MONEY stocks

WATCH: What’s the Point of Investing?

In this installment of Tips from the Pros, financial advisers explain why you need to invest at all.

MONEY retirement income

Boomers Are Hoarding Cash in Their 401(k)s—Here’s a Better Strategy

Paul Blow

Yes, you need a cash reserve in retirement, but you can go overboard in the name of safety. Here's how to strike the right balance.

As you close in on retirement, it’s crucial to minimize the risk of big losses in your portfolio. Given how expensive traditional safe havens, such as blue chips and high-quality bonds, have become, that’s tricky to do today. So for many pre-retirees, the go-to solution is more cash.

How much cash is enough? Many savers seem to believe that today’s high market valuations call for a huge stash—the average investor has 36% in cash, up from 26% in 2012, according to a recent study by State Street. The percentage is even higher for Baby Boomers (41%), who are approaching retirement—or already there.

That may be too much of a good thing. Granted, as you start to withdraw money from your retirement savings, having cash on hand is essential. But if you’re counting on your portfolio to support you over two or more decades, it will need to grow. Stashing nearly half in a zero-returning investment won’t get you to your goals.

To strike the right balance between safety and growth, focus on your actual retirement needs, not market conditions. Here’s how.

Safeguard your income. If you have a pension or annuity that, along with Social Security, covers your essential expenses, you probably don’t need a large cash stake. What you need to protect is money you’re counting on for income. Calculate your annual withdrawals and aim to keep two to three years’ worth split between cash and short-term bonds, says Marc Freedman, a financial planner in Peabody, Mass.  That lets you ride out market downturns without having to sell stocks, giving your investments time to recover.

This strategy is especially crucial early on. As a study by T. Rowe Price found, those who retired between 2000 and 2010—a decade that saw two bear markets—would have had to reduce their withdrawals by 25% for three years after each drop to maintain their odds of retirement success.

Budget for unknowns. You may be able to anticipate some extra costs, such as replacing an aging car. Other bills may be totally unexpected—say, your adult child moves back in. “People tend to forget to build in a reserve for unplanned costs,” says Henry Hebeler, head of AnalyzeNow.com, a retirement-planning website.

In addition to a two- to three-year spending account, keep a rainy-day fund with three to six months of cash. Or prepare to cut your budget by 10% if you have to.

Shift gradually. “For pre-retirees, the question is not just how much in cash, but how to get there,” says Minneapolis financial planner Jonathan Guyton. Don’t suddenly sell stocks in year one of retirement. Instead, five to 10 years out, invest new savings in cash and other fixed-income assets to build your reserves, Guyton says. Then keep a healthy allocation in stocks—that’s your best shot at earning the returns you’ll need, and you can replenish your cash account from those gains.

MONEY retirement planning

Why Gen X Feels Lousiest About the Recession and Retirement

THE BREAKFAST CLUB, from left: Molly Ringwald, Anthony Michael Hall, Emilio Estevez, Ally Sheedy, Judd Nelson, 1985.
Three decades after "The Breakfast Club" hit theaters, Gen X is still struggling. Universal—Courtesy Everett Collection

Sandwiched between much larger generations and stuck with modest 401(k)s, Gen Xers get no love from financial planners, marketers or media. No wonder they're feeling low.

The Great Recession took a heavy toll on all generations. Yet the downturn and slow recovery seem to have left Generation X feeling most glum.

Defined as those aged 36 to 49, Gen X members are least likely to say they have recovered from the crisis, according to the latest Transamerica Retirement Survey. They are most likely to say they will have a harder time reaching financial security than their parents. Gen X also is far more likely to strongly believe that Social Security will not be there for them and that personal savings will be their primary source of income in retirement.

“Generation X is clearly behind the eight ball,” says Catherine Collinson, president of the Transamerica Center for Retirement Studies. “They need a vote of confidence. But they still have time to fix their problems.”

Arguably, Gen X was feeling most beat up even before the recession. This group is in the toughest phase of life: kids at home, a mortgage, not yet in peak earning years. Mid-life crises typically hit at this age. Studies show that the busy child-rearing years tend to be the unhappiest of our life. The happiest years are 23 and 69 with a big dip in between.

