In retirement planning, have realistic expectations
By Gary Boatman
Published: Wednesday, Nov. 13, 2013, 12:01 a.m.
Baby boomers are the first generation of do-it-yourself retirement planners.
Our parents and grandparents received defined benefit plans from their employers that guaranteed a certain income during retirement. All contributions and investment risks were the responsibility of the companies.
This changed in 1978 when Congress passed the Tax Revenue Act. Many Boomers are not prepared as retirement time is quickly approaching.
Boomers are lacking many of the same financial skills as the rest of society. We receive very little education about financial issues and do not have time to keep up with all of the changes.
We sometimes do not recognize these weaknesses because of the entire information overload that we experience every day. We are the generation that wants immediate gratification and thus, giving up enough of today's income for tomorrow's benefit is foreign to our nature.
Also, economic timing has been working against us.
Stock market crashes in 2000 and 2008 have made getting historic investment returns impossible. That is why some of our prime earning years are known as the lost decade.
Housing values have tumbled, which is often one of our two biggest assets.
We have often been asked what our tolerance for risk is. This is a constantly changing question and answer. When markets are rising, we believe that we can handle this risk. When markets are volatile or going down, we become intolerant to risk.
This is why too many of us try to time markets by jumping in and out. By doing this we achieve less total return than the overall markets does.
Many boomers got caught in the Great Recession. We got squeezed out of jobs and had to look for replacement opportunities when there were not many. These boomers not only lost income, but the chance to contribute to future retirement. Worse yet, some had to use retirement assets early just to stay afloat.
In a study done by the Federal Reserve, it was discovered that the median household headed by a person aged 60 to 62 had a 401(k) balance with less than one-quarter of the funds required to maintain their standard of living during retirement. One bright spot is boomers are expected to live longer than previous generations. Of course, this will mean that we need additional income.
Boomers are resourceful. Many will work a few more years than they originally thought. This will mean that we can earn income during our peak years a little longer and not need to tap savings as soon. We can allow Social Security to continue to grow and take advantage of delayed credits and cost-of-living increases.
It is important to know the difference between the accumulation phase and the distribution stage. The rules are completely different. We cannot tolerate as much risk during retirement. We need to have a foundation of guaranteed income to cover our basic necessities.
Many people have heard about the 4 percent rule during retirement. This says that if you take out 4 percent of your assets each year, indexed for inflation, you will not run out of money.
This rule actually comes from the Trinity Study. In this study, some professors studied historical data published by Ibbotson Associates to examine possible withdrawal rates based on historical market data. From this, they concluded that 4 percent was a fairly safe number.
There are a few shortcomings from this study. First, their research ignored taxes and investment expenses. Since most of this retirement money is coming out of qualified accounts, the recipients must pay taxes on the withdrawals. It is safe to say that there will be some expenses coming out for any investment.
Maybe the biggest thing that the rule does not consider is the sequence of returns risk. Simply, this means that if there is a market correction early in the withdrawal cycle, you will run out of money much quicker than if any decline comes later in your cycle. Averages can be the same, but a sudden drop followed by later large increases will not keep you from running out of money. As you dip into more of the principle, there is not enough to earn back the losses.
The best way to protect yourself is to have realistic expectations and work with a distribution specialist.
Brokers often do not have the full arsenal of products available to meet all of the retirement challenges.
Gary Boatman is a certified financial planner and a local businessman who serves as president of the Monessen Chamber of Commerce.
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