These spending and investing precepts may encourage its longevity.
All retirees want their money to last a lifetime. There is no guarantee it will, but, in pursuit of that goal, households may want to adopt a couple of spending and investing precepts.
One precept: observing the 4% rule. This classic retirement planning principle works as follows: a retiree household withdraws 4% of its amassed retirement savings in year one of retirement, and withdraws 4% plus a little more every year thereafter – that is, the annual withdrawals are gradually adjusted upward from the base 4% amount in response to inflation.
The 4% rule was first formulated back in the 1990s by an influential financial planner named William Bengen. He was trying to figure out the “safest” withdrawal rate for a retiree; one that could theoretically allow his or her savings to hold up for 30 years given certain conditions (more about those conditions in a moment). Bengen ran various 30-year scenarios using different withdrawal rates in relation to historical market returns, and concluded that a 4% withdrawal rate (adjusted incrementally for inflation) made the most sense.1
For the 4% rule to “work,” two fundamental conditions must be met. One, the retiree has to invest in a way that will allow his or her retirement savings to grow along with inflation. Two, there must not be a sideways or bear market occurring.1
As sideways and bear markets have not been the historical norm, following the 4% rule could be wise indeed in a favorable market climate. Michael Kitces, another influential financial planner, has noted that, historically, a retiree strictly observing the 4% rule would have doubled his or her starting principal at the end of 30 years more than two-thirds of the time.1
In today’s low-yield environment, the 4% rule has its critics. They argue that a 3% withdrawal rate gives a retiree a better prospect for sustaining invested assets over 30 years. In addition, retiree households are not always able to strictly follow a 3% or 4% withdrawal rate. Dividends and Required Minimum Distributions may effectively increase the yearly withdrawal. Retirees should review their income sources and income prospects with the help of a financial professional to determine what withdrawal percentage is appropriate given their particular income needs and their need for long-term financial stability.
Another precept: adopting a “bucketing” approach. In this strategy, a retiree household assigns one-third of its savings to equities, one-third of its savings to fixed-income investments, and another third of its savings to cash. Each of these “buckets” has a different function.
The cash bucket is simply an emergency fund stocked with money that represents the equivalent of 2-3 years of income the household does not receive as a result of pensions or similarly scheduled payouts. In other words, if a couple gets $35,000 a year from Social Security and needs $55,000 a year to live comfortably, the cash bucket should hold $40,000-60,000.
The household replenishes the cash bucket over time with investment returns from the equities and fixed-income buckets. Overall, the household should invest with the priority of growing its money; though the investment approach could tilt conservative if the individual or couple has little tolerance for risk.
Since growth investing is an objective of the bucket approach, equity investments are bought and held. Examining history, that is not a bad idea: the S&P 500 has never returned negative over a 15-year period. In fact, it would have returned 6.5% for a hypothetical buy-and-hold investor across its worst 15-year stretch in recent memory – the 15 years ending in March 2009, when it bottomed out in the last bear market.2
Assets in the fixed-income bucket may be invested as conservatively as the household wishes. Some fixed-income investments are more conservative than others – which is to say, some are less affected by fluctuations in interest rates and Wall Street turbulence than others. While the most conservative, fixed-income investments are currently yielding very little, they may yield more in the future as interest rates presumably continue to rise.
There has been great concern over what rising interest rates will do to this investment class, but, if history is any guide, short-term pain may be alleviated by ultimately greater yields. Last December, Vanguard Group projected that, if the Federal Reserve gradually raised the benchmark interest rate to 2.0% across the three-and-a-half years ending in July 2019, a typical investment fund containing intermediate-term fixed-income securities would suffer a -0.15% total return for 2016, but return positively in the following years.3
Avoid overspending and invest with growth in mind. That is the basic message from all this, and, while following that simple instruction is not guaranteed to make your retirement savings last a lifetime, it may help you to sustain those savings for the long run.