And let’s not forget that Gen X is only two-thirds the size of Millennial (ages 18 to 35) and Baby Boomer (ages 50 to 68) populations. Marketing companies and the media have largely ignored this generation, which early on acquired the downbeat label: slackers. Collinson believes the financial industry is equally focused on older and younger generations, leaving Gen X all alone.

“They have to stake out a plan and pursue it on their own,” she says. “The harsh reality is people have to take on increasing responsibility for their own financial security.”

Maybe that’s why Gen X believes it must build a bigger nest egg. Asked for their retirement number, the median Gen X respondent said they need $1 million. Nearly a third said $2 million or more. The median figure for both Millennials and boomers was $800,000 with only 29% and 23%, respectively, saying they would need $2 million or more.

Perhaps Gen X is being realistic. Even $1 million won’t provide a cushy lifestyle. A 64-year-old retiring next year with that amount would receive an annual payout of only $49,000 a year, according to Blackrock’s CoRI index, which tracks the income your savings will provide in retirement. Looked at another way: purchasing an immediate annuity for $1 million today would buy $5,000 of monthly income, according to ImmediateAnnuities.com. Not bad. But less than most might expect.

Gen X has boosted savings since the recession, the survey found. The typical Gen X nest egg is now $70,000, more than double savings of just $32,000 in 2007. This suggests that Gen X did a good job of sticking to their 401(k) contribution rate during the downturn, buying stocks while they were low and enjoying the rebound. Millennials did a little better, going from $9,000 to $32,000. Baby Boomers were less likely to hang in through the tough times, partly because older boomers were already retired and taking distributions. The median boomer next egg has risen to $127,000 from $75,000 in 2007.

Overall, Baby Boomers felt the brunt of the downturn. They suffered more layoffs and wage cuts, took a bigger hit to their assets, and by a wide margin more Boomers believe their standard of living will fall in retirement. But at least many Boomers are still blessed with traditional pensions and have a better shot at collecting full Social Security benefits.

Millennials are old enough to have learned from the downturn but not so old that they had many assets at risk. This generation began saving at age 22, vs. age 27 for Gen X and age 35 for boomers. Millennials also benefit from modern 401(k) plan structures with easy and smart investment options like target-date funds and managed accounts.

Meanwhile, Gen X is largely pensionless and was something of a 401(k) guinea pig when members entered the labor force. Plans then were untested and lacked many of today’s investment options or any educational material. The plans may have been mismanaged, subject to higher fees or even ignored. Even today, the Gen X contribution rate of 7% lags that of Millennials (8%) and Boomers (10%). Gen X is also most likely to borrow or take an early withdrawal from their plan (27%, vs. 20% for Millennials and 23% for boomers). Some of this relates to their period in life. But they have other reasons to feel glum too.

Still, there is some hope for Gen X. Recent research by EBRI found that if this generation manages to keep investing in their 401(k)s, most could end up with a decent retirement—no worse than Baby Boomers. And they still have time. If Gen Xers raise their savings rate a bit more, they can retire even more comfortably.

Do you want help getting your retirement planning off the ground? Email makeover@moneymail.com for a chance at a makeover from a financial pro and to appear in the pages of Money magazine.

MONEY retirement income

5 Tips For Tapping Your Nest Egg

Cracked egg
Getty Images—Getty Images

Forget those complex portfolio withdrawal schemes. Here are simple moves for making your money last a lifetime.

It used to be that if you wanted your nest egg to carry you through 30 or more years of retirement, you followed the 4% rule: you withdrew 4% of the value of your savings the first year of retirement and adjusted that dollar amount annually for inflation to maintain purchasing power. But that standard—which was never really as simple as it seemed— has come under a cloud.

So what’s replacing it?

Depends on whom you ask. Some research suggests that if you really want to avoid running out of money in your dotage, you might have to scale back that initial withdrawal to 3%. Vanguard, on the other hand, recently laid out a system that starts with an initial withdrawal rate—which could be 4% or some other rate—and then allows withdrawals to fluctuate within a range based on the previous year’s spending.

