The Retirement Income Red Zone Danger

If you have put together a sizeable portfolio prior to retirement, knowing how to protect those assets during your first five years after retirement will be extremely important, especially if you want to be sure they will last the remainder of your life.  These first five years after retirement are sometimes referred to as the red zone ... the time when decisions you make can have the biggest impact on your future.

What Bad Decisions Do People Make in Early Retirement?

When people first retire, they often have a number of of pent-up dreams they wish to fulfill.  They still feel healthy and they may want to move somewhere new, travel, buy a boat or RV, and have a little fun.  After all, they have waited and saved their entire lives for this moment and they want to enjoy it before age and illness slows them down.

Next, retirees often stop saving and putting aside money for the future.  As they pull money from the principal without replacing it, retirees gradually see their assets become depleted.

In addition, retirees sometimes do not prepare adequately for rising expenses or problems that could come up in the future, including extra medical expenses such as health insurance deductibles, expensive treatments, long-term care, etc. They also sometimes fail to prepare for things like replacing their car, hot water heater, furnace or other expensive items.

Even if new retirees do not make any of the above mistakes during their first five years after retirement, their assets could become depleted because of poor investment decisions.

Should You Invest for Growth or Safety?

Investment advisors recommend that your retirement assets should be invested for both growth and safety ... but what is the correct balance?  According to an article by CNBC writer, Kelley Holland, "Five Crucial Retirement Years For Your Money," it is extremely important that you do not have negative investment returns during your first five years of retirement.  When experts from Prudential Insurance examined two hypothetical $1 million portfolios, Portfolio A had negative returns for 4 of the first 5 years, but positive returns for all of the remaining years of its existence.  Portfolio B had all positive returns in the first 5 years, but had negative returns in 4 of 5 years between years 25 and 30.

What were the results?  Portfolio A had dropped to zero within 15 years.  Portfolio B had doubled in value by the end of 30 years, despite the negative returns at the end.

What Should an Investor Do?

After examining the results of these two hypothetical portfolios, experts believe it is important that investors manage their money conservatively early in retirement so their portfolio continues to grow in value, even modestly, during this crucial period.  In order to do this, it would be a mistake for retirees to make risky investments or begin depleting their principal for trips or other large purchases.

Retirees need to work with their investment advisor to make sure their money is wisely invested.  Holland recommends that no more than 40 to 60 percent of a retirement portfolio should be in stocks (and, obviously, these should be Blue Chip stocks, not high-risk ones).

As retirees begin to live off their assets, their withdrawals should be modest and their asset allocation should be conservative, particularly during the first five years.  In other posts on this blog, we have reported that most investment advisors suggest that no more than 3 percent of assets should be withdrawn for living expenses during retirement, with tiny increases in the withdrawal rate as the years go by.  If the principal balance is invested conservatively, the assets of most people should last well over 30 years.

Some investment advisors also recommend that any income from the assets that is in excess of what is needed for living expenses should then be invested in stocks which, hopefully, will appreciate and provide an extra cushion for the future. This extra cushion will be especially helpful if there is a stock downturn in the future ... which is almost certain to happen every few years.

In the end, this plan is the one that is most likely to leave you with enough assets to last the remainder of your life.

If you are interested in reading more tips about handling your retirement income, where to retire, common medical problems, Medicare, Social Security and more, use the tabs or pull-down menu at the top of the page to find links to hundreds of additional articles.

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How to Make Your Money Last the Rest of Your Life

Managing Your Money Well
Helps You Enjoy Retirement More!

Many people worry about whether or not their money will last the rest of their lives.  This is not an unreasonable fear, and several of the posts you will see on this blog have been about how to cut your costs down before you retire so that you can live comfortably on Social Security and whatever other income you can expect to receive.  I've also mentioned a few times that it is wise to work as long as you can, in order to maximize your earned income as well as Social Security benefits. 

The 4% Withdrawal Solution

One area of concern for many people, however, is how to manage the distributions from your IRA, your 401K, or any other retirement savings that you have in place.  How much can you take out in order to insure that your assets will last?  I recently read about the 4% solution, a concept that is simple and makes it easy for anyone to figure out whether or not they are on track.  Here is how it works:

When you retire, at approximately age 66, total up the value of the stocks and cash that you have in liquid assets.  These are the assets you plan to draw down in order to supplement your Social Security.  To keep the math simple, let's assume they add up to $50,000.  Now, make a record of that number, as well as 4% of it, or $2,000. 

If you withdraw no more than $2,000 a year from these liquid assets, they should last 25 years, even if you get a 0% rate of return on the balance.  This means that, if you retire at 66, these assets should last until age 91.  If you get any interest or dividends during that time, which is quite likely, your assets will last even longer.  In fact, with a very conservative 2% rate of return, they should last years longer.

A More Conservative Approach to IRA Withdrawals

If you want to be ultra-conservative, you might start out taking less than 4% during the first few years of retirement.  Then, as you need the money, you can gradually increase how much you draw out each year. 

If, in later years, you want to make sure you are not drawing your money down too quickly, here is how to do a 5 year check on the principle:

After 5 years of withdrawals, you should have 80% or more of your original balance.
After 10 years of withdrawals, you should have 60% or more of your original balance.
After 15 years of withdrawals, you should have 40% or more of your original balance.
After 20 years of withdrawals, you should have 20% or more of your original balance.
After 25 years of withdrawals, you will have depleted your cash assets, unless you have earned dividends and interest over the years to stretch your assets out longer.

If you expect to live to be 100 or older, you may want to start making your withdrawals at an older age than 66, or you may want to only withdraw 3% a year instead of 4%.  At 3% a year, your cash assets should last for over 33 years, or until you are 99 years old or older, if you began withdrawing money at age 66.  Again, this is assuming that you have earned no additional interest or dividends.

Comparing This Method to an Annuity

Some retirees choose to purchase an annuity when they retire, using the money in their IRA or 401(k).  Before doing that, however, you will want to see if the payments you will receive from an annuity will be much larger than what you would get by using the 4% solution.  If not, the 4% solution might be a better alternative than an annuity, since you maintain control of your assets and can get a higher rate of return if interest rates go up.

However, if you decide to do this, you have to be disciplined about not spending down your assets too fast.  IF you start spending more than 4% during the early years of your retirement, because you want a new car, would like to travel, or have other expenses, you may find yourself poverty stricken in the later years.  If you do not think you will be that disciplined, then purchasing an annuity might be a better choice.  At least you will know for sure that you will always have the extra income.

Whichever plan you use, your assets should last the rest of your life if you manage them wisely.  Sadly, far too many people burn through their IRA's as soon as they are able to remove the money.  They are only postponing the time when they will run out of cash, and have to live solely on Social Security ... a very meager sum for most people.  Use your assets wisely, and your money will be there when you need it!

If you need other retirement information, including financial planning, where to retire, health concerns, and changing family relationships, use the tabs or pull down menu at the top of the page to find links to hundreds of additional articles.

You are reading from the blog:  http://www.baby-boomer-retirement.com

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