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
Citations.1 - money.cnn.com/2016/04/20/retirement/retirement-4-rule/ [4/20/16]2 - time.com/money/4161045/retirement-income/ [5/22/16]3 - tinyurl.com/hjfggnp [12/2/15]
Have our memories of the Great Recession altered our habits?
Consumer spending accounts for more than two-thirds of economic activity in the United States. Lately, that spending has moderated. Across the 12 months ending in March, personal spending advanced 3.4%. That matched the gain seen in 2015.1,2
Is a 3.4% annualized gain in personal spending adequate? Not in historical terms. During 2014, consumer spending accelerated 4.2%. The average monthly gain in consumer spending across the past 12 months (0.28%) is roughly half the historical average seen since 1959 (0.54%).1,2
While the personal spending rate has slumped recently, the personal savings rate has not. In March, it was at 5.4%. It has varied between 4-6% for more than three years, staying notably above the levels seen prior to the Great Recession of 2007-2009.3
Has consumer psychology been altered since then? That is an interesting question to consider, and it especially begs consideration, given the fact that inflation-adjusted personal spending has declined for three straight quarters.4
Real disposable income (that is, disposable income adjusted for inflation) has been rising without fail. It has increased for 13 straight quarters, beginning in Q1 2013 after the payroll tax cut at the end of 2012. You would think unflagging increases in real disposable income would promote greater economic expansion, but real gross domestic product grew just 1.5% in 2013 and only 2.4% in both 2014 and 2015. Those GDP levels are well below those seen in the early 2000s, not to mention the 1990s.4,5
When is too much frugality a bad thing? When it risks hampering economic growth. The 5.4% personal savings rate recorded in March tied a three-and-a-half-year high. As we are well into an economic recovery, it would seem only natural for Americans to spend more than they did several years ago.4
Perhaps people are just not ready to do that. As a Deutsche Bank research note asserted this month, the memory of the Great Recession may be too hard to erase: “The shock of the crisis likely increased the desire to hold more savings for precautionary motives.”4
Since 2001, Gallup has consistently asked Americans a question each year: “Are you the type of person who more enjoys spending money or who more enjoys saving money?”6
This year, 65% of respondents said they preferred saving and 33% of respondents said they preferred spending. That gap has never been so pronounced in fifteen years of polling.6
As recently as 2009, just 53% of Americans told Gallup they preferred saving while 44% indicated they preferred spending. The gap has gradually widened ever since, and it is now fairly consistent across all age groups.6
A little more polling history seems to affirm a perception shift. In 2006, Gallup found that 51% of Americans rated their personal financial situation as “excellent/good;” in that year, 50% of Americans preferred saving to spending. Four years later, only 41% of Americans felt their personal financial situation was “excellent/good”, and 62% indicated a preference for saving. This year, 50% of Americans ranked their personal finances as “excellent/good,” yet 65% preferred saving dollars to spending them. “The appeal of saving over spending shows some signs of being the new normal rather than a temporary reaction to the hard times after 2008,” Gallup’s Jim Norman observed last month.6
In its latest report on personal income and outlays, the Bureau of Economic Analysis says personal incomes were up 4.2% year-over-year as of March. Consumer prices rose but 0.9% in the same span. Unimpressive wage growth aside, it would appear that many households are nicely positioned to spend. Of course, what these two numbers do not take into account is debt: mortgage debt, student loan debt, credit card debt. The rebound in the personal savings rate surely relates to the goal of reducing such liabilities.7,8
The Great Recession taught America a great lesson about living within one’s means. Could that lesson, as vital as it is, now be constraining the economy? As economists try to pinpoint reasons for America’s slow recovery, they may want to cite the psychology of the consumer.