JP Morgan Asset Management has also weighed in. After contending in a recent paper that the 4% rule is broken, the firm went on to describe what it refers to as a “dynamic decumulation model” that, while comprehensive, I think would be beyond the abilities of most individual investors to put into practice.

So if you’re a retiree or near-retiree, how can you draw enough savings from your nest egg to live on, yet not so much you run out of dough too soon or so little that you end up sitting on a big pile of assets in your dotage?

Here are my five tips:

Tip #1: Chill. That’s right, relax. No system, no matter how sophisticated, will be able to tell you precisely how much you can safely withdraw from your nest egg. There are just too many things that can happen over the course of a long retirement—markets can go kerflooey, inflation can spike, your spending could rise or fall dramatically in some years, etc. So while you certainly want to monitor withdrawals and your nest egg’s balance, obsessing over them won’t help, could hurt and will make your retirement less enjoyable.

Tip #2: Create a retirement budget. You don’t have be accurate down to the dollar. You just want to have a good idea of the costs you’ll be facing when you initially retire, as well as which expenses might be going away down the road (such as the mortgage or car loan you’ll be paying off).

Ideally, you’ll also want to separate those expenses into two categories—essential and discretionary—so you’ll know how much you can realistically cut back spending should you need to later on. You can do this budgeting with a pencil and paper. But if you use an online tool like Fidelity’s Retirement Income Planner or Vanguard’s Retirement Expenses Worksheet—both of which you’ll find in the Retirement Income section of Real Deal Retirement’s Retirement Toolboxyou’ll find it easier to factor in the inevitable changes into your budget as you age.

Tip #3: Take a hard look at Social Security. The major questions here: When should you claim benefits? At 62, the earliest you’re eligible? At full retirement age (which is 66 for most people nearing retirement today)? And how might you and your spouse coordinate your claiming to maximize your benefit?

Generally, it pays to postpone benefits as your monthly payment rises 7% to 8% (even before increases for inflation) each year you delay between ages 62 and 70 (after 70 you get nothing extra for holding off). But the right move, especially for married couples, will depend on a variety of factors, including how badly you need the money now, whether you have savings that can carry you if you wait to claim and, in the case of married couples, your age and your wife’s age and your earnings.

Best course: Check out one of the growing number of calculators and services that allow you to run different claiming scenarios. T. Rowe Price’s Social Security Benefits Evaluator will run various scenarios free; the Social Security Solutions service makes a recommendation for a fee that ranges from $20 to $250. You’ll find both in the Retirement Toolbox.

Tip #4: Consider an immediate annuity. If you’ll be getting enough assured income to cover most or all of your essential expenses from Social Security and other sources, such as a pension, you may not want or need an annuity. But if you’d like to have more income that you can count on no matter how long you live and regardless of how the markets fare, then you may want to at least think about an annuity. But not just any annuity. I’m talking about an immediate annuity, the type where you hand over a sum to an insurance company (even though you may actually buy the annuity through another investment firm), and the insurer guarantees you (and your spouse, if you wish) a payment for life.

To maximize your monthly payment, you must give up access to the money you devote to an anuity. So even if you decide an annuity makes sense for you, you shouldn’t put all or probably even most your savings into one. You’ll want to have plenty of other money invested in a portfolio of stocks and bonds that can provide long-term growth, and that you can tap if needed for emergencies and such. To learn more about how immediate annuities work, you can click here. And to see how much lifetime income an immediate annuity might provide, you can go to the How Much Guaranteed Income Can You Get? calculator.

Tip #5: Stay flexible. Now to the question of how much you can draw from your savings. If you’re like most people, an initial withdrawal rate of 3% won’t come close to giving you the income you’ll need. Start at 5%, however, and the chances of running out of money substantially increase. So you’re probably looking at an initial withdrawal of 4% to 5%.

