NORCO, CA – 7 June, 2016 – There was a time when retirement was a lot less complicated. Pension programs were prevalent and there was confidence in the ability of Social Security to provide regular income. Personal savings, while necessary, played a smaller role in an overall retirement income plan. It’s now common for retirements, which once lasted around 15 years, to extend beyond 25 or 30 years, which is good news, but requires even more savings.
Today, Social Security faces an uncertain future and pensions are fast disappearing and being replaced by defined-contribution programs, which rely primarily on the individual for savings. As a result, the bulk of the burden for creating retirement income rests with the individual retiree. That means pre-retirees need to be a lot more aware of the various retirement tools out there and how they can be strategically combined to help address investment risks and potentially create an income stream that will last throughout retirement.
Planning for retirement income that can last 25+ years may mean spending less in retirement than during the working years, but understanding how different financial tools can help optimize your income may help you avoid needless penny pinching in the early years of retirement. For instance, there are strategies that incorporate an income stream that won’t be realized until later in life, allowing for more spending early in retirement in anticipation of that future income.
According to investment advisor and insurance professional Paul DiGerolamo, of DiGerolamo Family Insurance LLC, in Norco, California, there are a variety of strategies for creating long-term income in retirement, each with its own risks and benefits. The “right” strategy will be different for everyone, DiGerolamo says, depending on factors that include level of assets, risk tolerance and life expectancy.
“One strategy is to rely on systematic withdrawals from a well-diversified investment portfolio,” DiGerolamo says. “By keeping assets invested in the market, growth potential is maintained as well as some degree of liquidity.”
While DiGerolamo stressed the need for ensuring diversification in the investment portfolio, he also cautioned that diversification can only manage risk; it does not ensure a profit nor guarantee against loss.
Provided markets perform well, the growth from invested assets can help create future income streams. One of the risks inherent in this strategy is that markets may not perform well, and if you have to continue making withdrawals, those losses will be realized and could impair the ability to provide income throughout retirement.
“An option within this strategy is to employ some fixed income assets, like bonds, and hold them to maturity,” DiGerolamo says. “These assets can support short- or medium-term spending, while a more aggressive investment portfolio with higher expected returns is deployed for long-term expenses.”
Having the bonds in place for near-term spending can give investors more comfort during times of market decline, knowing their potential to provide interest that may be used for income and that they have time for their stocks to recover before they must be sold, DiGerolamo says. The challenge, again, is that if there is a need to sell the bonds early, it could result in losses, both capital losses and the loss of assets that were needed to cover future spending.
A third option is to create a guaranteed income stream through the use of annuities. As an insurance product, fixed annuities are not subject to the rise and fall of the market, and the guarantees associated with them are backed by the financial strength of the issuing insurer.
“Fixed annuities can be real or nominal, and the initial payments can begin with one year (single premium immediate annuities, or SPIAs), or be deferred to a later age (deferred income annuities, or DIAs),” DiGerolamo says. “And because you can structure them to provide income for life, they can provide longevity protection by hedging the risks associated with not knowing how long you will live.”
But annuities have their drawbacks, as well. They do not provide growth potential and there are typically surrender charges associated with withdrawing funds in the first 10 years or longer, making them impractical for those who have liquidity needs or uncertain future budgeting strategies.
Every strategy or financial product has a variety of pros and cons that should be fully explored with a professional, DiGerolamo says, but generally speaking, he tends to prefer a mix of strategies that can play to the pros and help minimize the cons.
“Partially annuitizing assets can be an effective way to build an income floor for retirement, while maintaining an investment portfolio provides continued growth potential and some degree of liquidity,” he says. “The key really is to be aware of the need to create sufficient income throughout retirement, however long that may be.”
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