1 - cnbc.com/2016/02/01/us-personal-income-dec-2015.html [2/1/16]
2 - tradingeconomics.com/united-states/personal-spending [5/22/16]
3 - tradingeconomics.com/united-states/personal-savings [5/12/16]
4 - usnews.com/news/articles/2016-05-11/years-later-psychological-scars-from-great-recession-skew-spending [5/11/16]
5 - statista.com/statistics/188165/annual-gdp-growth-of-the-united-states-since-1990/ [5/12/16]
6 - gallup.com/poll/190952/nearly-two-thirds-americans-prefer-saving-spending.aspx [4/25/16]
7 - shopfloor.org/2016/04/personal-spending-remained-soft-in-march-despite-decent-income-growth/ [4/29/16]
8 - reuters.com/article/us-usa-economy-inflation-idUSKCN0XB1I4 [4/14/16]
Let them know how they will receive retirement assets and insurance benefits.
Will your heirs receive a fair share of your wealth? Will your invested assets go where you want them to when you die?
If you have a proper will or estate plan in place, you will likely answer “yes” to both of those questions. The beneficiary forms you filled out years ago for your IRA, your workplace retirement plan, and your life insurance policy may give you even more confidence about the eventual transfer of your wealth.
One concern still remains, though. You have to tell your heirs that these documents exist.
That does not mean sharing all the details. If you have decided that some of your heirs will one day get more of your wealth than others, you can keep quiet about that decision as long as you live. You do want to tell your heirs the essential details; they should know that you have a will and/or an estate plan, and they should understand that you have named beneficiaries for your retirement accounts, your investment accounts, and your insurance policies.
Over time, you must review your beneficiary decisions. In fact, you may want to revisit them. As an example, say you opened an IRA in 1997. Your life has probably changed quite a bit since 1997. Were you single then, and are you married now? Were you married then, and are you single now? Have you become a parent since then? If you can answer “yes” to any of those three questions, then you need to look at that IRA beneficiary form now. Your choices may need to change.
Here is a quick look at how beneficiary decisions play out for a few of the most popular retirement accounts.
Employer-sponsored retirement plans. These are governed by the Employee Retirement Income Security Act (ERISA), which rules that if the late accountholder was married, the surviving spouse is entitled to at least 50% of the account assets. That applies even if another person has been designated as the primary beneficiary. In such a case, the spouse and the primary beneficiary may split the assets 50/50. (The spouse can actually waive his or her right to that 50% of the invested assets through a Spousal Waiver form. A spouse usually has to be older than 35 for this to be allowed.) These rules also apply for other types of ERISA-governed retirement assets, such as pension plan accounts and corporate-owned life insurance.1,2
The Supreme Court has decided that these rules take priority over state laws (Egelhoff v. Egelhoff, 2001; Hillman v. Maretta, 2013) and divorce agreements (Kennedy Estate v. Plan Administrator for the DuPont Saving and Investment Plan, 2008).3,4
If a participant in one of these retirement accounts remarries, the new husband or wife is entitled to 50% of those assets at death. While a plan participant may name a child as the beneficiary of a retirement account after a divorce, remarriage will leave only 50% of those assets with that child when the accountholder dies, rather than 100%, unless the new spouse waives his or her right to receiving 50% of the assets. The new spouse will be in line to receive that 50% of the account even if unnamed on the beneficiary form.1
IRAs. Unlike an employer-sponsored retirement plan, a spouse does not have automatic beneficiary rights with an IRA. That is because IRAs are governed under state laws rather than ERISA. One interesting estate planning aspect of an IRA rollover is that the owner of the new IRA has the freedom to name anyone as the primary beneficiary.1
Life insurance policies. The death proceeds go to the named beneficiary; occasionally, a beneficiary may not know a policy exists.