Whatever initial withdrawal you start with, be prepared to change it as your needs, market conditions and your nest egg’s value change. If the market has been on a roll and your savings balance soars, you may be able to boost withdrawals. If, on the other hand, a market setback puts a big dent in your savings, you may want to scale back a bit. The idea is to make small adjustments so that you don’t spend so freely that you deplete your savings too soon—or stint so much that you have a huge nest egg late in life (and you realize too late that you could have spent large and enjoyed yourself more early on).

My suggestion: Every year or so go to a retirement calculator like the ones in Real Deal Retirement’s Retirement Toobox and plug in your current financial information. This will give you a sense of whether you can stick to your current level of withdrawals—or whether you need to scale back or (if you’re lucky) give yourself a raise.

MORE FROM REAL DEAL RETIREMENT

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MONEY financial advice

How Listening Better Will Make You Richer

140724_HO_Listening_1
Ruslan Dashinsky—iStock

A financial adviser explains that when you hear only what you want to hear, you can end up making some bad money choices.

Allison sat in my office, singing the praises of an annuity she had recently purchased. She was 64 years old, and she had come in for a free initial consultation after listening to my radio show.

“The investment guy at the bank,” she crowed, “told me this annuity would pay me a guaranteed income of 7% when I turn 70.”

I asked her to tell me more.

Allison had invested $300,000 as a rollover from her old 401(k) plan. She was told that at age 70, her annuity would be worth $450,000. Beginning at age 70, she could take $31,500 (7% of $450,000) and lock in that income stream forever.

“And when you die, what will be left to the kids?” I asked.

“The $300,000 plus all my earnings!” she said.

Suddenly my stomach began to sour.

Allison, I was sure, had heard only part of what the salesperson had told her.

I followed up with another question: “Besides the guaranteed $31,500 annual income, will you have access to any other money?”

“Oh yes,” she answered. “I can take up to 10% of the account value at any time without paying a surrender charge. In fact, next year I plan to take $30,000 so I can buy a new car!”

This story was getting worse, not better.

It was time to break the news to Allison.

I asked her to tell me the name of the product and the insurance company that issued it. Sure enough, I knew exactly the one she bought, since I had it available to my clients as well.

That’s when the conversation got a little tense.

I explained that if she withdrew any money from her annuity prior to beginning her guaranteed income payment, there was a strong likelihood she wouldn’t be able to collect $31,500 per year at age 70. Given the terms of the annuity, any such withdrawals now would reduce the guaranteed payment later.

She disagreed.

I explained that, with this and most other annuities, if she started the income stream as promised at $31,500, she would not likely have any money to pass on to the children.

She told me I was wrong — and defended the agent who sold her the annuity. She said that she bought a guaranteed death benefit rider so that she could protect her children upon her death.

I encouraged her to read the fine print. As expected, she reread the paragraph that stated that the “guaranteed death benefit” was equal to the initial investment plus earnings, less any withdrawals. When I told her that her death benefit in all likelihood would be worth nothing by age 80, she quickly said, “I need to call my agent back and check on this.”

I have conversations like this a lot, and not just with annuities. When it comes to investments, whether they’re annuities, commodity funds, or hot stocks, people often hear only what they want to hear. At various points in his sales pitch, the annuity salesman had probably said things like “guaranteed growth on the value of the contract,” “guaranteed income stream,” “can’t lose your money,” and “heirs get everything you put in.” What she had done was merge the different parts of the sales pitch together and ignore all the relevant conditions and exceptions.

When people hear about a product, there’s an emotional impact. “I want to buy that,” they think. They focus only on the benefits of the product; they assume the challenging parts of the product — the risks — won’t apply to them.

This story has a happy ending. Before Allison left my office, I asked when she received her annuity in the mail. “Three days ago,” she said.

I reminded her of the ten-day “free look” period that’s given to annuity buyers as a one-time “do-over” if they feel that the product they purchased isn’t right for them.

She called me back within two days. “The agent doesn’t like me very much,” she said. She had returned the annuity under the “free look” period and expected to get a full refund. The annuity salesman had just lost an $18,000 commission.

