Note: This story is sponsored by USAA.
What’s the biggest retirement fear? Years of research (and my own anecdotal polls involving asking big groups of people to raise their hands when I’m giving a talk) confirm it’s running out of money before you run out of time. One study from Allianz showed it’s a bigger fear even than death. And it’s understandable. The thought of being asked to spend your last years, even last decades, living uncomfortably because of a lack of resources is disheartening to say the least.
Frankly, though, there are other losses that many of us fear if not as much, then nearly as much. Loss of our home to a natural disaster. Loss of our health to a chronic condition. So what do we do? We buy homeowners insurance to replace that home if a hurricane were to knock it to the ground. We make sure to evaluate our health insurance options so that we’re in the best plan for our needs. But when it comes to our retirement nest eggs, many of us don’t look through the same lens, explains JJ Montanaro, Financial Planner with the Military Affairs Advocacy Group at USAA. “Even when you apply the 4 percent rule [that is supposed to ensure you don’t run out of money in retirement] there’s an element of hope in it, too,” he notes. Here’s a look at a few ways to remove hope from the equation.
Consider an annuity to cover your fixed costs. Montanaro and many other financial experts (and economists) are in favor of converting a chunk of your assets in retirement (or even a few years before retirement) into a paycheck that will help cover your fixed costs. The simplest way to do this is with an immediate pay annuity. To figure out how much income you need, first figure out what your fixed costs are likely to look like. Then consider how much Social Security, your Military pension and any other pension income is likely to cover. Annuitize enough to cover the rest, but also to leave some of your money where it can grow. This is key, notes Wade Pfau, Professor of Retirement Income at the American College, because it can also provide you needed liquidity in case of an unplanned large expense.
Don’t annuitize all at once. A long retirement can typically be broken into three segments, each with a different pattern of spending. The decade from 65 to 75 is your most active; retirees often travel, eat out, start businesses. Your spending during these years will likely mirror those during your working years except that you won’t be saving – and if you’ve been saving heavily, you may see a significant reduction in your overall need for money. From 75 to 85, retirees typically slow down; spending starts to wane as travel tails off and people spend more time at home. And from 85 on, healthcare concerns often arise and the spending that goes with them (and the need for long term care) goes up as well. Because you may not need as much early on as you’ll need later, because interest rates are extremely low right now (and annuity buyers benefit when they rise), and because you get more out of every dollar you annuitize as you age, it typically makes sense to annuitize in chunks rather than all at once.
Make sure to consider your spouse’s lifespan as well. Remember as you’re embarking on a strategy like this that the purpose is one of insurance. That means that although the payout on an annuity will be greater if it’s calculated solely on the life of one spouse, it could leave the other in the aforementioned running-out-of-money scenario you were trying to avoid. Montanaro notes that it’s akin to figuring out whether to opt into the Survivor Benefit for your Military pension or not. If you do, he explains, your surviving spouse receives 55% of your covered retirement pay with an inflation adjustment each year. “If you don’t,” he says, “that can be a huge problem.”
Manage your sequence of returns. Finally, when it comes to the money remaining in your retirement portfolio, you may want to rethink the way you manage the risk you’re taking, says Pfau. Traditional thinking argues that you take more investment risk in the early years of retirement – when you have more time to rebound from market downturns. But recent research Pfau conducted with Michael Kitces, also a professor at The American College, shows keeping your stock allocation lower in those early years may be another way to protect your savings from loss. The duo looked at four market scenarios in retirement. When the markets are down early in your retirement but rebound later on, having less in equities during those early years helps you stay afloat. When the markets are up early in retirement, down later on, having a higher stock allocation early on will temper your early returns, but you won’t run out of money that way, Pfau notes. If the markets are strong throughout your retirement, having less in equities means you won’t have as much money as you might have, but again you won’t run short. And if the markets are down throughout retirement, no strategy will help. All in all, Pfau says, it’s a “more effective risk management strategy.”
Learn more about how you can live #LifeUninterrupted at USAA.com/myretirement, and consider getting a no-charge retirement review today by calling 1-800-531-3392.