Don't Outlive Your Retirement Nest Egg

Physician's Money Digest, January31 2004, Volume 11, Issue 2

Although much has beenwritten about building aretirement nest egg, it's justas important to plan carefullyfor how you're going to crack thatnest egg during retirement. Thanks totop-notch medical care and healthierlifestyles, Americans are living longertoday and spending more time in retirementthan previous generations, puttingpressure on their hard-earned savings.The goal in managing retirementincome is to minimize the risk of outlivingaccumulated assets. Depleting yourretirement assets early can have significant implications for you, your spouse,and your children.

Identify Spending Needs

Your spending needs during retirementwill be the primary driver behindyour financial plan. To ensure that youdon't outlive retirement assets, it's recommendedthat you set an annual withdrawalamount using the equivalent of3% to 4% of your portfolio value at thetime of your retirement. Adjust thisfixed dollar amount each year for inflation.Studies have shown that withdrawalrates above this percent introducea significant risk of exhaustingretirement assets. On a $1-million portfolio,this would mean $30,000 to$40,000 per year, adjusted for inflation.Need to withdraw more? If you do, youincrease your risk of depleting assets.

Biggest miscalculations:

Many retirees also rely on outdatedrules of thumb for retirement spending,which can increase the risk of outlivingyour assets. Don't use average longevity figures tocalculate how long retirement assetsmust last and how much you can withdraweach year. Although the averagelife expectancies of American men andwomen today are about 74 and 80years respectively, according to theNational Center for Health Statistics,the averages are just that—averages.

Understand the Averages

The averages mask the fact that asyou grow older, the likelihood thatyou'll live longer increases. Considerthe statistics of the Society of ActuariesRP-2000 Mortality Tables. For example,a man who lives to age 65 has a63% chance of living to age 80 and a20% chance of living to age 90. Awoman who reaches age 65 has a 32%chance of reaching age 90 and a 13%chance of living to age 95. If the 65-year-olds are married, there's a 45%chance that one of them will live to age90. If you rely on average longevity figureswhen setting your spending plan,you face a considerable risk of outlivingassets. It's important to consider howcomfortable you and your spouse arewith this risk and what strategiesyou've used to mitigate this risk.

Many retirement planners suggestthat if you live longer than expected,you can simply adjust your spending tomake sure your assets last. However,this approach requires that you havethe flexibility to reduce your spending ifyou live a long life or if your portfolioreturns are less than expected. So whenyou plan for retirement, go well beyondaverage longevity.

Consider an Annuity

A retirement vehicle that will minimizethe risk of outliving your assets isan income annuity. They're similar tolife insurance, in reverse. In return for alump-sum payment, you can receiveregular income payments for as long asyou live. By purchasing an income annuity,you're ensuring that you, or youand your spouse, have an incomestream for life. In fact, you may be ableto prudently spend more money in retirementby using an annuity becauseyou won't need to economize for livinglonger than expected.

Essentially, by not owning this insurance,you're making a bet that youwill not outlive your assets or that youwill have the ability and discipline tosubstantially reduce spending if needed.An income annuity negates this risk.

Assist Aging Parents

This sort of guaranteed incomestream can also help to ease the challengeof the financial relationship betweenadult children and their elderlyparents. As many baby boomer-physicianswho are now caring for theirelderly parents know, managing a parent'sfinances is sometimes challenging.

It can be difficult and uncomfortableto make recommendations to aparent so that they can manage theirspending and income needs. And if aninvestment doesn't perform as expected,an adult child may have to shoulderthe blame or take on the financial responsibilityof caring for their parent.Income annuities, with their constant,unending income stream, can simplifyfinancial planning by providing incomefor nondiscretionary expenses, such ashealth insurance, taxes, and rent.

Create Portfolio Variety

Income annuities come in two flavors:fixed and variable. Fixed-incomeannuities provide a fixed payment, typicallywith an option to increase thepayment annually to keep up with inflation.Variable income annuities providea variable payment based on the performanceof underlying investments thatyou choose. In addition, they offer optionsto provide income for life or a specificperiod and options to direct paymentsto a spouse or beneficiary afterthe annuitant's death. Many income annuityproviders have online calculatorsthat can provide you with a quote.When comparison shopping for thistype of insurance, it's important to evaluatethe rating of the insurer and selecta top-rated provider. You want to besure the insurance company is aroundas long as you are.

Buying an income annuity is not anall-or-nothing proposition. Annuitiesmay make sense as one piece of yourpost-retirement portfolio. A qualified fi-nancial planner can help you determinean appropriate portfolio mix and retirementwithdrawal strategy.

Robert D. Nestor is a principal ofthe Vanguard Group and head ofVanguard's Annuity and InsuranceServices Group. Prior to this role, hewas head of the Fund DevelopmentUnit in Vanguard's Portfolio ReviewGroup and a manager in Vanguard's FundAccounting Department, overseeing the internationalaccounting unit and security-lending program. Heis also a member of the Financial Analysts ofPhiladelphia and the Association for InvestmentManagement and Research. He welcomes questionsor comments at 800-291-3054.