April 2008

Ah, retirement.

It's time to trade in breakfast meetings for morning yoga, business trips for winters in Barbados, perfecting your PowerPoint prowess for powering up your golf swing.

And it's time to start spending your retirement portfolio instead of saving it.

That's tougher than it sounds.

"We put so much emphasis on saving for retirement," says Michael Byrne, vice president and senior financial consultant at Northern Trust. "But the way you spend your retirement savings can have as much impact on your lifestyle as the way you accumulated your assets in the first place."

Transforming your retirement assets into income is a sophisticated art — one that trips up many otherwise successful investors. Here are five mistakes to avoid in managing your retirement income:

1. Don't fail to plan.
Over a 30-year retirement, your financial needs are bound to change.

In fact, retirees go through three distinct lifestyle phases, according to Northern Trust's Living Well Planning Guide. Each phase has its own shifting priorities, needs and decisions that can have serious consequences on your lifestyle and standard of living.

So retirement is not a "one-size-fits-all" time of life. Your financial advisor can help you develop a comprehensive financial plan before you retire. During retirement, you'll want to revisit that plan regularly.

"If your life plan changes dramatically — you decide to move, buy a second home, put the grandchildren through college — your financial plan should change with it," Byrne says.

2. Don't invest too conservatively.
With life expectancies increasing every year, you could be looking at a 25- to 30-year retirement. That means your investments need to outpace inflation for the long haul.

"Equities are an important part of a diversified portfolio, even late in life," Byrne says.

Remember, your portfolio might change.

3. Don't tap the wrong assets first.
A solid withdrawal strategy can reduce your tax burden now and in the future. So withdraw:

• For asset allocation. Sell retirement account assets first to keep a portfolio diversified while minimizing tax consequences.
   
• To reduce taxes. Leave money to grow in retirement accounts as long as possible. Draw down taxable accounts first, tax-deferred accounts like IRAs and 401(k)s next and tax-free Roth IRAs last.
   
• Because you have to. IRA required minimum distribution rules kick in during April of the year following the year you turn 70 1/2.

4. Don't overspend early on.
How much will it cost to support a comfortable lifestyle in retirement? Count on spending at least 80 percent of your pre-retirement income during retirement, Byrne counsels.

How much should you spend? Plan to withdraw no more than 4 percent of your portfolio a year, Byrne suggests. Those withdrawal rates have been shown to be sustainable over time in sophisticated computer simulations.

So to come up with a budget, multiply the value of your current portfolio (let's call it $3 million) by a sustainable withdrawal rate (let's call it 4% a year) to come up with a reasonable retirement budget.

In this case, that would be $120,000 a year. Then add any income from pensions, annuities or other income-producing assets to that amount.

Now comes the hard part: sticking to that budget.

5. Don't forget to factor in rising health care costs.
The cost of health care is the No. 1 retirement concern among millionaire households, according to Northern Trust's third annual Wealth in America study, a survey of some 1,000 millionaire households.

And no wonder.

The average 65-year-old couple living into their 80s might need to cover up to $300,000 in premiums and out-of-pocket healthcare costs during their retirement, according to the Employee Benefit Research Institute.

And that doesn't include long-term care or nursing home costs, which aren't generally covered by Medicare. Long-term-care costs may well triple during the next 20 years, according to the U.S. General Accounting Office.

"Whether to purchase long-term care insurance or self insure is a complex decision," Byrne says. "It will depend on such individual factors as whether you're married and how much you plan to provide for heirs."

Your financial planner should cover healthcare and long-term care costs as part of your comprehensive financial analysis.

Which brings us to a final "don't": Don't forget to include your financial advisor in your major retirement income decisions.

Achieving the proper asset allocation to provide the growth, income and liquidity that's right for you at every stage of retirement is a sophisticated, dynamic process.

"Setting up a portfolio that will provide a healthy income for five or 10 years — let alone 30 — is no small task," Byrne says. "Working with your financial advisor to transform assets to income during retirement may be even more important than it was to consult with experts when you were building your portfolio in the first place."