Will You Outlive Your Money?

Where will we get the money we need to live a longer life for the rest of our lives?  Modern medicine has performed miracles in extending our life spans.  But, that creates the need for more money for our retirement.

This is now a general problem faced by many of us Baby Boomers.  Everyone needs to deal with it.  And I will offer some pretty simple solutions.

Old formulas about what we need are out-of-date.  They no longer produce the results called for by this new, and pleasant, reality.  An “income for the rest of our life” is different today than it would have been many years ago.  Studies say many of us Baby Boomers will have retirement periods of 20-40 years.  Experts give this the title, “Longevity Risk”, the risk that our longer lives will find us running out of money to live on.

Does retirement planning properly deal with this pleasant but challenging problem?

If we can build a massive portfolio, our only question is the lifestyle wanted during retirement years.  How much can we travel?  How much can we leave to our children and grandchildren?

But few of us are in that position.  Our problem is more of “Will there be enough for me to be independent for the rest of my years?”

Most retirement strategies target the budget you and your spouse want for your life expectancies after you retire.  During an “accumulation period” you try to build enough added principal that will produce the income you need to pay for those budgeted expenses.  Assumptions exist about how much you can take out from the fund each year to pay those expenses.  That calculation needs to consider still having enough in the balance to continue producing what you will need in the future.  Recently the benchmark of a 4% projected withdrawal each year reduced to 3% each year because of lower interest rates.  And projections often include dipping into principal to meet the continuing budgeted needs.

At some point, the balance exhausts and there is no more money.  Good planning will make it so that does not happen too soon.  But, we have the hope we will live longer than that.  So, then what do we do?

The current popular ways to try to gather enough money so there is enough income includes “Qualified Plans”.  These are usually IRA’s and 401k plans.  They entice us with a deduction (to a limited extent) for money we put into them.  Plus the income they earn before we make withdrawals is tax deferred.  That can help create a larger balance than doing it on our own outside such “Qualified Plans” and paying taxes along the way.

However, these plans have some issues.

First, when the income comes out in withdrawals, it is taxed.  And the tax expense happens during our retirement when we need to keep as much income as we can.

Second, most of these accounts, direct or indirectly, end up in the stock market.  That leaves our retirement nest egg subject to the risk of market loss.  We should not forget what happened to many retirement savings at the crash of 2008 and the recession that followed.

A new set of proposed rules for the financial services industry highlights another problem with these stock market related accounts.  To create more fairness, the Administration wants financial advisers to have a responsibility to the people they invest for.  That’s you and me. This new rule also recognizes there are large fees paid to advisers.  These fees lessen our returns and the potential growth of our accounts.  Plus, are the advisers directing us to those investments that pay them the highest commissions?  Do those provide the best opportunity for us?

Properly managed Qualified Plan accounts can produce good results.  However, if you are not familiar with dealing with the stock market, those accounts create much nervousness; carry a lot of risk, and are charged a lot in fees.  And that results from our lack of knowledge about and bargaining power in the stock market.

A safe and simple alternative exists.  Guaranteed accounts from regulated companies can grow better than simple interest savings.  Without taking a market risk with a stock market investment, growth of indexes (like the S&P 500) can increase how much interest you receive.  At the same time, if the index you selected goes down in value, they do not take the interest back. [DISCLOSURE: When asked to place money for someone planning for retirement, this is the only type account I work with.]

These accounts can more easily last for the rest of your life, no matter how long that is; and, no matter what happens in the stock market.  Some even have guarantees to do that.  How does that happen?

The accounts that do this are from Life Insurance and Annuity Companies.  Your state insurance commissioners regulate them.  This control includes periodic audits.  Also, there are rules the issuing company must set aside enough reserves to make sure you get what they promised. “Reserves” means those amounts go into  separate account not subject to the risks the company may take for its own account.  The FDIC or SIPC do not guarantee these accounts.  However, the history is this.  Because of the guarantees given, the reserves that are set aside, regulation of the industry, and the conduct of other insurance or annuity companies if one goes out of business, account holders have a history of not losing money from these accounts.

[NOTE:  Some account holders have lost money in “Variable” Life Insurance or Annuities.  But, that is because their separate accounts suffered stock market losses.  That is different from what I describe here.  My recommendations include not investing in variable annuities or life insurance because of that market risk.]