And I once again saw the wisdom of something I tell my clients every day: Prior to ever making a financial decision, it is absolutely critical you evaluate how this decision integrates into your overall financial life. That’s what’s important — not falling in love with a product.

———-

Marc S. Freedman, CFP, is president and CEO of Freedman Financial in Peabody, Mass. He has been delivering financial planning advice to mass affluent Baby Boomers for more than two decades. He is the author of Retiring for the GENIUS, and he is host of “Dollars & Sense,” a weekly radio show on North Shore 104.9 in Beverly, Mass.

MONEY 401(k)s

The New 401(k) Income Option That Kicks In When You’re Old

The U.S. Treasury allows savers to buy deferred annuities in their retirement plans. But no need to rush in now.

The U.S. Treasury Department has just given a tax break and its blessings to retirement savers who want to buy long-term deferred annuities in their 401(k) and individual retirement accounts.

The new rule focuses on a particular kind of annuity. These so-called deferred “longevity” plans kick in with guaranteed income when the buyer turns, say, 80 or 85 years old. For example, a 60-year-old man who spent $50,000 on a longevity annuity from New York Life could lock in $17,614 in annual benefits when he turned 80, the company said.

Like most insurance policies and traditional pension plans, these “longevity” plans take advantage of the pooling of many lives. Not everyone will live beyond 80 or 85, so those who do so can collect more income than they would have been able to produce on their own.

That takes the worry of outliving your money off the table. It also lets you take bigger retirement withdrawals in the years between 60 and 80. A saver who put 10% of her nest egg into one of these policies could withdraw as much as 6% of her retirement account in the first year instead of the safer and more traditional amount of 4 percent, estimates Christopher Van Slyke, an Austin, Texas, financial adviser.

A fee-only planner who tends to view many insurance products with some skepticism, Van Slyke likes these longevity plans for those reasons and because they convey a tax break, too: IRA and 401(k) money spent on these policies—up to 25% of the account’s value or $125,000, whichever is less—is exempt from the required minimum distribution rules that force savers over 70 1/2 to make withdrawals that count as taxable income.

The insurance industry loves this new rule, too, so consumers can be excused for taking some time to consider all the costs and angles. Treasury official J. Mark Iwry announced the new rule—declared effective immediately— at an annuities industry conference on Tuesday, and it was a crowd pleaser.

Related: Where are you on the Road to Wealth?

For retirement savers, the math just got harder. Should you buy such a plan? If so, when and how? What should you look for? Here are some considerations.

* You don’t have to rush. The younger you are, the cheaper these annuities are. A 40-year-old male putting down that same $50,000 with New York Life would get $31,414 in monthly benefits—almost twice the payout of the 60-year-old. But there’s a downside to that: Most do not have built-in inflation protection, points out David Hultstrom, a Woodstock, Georgia, financial adviser. So if you’re buying a $1,200-a-month benefit now but not collecting it for 20 years, you’ll be disappointed with its buying power. At a moderate 3% annual inflation rate, in 20 years that $1,200 would cover what $664 buys now.

* There are other reasons to wait. These policies are relatively new, and the Treasury’s rule “will open the floodgates,” Van Slyke says. Expect heightened competition to improve the policies. Furthermore, annuity payouts are always calculated on the basis of current interest rates, which remain near historic lows. A policy bought in a few years, in a (presumably) higher interest-rate environment probably would provide higher levels of income.

* Age 70 might be a good time to jump for those with lots of assets. Those required taxable distributions start the year you turn 70 1/2, so if you’re worried about the tax hit of taking big mandatory distributions, you could pull some money out of the taxable equation by buying one of these policies with it. Your benefits would be taxable as income in the year you receive them.

* Social Security is the best annuity. Before you spend money to buy an annuity, use money you have to defer starting your Social Security benefits as long as possible. Your monthly benefit check will go up by roughly 8% a year for every year after 62 that you defer starting your benefits. Social Security benefits are inflation protected, unlike these annuities.