Recently, 60 Minutes did an expose on the insurance industry. Major insurers had withheld more than $7.5 billion in life insurance death proceeds from beneficiaries. They had a contractual reason for doing so: the beneficiaries had never stepped forward to file claims.5
While many of the policies involved were valued at $10,000 or less, others were worth over $1 million. The deceased policyholders had either failed to tell their heirs about the policies or misplaced the copies and the paperwork. Their heirs did not know (or know how) to claim the money. As a result, the insurance proceeds lay unclaimed for years, and the insurers only now feel pressure to pay out the benefits.5
Update your beneficiaries; let your heirs know how vital these forms are. Make sure that your beneficiary decisions on retirement, brokerage and bank accounts, college savings plans, and life insurance policies suit your wealth transfer objectives.
1 - 401khelpcenter.com/401k_education/connor_beneficiary_designations.html [4/21/16]
2 - nolo.com/legal-encyclopedia/claim-payable-on-death-assets-32436.html [4/21/16]
3 - marketwatch.com/story/check-your-beneficiary-designations-now-2013-09-17/ [9/17/13]
4 - forbes.com/sites/deborahljacobs/2013/06/03/supreme-court-favors-ex-wife-over-widow-in-battle-for-life-insurance-proceeds/ [6/3/13]
5 - cbsnews.com/news/60-minutes-life-insurance-investigation-lesley-stahl/ [4/17/16]
That development may mean lifestyle as well as financial adjustments.
Your significant other may retire later than you do. Sometimes that reality reflects an age difference, other times one person wants to keep working for income or health coverage reasons. If you retire years before your spouse or partner does, you may want to consider how your lifestyle might change as well as your household finances.
How will retiring affect your identity? If you are one of those people who derives a great deal of pride and sense of self from your profession, leaving that career for life around the house may feel odd. Who are you now? Who will you become next? Can you retire and still be who you were? Hopefully, your spouse recognizes that you may have to entertain these questions. They may prompt some soul-searching, even enough to affect a relationship.
How much down time do you want? That is worth discussing with your spouse or partner. If you absolutely hate your job, you may want weeks, months, or years of relaxation after leaving it. You can figure out what to do next in good time. Alternately, you may see every day of retirement as a day for achievement; a day to get something done or connect with someone new. Your significant other should know whether you prefer an active, ambitious retirement or a more relaxed one.
How will household chores or caregiving be handled? Picture your loved one arising at 6:30am on a January morning, bundling up, heading for work and navigating inclement weather, all as you sleep in. Your spouse or partner may grow a bit envious of your retirement freedom. One way to offset that envy is to assume more of the everyday chores around the house.
For many baby boomers, caregiving is also a daily event. When one spouse or partner retires, that can rebalance the caregiving “equation.” One or more individuals have to provide 100% of the eldercare needed, and retirement can make shared percentages more equitable or allow a greater role for a son or daughter in that caregiving. Some people even retire to become a caregiver to Mom or Dad.
Do you have kids living at home? Adult children? Right now, in this country, every fifth young adult is living with his or her parents. With so many new college graduates having to accept part-time or low-paying service industry jobs, and with education loan debt averaging roughly $30,000 per indebted graduate, this situation will persist for years and, perhaps, even become a new normal.1
You and your loved ones may find yourself on different timetables. Maybe your spouse or partner works from 8:00 a.m. to 5:00 p.m. in a high-stress job. Maybe your children attend school on roughly the same schedule. How do they get to and from those places? Probably through a rush-hour commute, either in a car or amid the crowds lined up for mass transit. If you have abandoned the daily grind, you may have an enthusiasm and a chattiness in the evening that they lack. Maybe they just want to unwind at 6:30pm, but you might be anxious to reconnect with them after a day alone at home.
Talk about retirement before you retire. What should your daily life look like? What are the most important things you want out of the retirement experience? How do your answers to those questions align or contrast with the answers of your best friend? As you retire, make sure that your spouse or partner knows your point of view, and be sure to respect his or hers in the bargain.
1 - chicagotribune.com/business/success/savingsgame/tca-boomerang-children-affecting-parents-retirement-plans-20160413-story.html [4/13/16]
Just how gloomy does its future look?
