I recently met with a marketing company to discuss filming a new TV commercial for Fourth Avenue Financial. In the creative process, I was asked to identify the most common concern new clients expressed when meeting with me. As I thought about this, it became clear most concerns of those nearing retirement were variations of the question, “How will I turn my retirement savings into a lasting, dependable income?” It seems the financial services industry does well alerting people of the need to invest for retirement, but fails to deliver concise answers on how to use these funds when the time comes.
When you retire from work, it’s your money’s turn to go to work for you. Today’s low interest rate environment, combined with longer life spans, means your money will have to work longer and harder than ever before. The way you build your portfolio and how you elect to take income are very important in creating durable, lasting income that minimizes taxes and gives a defense against inflation. I see common planning mistakes falling into these broad categories:
Becoming too conservative: It is natural and even necessary to be more conservative as you approach retirement. Totally abandoning the markets, where most built their retirement savings, will expose you to the risk of inflation. Remember that postage stamps were 29 cents 20 years ago and are 49 cents today. Do you plan to enjoy a 20-year retirement? If so, you need to plan to manage this risk.
Staying too aggressive: I frequently see retirees sticking by the investment strategy that served them well while building their 401k nest egg. This is sometimes more heavily concentrated in equities or employer stock and can prove more volatile than advisable when taking retirement distributions. Stocks should be in a retiree’s investment allocation to provide long-term growth that combats inflation, but volatility can work against you when taking monthly income distributions.
Taking too much income: Over the long term, stock market returns have historically fallen between 8-10 percent. While these returns are true, they do not happen in a straight line. This presents a problem because a retiree usually requires a fairly consistent income stream. If the market is down and you withdraw from your investments, your funds will begin to deplete and it will become increasingly difficult to recover when the markets rebound. The variability and timing of market returns impact the prudent level of income your portfolio can produce. If you want your income stream to be long-lasting and rising to counter inflation, you will need to take withdrawals at a much lower rate than the long-term market average.
Forgetting about tax consequence: How and where you plan to take your income can have a large impact on how far you can stretch your retirement savings. For instance, is your monthly income need creating a capital gain or taxable income? If you are taxed less, you will need to take less money to meet your needs, preserving the balance to meet future income needs.
Most of us work on saving for retirement for the better part of 40 years. When the time comes to consume the fruits of our labors, we must get it right the first time and make the most of it.