* Think of your heirs. Money spent to buy an annuity is gone, baby, gone, so you can’t leave it to your kids. Some of these annuities will offer “return of premium” provisions. That means that if you die before you’ve received your purchase price back in monthly checks, your heirs can get the rest back. But that will probably cost you something in the first place. New York Life, for example, shaves almost $4,000 a year of annual payout for the 60-year-old who wants to add that protection to his policy. The heirs would get only cash that has been falling in value for all the years you’ve held the policy, not any income on that cash.

* This won’t solve your long-term care problems. The more money you have tied up in an annuity when you need round-the-clock nursing care, the less you have available to pay for that care. So if you want to use a longevity annuity to give yourself some income in those later years, you should also assure you have the big bad expenses covered. That means setting aside enough other money to pay the $7,000 to $10,000 a month it can cost for full-time nursing care, or buying a long-term care insurance policy you have faith in and can afford.

MONEY Ask the Expert

Should I Buy a Deferred Income Annuity—and When?

140605_AskExpert_illo
Robert A. Di Ieso, Jr.

Q: I’m interested in buying a deferred income annuity to supplement my income in my later retirement years. What is the best age to buy one? – Jeremy, Austin, Texas

A: As worries about running out of money in retirement grow, so has interest in deferred income annuities. Also known as longevity insurance, sales of these products hit $2.2 billion last year, double the amount in 2012, which was the first year of significant sales, according to Beacon Research and the Insured Retirement Institute.

Deferred income annuities are popular because they give you a hedge against outliving your money. They work like this: You give a lump-sum payment to an insurance company and in return, you get a guaranteed stream of income for life. In that way, deferred annuities are similar to immediate annuities. But with immediate annuities, the income kicks in right away. With deferred annuities, as the name suggests, the benefit payments don’t start until much later, perhaps 10 or 20 years down the road. Because the payments take place so far in the future, you can buy a bigger benefit with a deferred annuity compared to an immediate annuity.

Say you are a 65-year-old man today, and you deposit $50,000 into a longevity annuity that doesn’t start making payments for 15 years. You would get payments of about $1,300 a month starting at age 80. That’s another $15,000 a year in income. The longer you wait for the payments to kick in, the more you’ll get. In that same example, if you wait till age 85 for the payment to start, your monthly income jumps to $2,475. By contrast, a 65-year-old man who invests $50,000 in an immediate annuity today would get monthly payments of about $280 a month.

Of course, the downside is that if you don’t make it to 85 or whatever age you select for payments to start, you get nothing. You also need to consider that the benefits are not inflation-adjusted, so their purchasing power will have declined.

As for when to purchase the annuity, the younger you are, the better the deal. If you make the $50,000 purchase at age 55, instead of 65, with benefits that kick in at age 85, you will get 50% more income—$3,800 a month.

But first, you need to decide whether this move makes sense for you. That depends on your other sources of guaranteed income. If you already have a pension that covers most of your essential costs, you probably don’t need one. And the longer you can delay taking Social Security, which increases each year until age 70 and is adjusted annually for inflation, the less attractive it is to lock up money in an annuity. “Social Security is the best annuity income you can buy today,” says David Blanchett, director of retirement research at Morningstar Investment Management.

Beyond protection against outliving your money, however, deferred income annuities can give you peace of mind by reducing the stress of making your money last till you’re 100. “Longevity annuities remove a lot of uncertainty and that’s very valuable to retirees,” says Blanchett.

MONEY retirement income

Need Retirement Income? Here’s the Hottest Thing Out There

gold nest eggs
Joe Belanger / Alamy—Alamy

Sales of fixed annuities are surging as income-strapped retirees seek ways to rescue their retirement plans.

Annuity sales are exploding higher as retirees look to lock up guaranteed lifetime income in an environment where fewer folks leaving the workplace have a traditional pension. In a sign of wise planning, easy-to-understand basic income annuities are among the fastest growing of these insurance products.

In all, net annuity sales reached $56.1 billion in the first quarter—up 13% from a year earlier, based on data reported by Beacon Research and Morningstar. Variable annuities, often seen more as a tax-smart investing supplement for the wealthy than a vehicle for lifetime income, account for most of the market. These annuities, which essentially let you invest in mutual funds with some insurance guarantees, saw first-quarter net sales of $33.5 billion—down slightly from a year ago. (For more on the cost and potential risks of variable annuities, click here and here.)