Will Social Security run out of money in the 2030s? For years, Americans have been warned about that possibility. Those warnings, however, assume that no action will be taken to address Social Security’s financial challenges.
Social Security is being strained by a giant demographic shift. In 2030, more than 20% of the U.S. population will be 65 or older. In 2010, only 13% of the nation was that old. In 1970, less than 10% of Americans were in that age group.1
Demand for Social Security benefits has increased, and the ratio of retirees to working-age adults has changed. In 2010, the Census Bureau determined that there were about 21 seniors (people aged 65 or older) for every 100 workers. By 2030, the Bureau projects that there will be 35 seniors for every 100 workers.1
As payroll taxes fund Social Security, the program faces a major dilemma. Actually, it faces two.
Social Security maintains two trust funds. When you read a sentence stating that “Social Security could run out of money by 2035,” that statement refers to the projected shortfall of the Old Age, Survivors, and Disability Insurance (OASDI) Trust. The OASDI is the main reservoir of Social Security benefits, from which monthly payments are made to seniors. The latest Social Security Trustees report indeed concludes that the OASDI Trust could be exhausted by 2035 from years of cash outflows exceeding cash inflows.2,3
Congress just put a patch on Social Security’s other, arguably more pressing problem. Social Security's Disability Insurance (SSDI) Trust Fund risked being unable to pay out 100% of scheduled benefits to SSDI recipients this year, but the Bipartisan Budget Act of 2015 directed a slightly greater proportion of payroll taxes funding Social Security into the DI trust for the short term. This should give the DI Trust enough revenue to pay out 100% of benefits through 2022. Funding it adequately after 2022 remains an issue.4
If the OASDI Trust is exhausted in 2035, what would happen to retirement benefits? They would decrease. Imagine Social Security payments shrinking 21%. If Congress does not act to remedy Social Security’s cash flow situation before then, Social Security Trustees forecast that a 21% cut may be necessary in 2035 to ensure payment of benefits through 2087.3
No one wants to see that happen, so what might Congress do to address the crisis? Three ideas in particular have gathered support.
*Raise the cap on Social Security taxes. Currently, employers and employees each pay a 6.2% payroll tax to fund Social Security (the self-employed pay 12.4% of their earnings into the program). The earnings cap on the tax in 2016 is $118,500, so any earned income above that level is not subject to payroll tax. Lifting (or even abolishing) that cap would bring Social Security more payroll tax revenue, specifically from higher-income Americans.3
*Adjust the full retirement age. Should it be raised to 68? How about 70? Some people see merit in this, as many baby boomers may work and live longer than their parents did. In theory, it could promote longer careers and shorter retirements, and thereby lessen demand for Social Security benefits. Healthier and wealthier baby boomers might find the idea acceptable, but poorer and less healthy boomers might not.3
*Calculate COLAs differently. Social Security uses the Consumer Price Index for Urban Wage Workers and Clerical Workers (CPI-W) in figuring cost-of-living adjustments. Many senior advocates argue that the Consumer Price Index for the Elderly (CPI-E) should be used instead. The CPI-E often gives more weight to health care expenses and housing costs than the CPI-W. Not only that, the CPI-E only considers the cost of living for people 62 and older. That last feature may also be its biggest drawback. Since it only includes some of the American population in its calculations, its detractors argue that it may not measure inflation as well as the broader CPI-W.3
Social Security could still face a shortfall even if all of these ideas were adopted. The Center for Retirement Research at Boston College estimates that if all of these “fixes” were put into play today, the OASDI Trust would still face a revenue shortage in 2035.3
In future decades, Social Security may not be able to offer retirees what it does now, unless dramatic moves are made on Capitol Hill. In the worst-case scenario, monthly benefits would be cut to keep the program solvent. A depressing thought, but one worth remembering as you plan for the future.
