Make It Last

October 2002

You’ve read their stories: Americans who, after 40 years of nine-to-fiving it, tucked their ample nest eggs under their arms and headed out on their retirement adventures. CRACK! That’s the sound of a nest egg breaking.

The bear market of the past two-and-a-half years has wiped out more than $678 billion of retiree wealth, according to the University of Michigan’s Health and Retirement Study. Add low interest rates, receding Social Security benefits and a shrinking number of guaranteed-benefit pensions from employers — and it’s no wonder many of today’s retirees and near retirees are having to scramble to make sure their money lasts as long as they do.

"We pay a lot of attention to accumulating retirement assets," says Peter Hendrick, second vice president in Northern Trust’s personal financial planning group. "But spending those assets wisely — making sure your savings outlive you — may be an even greater challenge."

Here are some strategies to improve the odds of outliving your savings.

Planning matters
First, get a realistic handle on how long your retirement is likely to last. But don’t bet your retirement security on your statistical lifespan, Hendrick counsels. Although the average lifespan for a 65-year-old man is 80.9, according to the National Center for Health Statistics, any one 65-year-old man might live far longer than that.

"Your retirement might last 15 years — or it could last 35 years," Hendrick says. "To make sure your money lasts, it’s best to plan for a longer retirement."

How long? Some advisors recommend projecting a lifespan as long as 100 years.

Next, calculate your likely retirement expenses. Put your necessary expenditures (food, shelter, health care) in one column and your nice-to-haves in another. (Yes, unfortunately, your twice-weekly golf game is a nice-to-have!) This is the time to think about the unpleasant aspects of aging, such as the potential cost of long-term care.

Draw it out
The next step is to devise a strategy for converting your assets into retirement income to cover those expenses. You have at least two options:

• Spend your portfolio. One approach is to withdraw a percentage of your portfolio’s initial value, increasing the amount each year so your income keeps pace with inflation. The trick is to choose a percentage that nurses your portfolio along for the rest of your life.

"The problem with this approach is that we tend to be too optimistic," says Hendrick. "We look at past returns that have reached high double digits and say, 'Let’s withdraw 10 percent a year.'"

But returns fluctuate over time — an economic rule that we’ve certainly seen illustrated the last five years.

So what percentage can you withdraw to ensure that your money lasts as long as you do — even if a bear eats a chunk of your assets somewhere along the line?

Who knows? There’s no way to guarantee future success. But one way to improve it is to study historic markets. Bean counters have run the numbers and shown that a meager 4 percent spending strategy would have kept portfolios afloat during any 30-year period since 1926.

Ouch! While 10 percent of your, say, million-dollar retirement nest egg may sound like a reasonable income, 4 percent probably seems downright skimpy.

Good thing there’s another way.

• Buy yourself an income. The second approach is to pay someone to send you a regular paycheck. That means putting at least a portion of your nest egg into a fixed-income vehicle, such as an annuity.

Annuity sales hit a record $22.1 billion during the first quarter of this year, according to The Wall Street Journal. No wonder they’re hot: At a time when nothing else seems certain, annuities can deliver a guaranteed income for life.

What portion of your assets should you invest in an annuity?

Of course, that depends on your individual situation. But here’s a place to start. According to research conducted by Ibbotson Associates for Money magazine (June 2002), this formula improved the odds of meeting your targeted income for life:

• 25 percent of assets in a variable annuity
• 25 percent in a fixed annuity
• 50 percent in a portfolio comprising 70 percent large-company stocks and 30 percent in intermediate-term bonds

Caveats: Fixed income vehicles are selling at a premium right now, Hendrick warns. Annuity fees run high. Shop carefully.
 

"Plan on single-digit returns over the next several years. Be happily surprised if returns exceed that, rather than the reverse."

Security stretchers
Here are some other financial moves that can help you improve your financial security:

• Diversify. If you’ve gotten out of equities because you don’t like what the recession has done to your portfolio, you’re doing yourself a disservice. No bear can chew away at your portfolio with quite the consistency that inflation can. The dollars you spend for dinner at Charlie Trotter’s today might buy you a Big Mac with fries near the end of your retirement. The way to protect your buying power: Stick with stocks.

"Depending on your age and situation, you need to have a certain percentage of your assets in equities," says Hendrick.

"We spend a great deal of time with clients determining an appropriate asset allocation strategy, taking into account risk tolerance as well as income requirements. It is important to strike a balance that takes both into consideration."

• Lower your expectations. Expect total returns, including dividends, of 4 percent to 8 percent, Hendrick advises.

"You need to plan on single-digit returns over the next several years," he says. "Let yourself be happily surprised if returns exceed that, rather than the reverse."

• Tighten your belt. But don’t deprive yourself of enjoyment.

"If you have planned for great travel in your retirement, don’t cancel plans," Hendrick says. "Instead, save money with alternative destinations or less expensive hotels. Don’t neglect to celebrate retirement."

• Keep your day job. Put off early retirement or go back to work.

Don’t stop
Perhaps the biggest key to retirement security: Continue to be active in your financial planning.

"In the last couple of years, people have become paralyzed by the effect the market has had on their portfolios," Hendrick says. "It’s important to realize that inaction is a decision action in itself — and probably the wrong one."

"Instead of wasting time worrying about the past, visit your financial advisor to talk about how to reposition your portfolio for the future."

Want more information?
Ask your Relationship Manager about annuities offered through Northern Trust Securities, Inc. or call the Northern Funds Center at 800/595-9111.