Meanwhile, net sales of fixed annuities, which offer more certain returns, surged to levels last seen in the rush to safety at the height of the Great Recession—totaling $22.6 billion for the quarter. Fixed annuities come in simple and complex varieties—those indexed to the stock market can be confusing and laden with fees. But the subset known as income annuities—the most basic and straightforward of the lot—grew at a 50% clip versus 44% for the index variety.

Basic income annuities, also known as immediate annuities, remain a tiny portion of the overall $2.6 trillion annuity market. Yet they are what most investors think of when they ponder buying an income stream. With an immediate annuity you plunk down cash and begin receiving pre-set guaranteed income over a period of, say, 10 or 20 years, or life. Rates have been relatively low, as they are for most fixed-income investments. Recently a 65-year-old man investing $100,000 could get a lifetime payout of 6.6%, according to ImmediateAnnuities.com.

Another type of fixed annuity, called a deferred income annuity or longevity annuity, lets you put down a lump sum in return for income that starts years later —think of it as a form of insurance for old age. Though less well known, longevity annuities are increasingly popular, with sales reaching $620 million in the first quarter, up 57%, according to LIMRA, an insurance marketing research group. You can find other types of annuities designed lock up income, but the amount of the payout is often a moving figure and the fee structure can be difficult to understand.

Lifetime income has emerged as perhaps the biggest retirement challenge of our age. The gradual shift from defined benefit plans to defined contribution plans over the past 30 years has begun to leave each new class of retirees without the predictable, monthly stream of cash needed to cover basic expenses. The push is on to help these retirees convert their 401(k) and IRA savings to a guaranteed income stream. But innovation is not coming fast, and traditionally many investors have been reluctant to tie up their money in fixed annuities. So the quarterly sales trends are heartening. They suggest that individuals are acting to shore up a critical aspect of their retirement plan.

MONEY Social Security

Surprise! Even Wealthy Retirees Live On Social Security and Pensions

Older Americans with six-figure portfolios rely on old-fashioned programs for half their income.

Where do affluent retirees get their income? Portfolios invested in stocks and bonds, you might think—but you’d be wrong. Turns out many are living mainly on Social Security and good old pensions.

That’s the surprising finding of new research from a surprising source: Vanguard, a leading provider of retirement saving products like individual retirement accounts and 401(k)s. Vanguard studied the income sources and wealth holdings of more than 2,600 older households (ages 60-79) with at least $100,000 in retirement savings. The respondents’ median income was $69,500, with median financial assets of $395,000. (The value of housing was excluded.)

The researchers were looking for answers to a mysterious question about the behavior of wealthier retirement account owners: Why do few of them draw down their savings? They found that nearly half the aggregate wealth of these households comes from the two mothers of all guaranteed income programs, Social Security (28%) and traditional defined-benefit pensions (20%).

The median annual income for these households is $22,000 from Social Security, with an additional $20,000 from pensions. Tax-deferred retirement accounts came in third among those who have them, at $13,000 (11%).

“Only a small number of the people who have 401(k)s and IRAs are really relying on them as a regular source of income,” said Steve Utkus, director of the Vanguard Center for Retirement Research. “There’s a lot more income from pensions than we expected,” he adds.

That last finding may seem surprising, given all the publicity about shrinkage of defined-benefit pensions. Although most state and local government workers still have pensions, only a third of private-sector workers hold a traditional pension, down from 88% in 1975, according to the National Institute on Retirement Security. And NIRS data points to a continued slide in the years ahead.

“Will this look different 10 years from now—will we have less pension income and more from retirement savings accounts? I think so,” Utkus says.

Another interesting finding: 29% of affluent retirees get some income from work, with a median income of $24,600. And the rate of labor force participation was even higher—40%— among households more reliant on retirement accounts.