1 - money.usnews.com/money/retirement/articles/2014/06/16/the-youngest-baby-boomers-turn-50 [6/16/14]
2 - fool.com/retirement/general/2016/03/20/the-most-important-social-security-chart-youll-eve.aspx [3/20/16]
3 - fool.com/retirement/general/2016/03/19/1-big-problem-with-the-3-most-popular-social-secur.aspx [3/19/16]
4 - marketwatch.com/story/crisis-in-social-security-disability-insurance-averted-but-not-gone-2015-11-30 [11/30/15]
Today’s retirees must be more self-reliant than their predecessors.
Decades ago, retirement was fairly predictable: Social Security and a pension provided much of your income, you moved to the Sun Belt, played tennis or golf, and you lived to age 70 or 75.
To varying degrees, this was the American retirement experience during the last few decades of the previous century. Those days are gone; retirees must now assume greater degrees of financial self-reliance.
There is no private-pension safety net today. At one time, when Social Security was paired with a pension from a lifelong employer, a retiree could potentially enjoy a middle-class lifestyle. In January, the average monthly Social Security benefit was $1,341. The highest possible monthly benefit for someone retiring at Social Security’s full retirement age in 2016 is $2,787.80, or $33,453.60 a year. So in many areas of this country, living only on Social Security does not afford you the same lifestyle you may have had when you were working. Elders who thought they could rely on Social Security to get by have learned a bitter truth, one we should note. We must supplement Social Security with other income streams or sources.1,2,3,4
We carry more debt than our parents and grandparents did. It is much easier to borrow money (and live on margin) than it was decades ago. Some people face the prospect of retiring with outstanding student loans, car loans, and business loans, in addition to home loans.3
Some of us are retiring unmarried. With the divorce rate being where it is, some baby boomers will retire alone. Perhaps they will share a residence with a sibling, child, or friends; that may give them something of an economic cushion in terms of meeting daily living costs. Then again, some married households were single-income households in the 1970s and 1980s, but retirees managed.3
We will probably live longer than our parents did. In 1985, the average life expectancy for a 65-year-old man in this country was 79; the average life expectancy for a 65-year-old woman was 84. Today, the average 65-year-old man is projected to live to 91, the average 65-year-old woman to 94. Our parents could depend on the combination of Social Security, pension income, and fixed-income vehicles for a 10-year or 15-year retirement. In contrast, many of us will have to try some growth investing to keep our money growing across a probable 20-year or 30-year retirement.4
We will likely have to insure ourselves if we retire before age 65. The national average retirement age (according to a SmartAsset study of Census Bureau data) is now 63. With private health insurance becoming the new normal, that means many of us will have to find some kind of private health coverage if we retire too young to be eligible for Medicare. Furthermore, the cost of many out-of-pocket medical expenses not covered by Medicare is certainly greater than it once was.5
We must rise to the financial challenge retirement presents. During the 1980s, more than 40% of U.S. private sector employees participated in a pension plan designed to bring them eventual retirement income. In the middle of that decade, Social Security accounted for 65% of U.S. retiree income. Right now, 19% of private firms offer traditional pension plan programs and Social Security represents but 27% of retiree income.4
Our retirement will differ from that of our parents. It will likely be longer and arguably feature a better quality of life. Every aspect of our later years may become more comfortable, more bearable for ourselves and our loved ones. Retirement planning is one of the most valuable tools to assist you in realizing that goal.
1 - faq.ssa.gov/link/portal/34011/34019/Article/3736/What-is-the-average-monthly-benefit-for-a-retired-worker [2/17/16]
2 - faq.ssa.gov/link/portal/34011/34019/Article/3735/What-is-the-maximum-Social-Security-retirement-benefit-payable [2/18/16]
3 - blog.nsbank.com/retirement-planning-3/ [12/14/15]
4 - marketwatch.com/story/how-retirement-has-changed-in-the-last-30-years-2016-02-16 [2/16/16]
5 - smartasset.com/retirement/average-retirement-age-in-every-state [10/28/15]