Retirement Financial Planning

We've all heard this classic "good news/bad news" story: people today live longer than ever before and spend more years in retirement than in the past, but as a result they often run out of money. Today, men and women who reach 65 can expect, on average, to live to ages 82 and 85, respectively. Many of us will live even longer than that. Now, more than ever, the great challenge of this extended life is making your money last as long as you do.

In planning how to live successfully off what you've saved, consider the following factors:

• Your health

• Number of retirement years (try not to underestimate)

• Expenses to maintain your desired retirement lifestyle

• Your sources of retirement income and dollar amounts from each

• Possible need for future long-term care

• Future economic variables (including inflation, property values, interest rates, taxes)

• Your investment risk

When you retire, your possible sources of income include Social Security benefits, pension funds, savings and investments, work, and inheritances. Although each retiree's situation is unique, everyone faces similar issues in planning how to draw down accumulated savings to ensure a pleasant and secure retirement. Managing the process wisely takes creativity, regular attention, and a willingness to adjust the plan as needed. There are things you can do to make your money last as long as you need it.

For maximum protection, diversify your assets.
Put your money into a range of investments to offset the risks tied to any one investment. Then if one investment loses money, the loss does not affect all of your assets. Many experts suggest that younger persons and retirees alike try to spread their assets among stocks, bonds, and cash. Diversification is important within each of these three categories as well. For example, if you own stocks, you should not put all of your money into the stocks of one company or one business sector, such as the technology industry.

Don't be too conservative in your investments.
The key is to strike a balance between making your assets last and making them grow. Over time, stocks provide higher returns than other investments and can help you keep up with (or outpace) inflation. In the final analysis, the proper mix of investments is a highly personal decision. If you have a financial advisor, this is something you should discuss with them.

Set a withdrawal rate and make annual adjustments for inflation and investment performance.
To extend the life of your retirement portfolio, many experts recommend a beginning withdrawal rate of no more than 4 percent of your total retirement assets, with an annual increase tied to the rate of inflation in following years. Note that withdrawals also must take into account the performance of your investments. In other words, in order to generate a steady stream of income that continues to grow, the return on all your investments must be higher than the percentage you withdraw.

Decide when to begin getting Social Security.
One question you will need to address is when to begin collecting Social Security benefits. You may wish to postpone benefits until full retirement age or later to receive larger monthly payments. And for anyone born after 1937, your full retirement benefit age is no longer age 65. This decision will involve many factors including both your financial and physical health, and should be evaluated carefully before choosing a course of action.

Build a cash buffer to cover 3-5 years of living expenses.
Your retirement savings should include liquid assets, such as a money market account. This is recommended so that, in the first years of retirement, you do not have to sell equity investments in a down market, or claim Social Security before you really need it.

Make adjustments along the way.
At least once a year, re-evaluate how you are doing. As the market changes and inflation rates vary, you may need to change where you have your assets. If the stock market has had a particularly good year, you might choose to sell some stocks. If stocks are suffering, you may want to sell some bonds instead. Also, review your spending to see if you are on track with your budget; if not, look for ways to reduce expenses. And remember, you probably owe taxes on the money, so put some aside for taxes. Keep in mind that while you want to maintain an updated investment strategy, overtrading can result in high fees.

Consider Annuities
Annuities guarantee you a monthly income stream either for a specific period or for life, in exchange for your lump sum payment to an insurance company. On the downside, fixed annuities, which pay a set amount, may not keep up with inflation. Variable annuities, with a payout tied to the market, are subject to market declines. Retirees have also been the recent targets of variable annuity scams involving high surrender charges and steep sales commissions. Generally, annuities are an appropriate option only if you plan to invest in them for an extended period of time. In addition, if you die prior to the term of any annuity, the remaining funds will not go to your heirs. Be sure to check the strength and reputation of any company that offers annuities. If you have an investment advisor, consult with them before purchasing a variable or other type of annuity.

Factor in medical costs.
Unfortunately, for most of us—even the healthiest of us—aging means additional health care costs. Even with Medicare coverage upon your 65th birthday, you will find that many costs are not covered. Medicare deductibles, prescription drugs, and private insurance costs all add up. The harsh reality is nursing home care is costly—perhaps as much as $60,000 a year. To keep costs in check, you may want to consider "Medigap" and long-term care insurance. Also, see if you are eligible to establish a Health Savings Account. Beginning in 2006, you may also want to sign up for the new prescription drug benefit under Medicare. Consider this new benefit carefully, because you will pay more to join the program for every year that you delay enrollment. The bottom line is: Don't let health-care expenses catch you off guard-plan ahead!

Work and increase your income.
If the numbers just aren't adding up, improving your cash flow may help. You may choose to postpone retirement or remain on the job in a part-time or consulting position. This reduces the amount of savings you will need for retirement and cuts down on time during which you may be tempted to spend retirement funds.

Change your lifestyle.
If working isn't an option, find ways to conserve your assets. Lower your housing costs by moving into a smaller place, or adjust your lifestyle in other ways (cut down on restaurant dining or eliminate a deluxe cable package, for example) to decrease spending. Watch out for fees and taxes.

Making your retirement assets last as long as they need to may seem a daunting task, but a little preparation and attention can go a long way toward ensuring comfort and peace of mind throughout your retirement years.

Additional Resources:

AARP's "What to Consider When Choosing a Drug Discount Card"

Prescription Drug Effectiveness and Cost Comparisons

AARP on Estate Planning

U.S. Department of Labor

U.S. Securities and Exchange Commission

Alliance for Investor Education

Investment Company Institute