“That’s only going to jump dramatically over the next few years,” Utkus says. “All the surveys show there’s a real demand for work as a structure to life. People say they can use the money, or they want to work to get social interaction.”

The findings are all the more striking because the big buzz in the retirement industry these days is about how to generate income from nest eggs. That includes creation of income-oriented portfolios, systematic drawdown plans and annuity products that act as do-it-yourself pensions.

Yet few retirement account holders actually are tapping them for income. The Investment Company Institute reports that just 3.5% of all participants in 401(k) plans took withdrawals in 2013. That figure includes current workers as well as retirees; the numbers are higher when IRAs are included, since those accounts include many rollovers from workplace plans by retired workers. With that wider lens, 20% of younger retired households (ages 60-69) take withdrawals, according to a study for the National Bureau of Economic Research and the Social Security Administration’s Retirement Research Consortium.

The income annuity market has been especially slow to take off. One option is an immediate annuity, where you make a single payment at the point of retirement or later to an insurance company and start getting a monthly check; the other is a deferred annuity, which lets you pay premiums over time entitling them to future regular income in retirement.

Deferred annuity sales doubled in 2013, to about $2 billion, according to LIMRA, the insurance industry research and consulting group. But that’s still a drop in the bucket of the broader retirement products market. And the Vanguard survey found that just 5% of investors surveyed held annuity contracts.

“The theme of translating retirement balances into income streams is emerging very slowly,” Utkus says.

The Vanguard study also underscores the importance of smart Social Security claiming decisions, especially delayed filing. “There’s been a sea change over the past year,” Utkus says, with more people recognizing that delayed filing is one of the best ways to boost guaranteed income in retirement. Vanguard is “actively discussing” adding Social Security advice to the services it offers investors, he says.

 

 

MONEY Macroeconomic trends

Momentum Strategy: Skip Stocks, Go for Sectors

A momentum strategy can boost returns without too much risk. Just don't be too greedy. Illustration: Taylor Callery

You’ve no doubt been warned more than once that chasing last year’s winners is a fool’s game that increases your trading costs, tax liability, and investment risk.

That’s especially true if you are constantly moving in and out of individual securities, which is the classic momentum strategy. Yet a decent body of research suggests that entire asset classes that shine in one year have a better-than-average chance of outperforming in the next.

“Momentum is persistent, pervasive, and well documented in virtually every investment and in every country,” says Gregg Fisher, chief investment officer with the asset-management firm Gerstein Fisher.

So how do you take advantage of momentum wisely? As with many things in life, moderation is key.

Lessen the bounce

Sam Stovall, chief equity strategist with S&P Capital IQ, points out that any added gains from buying what’s been going up “don’t come free.” History shows that momentum investors have to assume greater fluctuations in their returns.

But there’s a neat twist to the numbers. Researchers at the asset-management firm Leuthold Group divvied up the investment universe into seven major asset classes: blue-chip U.S. stocks, small-company shares, foreign equities, government bonds, commodities, gold, and real estate investment trusts.

Over the past four decades, a portfolio entirely made up of the prior year’s absolute top asset class beat the S&P 500 by more than three percentage points a year, but it was also two-thirds choppier.

A “bridesmaid” portfolio composed of the previous year’s second-highest performer, however, was only slightly more volatile than the index, and it returned five percentage points more. (For the record, last year’s runner-up asset class was blue-chip U.S. stocks. Small U.S. stocks were the absolute winner.)

Be only a little greedy

Of course, no sane investor would keep such an undiversified portfolio; there are years it would kill you.

In 1997, for instance, you would have lost more than 14% holding a basket of commodities while the S&P 500 returned more than 33%. And turning over sizable chunks of your holdings would indeed cost you in fees and taxes, eating into your gains. So momentum strategies should be applied with a good bit of caution.

Fisher suggests that you think about leaning slightly toward what’s hot — say, by moving up to 10% of your portfolio to a momentum-driven approach — rather than committing huge chunks of your capital.

“Our view is that investors are well served by tilting toward momentum,” Fisher says. “But they’re even better served by doing so in the context of a well-diversified portfolio.”

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