"silent killer."
"When clients come in, it isn't the first five to 10 years that
projections look bad, it's the second half of their retirement where
they get beat up," says Frank Fantozzi, a Cleveland-based financial
adviser.
To protect themselves, retirees should add to their portfolios
multiple types of assets that can keep up with or even beat rising
costs. Still, many advisers maintain that the best way to combat
inflation in a well-diversified portfolio is by investing in equities.
"It's the only asset class that will give them returns greater than inflation," Mr. Gibney says.
Real-estate investment trusts, or REITs, can be an inflation hedge,
but advisers say retirees should be cautious about which parts of the
real-estate market they invest in.
"Focus on the most stable, high-quality corporate tenants," says Tim
Lee, managing director of Monument Wealth Management in Alexandria, Va.
Market volatility can be nerve-racking for retirees, prompting some to flee to ultraconservative investments.
To iron out some of the big ups and downs—and therefore quell some
of the urges to swing too far to "safety"—some advisers recommend
constructing a diverse portfolio that includes a slice of alternative
investments, including nontraded REITs, which are similar to traditional
REITs but don't trade on exchanges, managed futures, which are futures
positions entered into by professional money managers on behalf of
investors, and long/short funds.
"Alternatives can help control risk because they don't tie or
correlate well with fixed income and equities," says Mr. Fantozzi, who
suggests putting 5% to 20% of a portfolio into alternative investments,
depending on market conditions.
Long/short funds, for example, employ trading strategies similar to
those used by hedge funds, simultaneously betting for and against a set
of stocks. In a sideways market, these funds can be useful, says Mr.
Fantozzi.
It's a particularly difficult time for tax planning, given the
uncertainty surrounding next year's tax rates. Still, there are things
retirees can do now to keep portfolio withdrawals as tax-efficient as
possible.
The required minimum distributions that most retirees have to start
taking at age 70½ are based partly on the plan's account balance as of
the preceding December. To reduce that total balance—and potentially the
required minimum distributions later on—some retirees might want to
start taking withdrawals in their 60s.
This is especially true for early retirees who are currently in
lower income brackets because of a recent job loss or forced retirement,
says Michael Eisenberg, a certified public accountant in Los Angeles.
Still, it's not a simple decision. Each year, retirees need to weigh
the consequences of pulling funds from one account versus another.
In a taxable account, net long-term capital gains are taxed at a
rate lower than the ordinary income-tax rate for withdrawals from
tax-deferred retirement plans.
Be aware that taking money out of a retirement account or selling
securities at a sizable taxable gain—rather than pulling cash from a
certificate of deposit, money-market fund, savings or checking
account—could result in higher taxes on Social Security benefits if it
bumps income above a certain threshold.
"When you reach a certain level of income, then some of your Social Security becomes taxable," says Mr. Eisenberg.
Ms. Prior is a reporter for Dow Jones Newswires in New York. Email her at anna.prior@dowjones.com.