Commissions paid to agents like me do not reduce the money your guaranteed account sets aside to earn interest for you.  What you put in is what earns interest. [NOTE: If you do not stay for the long-term, there are adjustments to account for the fact the company planned on your staying for the long-term.  This is similar to early withdrawal penalties in long-term certificates of deposit.]  To be clear, you do not put your money into the stock market.  But you can get more interest when your selected index goes up in value.

Will these accounts give you as much growth as a successful stock market account?  Probably not.  However, you do not take the risks of stock market investing.

Analyzing a proposed account’s potential growth based on reasonable assumptions can show how it might grow.  This is a projection of the extra interest that goes into your account when the selected index goes up in the future. The results will project what amount could be in the fund to create income when you are ready to start making withdrawals, and what that income will be each year.  [NOTE: There has been controversy about “illustrations” some companies have used in the past.  Many considered those too aggressive about potential growth; meaning they suggested more growth than was reasonable to expect.  However, the insurance industry has recently modified its rules so illustrations of policies with interest tied to an index are reasonable.  Plus, good illustrations will also show the potential if only guaranteed levels of growth happen.  There should be no surprises.]

This type of guaranteed account takes two basic forms.

The first is the deferred fixed index annuity.  You put a lump sum in an annuity that grows in interest over the years.  Tax is deferred until you start taking the money out.  There are some tax and general restrictions on when you can take the money out.  So, this is for your “nest egg” money you do not need currently or in an emergency.  When you start withdrawing, the income is taxed but in a way that gives you credit for the return of your principal. Meanwhile, your money is protected from creditors.  Typically, the amounts you withdraw are pretty much set; but, the payments can last for the rest of your life.  A life annuity is a guaranteed stream of payments for as long as you live.

Companies that issue annuities also have features that provide special benefits.  Many put a bonus amount into your account when you set it up.  This means there is more money earning interest for you than only what you deposited.  Also, there are “income riders”; which guarantee a minimum income stream you will get starting at the age you begin taking withdrawals.  If your account has grown to allow for more income than that, then you would obviously choose that higher payment.

The second type account is the index universal life insurance policy.  Instead of the classic universal policy where you earn interest based on the insurance company’s investment performance, you select your own index.  The interest you earn each period will be some minimum guaranteed amount plus a portion of the growth of your selected index each period.  In this account, there are some charges for the cost of the insurance on your life.  But, here too, the income growth is tax deferred.  When you are ready to start withdrawing, special rules about life insurance contracts let you take loans as distributions; which are not income taxable. So, you get to keep more of the distributed amount.  When properly managed these net distributions can last the rest of your life; plus your beneficiaries still get the proceeds of a death benefit.

These accounts solve the basic issue of knowing there will be money to last as long as you live.  However, I recommend a different way to look at the issue than in most retirement planning.  Most planners tell you to decide on your budget first.  Then they try to help you create the money to be able to fund the budget.  You have to decide on your “risk tolerance” when making decisions about their recommendations.  But why take any market risk at all?

Working with guaranteed accounts does not create dramatic growth in wealth.  Only high risk investing offers that possibility.  Guaranteed accounts are designed to be safe, first and foremost.  There is no risk of market loss.  That is their benefit.  At the same time, using index based interest growth, they can grow better than more simple interest bearing accounts.  So, there is growth; just not the growth that could come, if all worked out, from more risky investments.

Because of this I suggest another approach to retirement planning.  Look at how much you have to deposit into one or more of these guaranteed accounts.  Then analyze how much they can grow using the guaranteed rates and reasonable illustrations of potential growth from index based added interest.  You can project how much you will have at the time you want to start taking withdrawals.  “Income Riders” in deferred fixed index annuities give you a guarantee what that income stream would be.  This makes clear how much income you will have every year for the rest of your life from these accounts.  With that in mind, the budget you can afford becomes clear.

Of course, overall planning should take potential social security income into account.  Also, there should be some provision to deal with health expenses and the need most will have for some long term care.  For some, deferred fixed income annuities and index universal life insurance policies are a suitable part of a larger plan.  Those are topics for another time.

While the lifestyle you can have from these guaranteed accounts may not be what you hoped for, at least you know for certain the income will be there.

You will not run out of money for the rest of your life.  That basic security will give you the peace of mind to better enjoy the prospects of living the longer life modern medicine made possible.