Take a Fresh Look at Retirement Planning

Physician's Money Digest, June30 2003, Volume 10, Issue 12

In baseball, when the home team ralliesfrom a 5-run deficit to tie the score inthe eighth inning, it's not surprising tohear the announcer say, "It's a wholenew ball game." For fans of the hometeam, that sparks excitement and enthusiasm.Of course, for fans of the teamthat just blew the 5-run lead, the air hasjust come out of their balloon and theyscramble in an attempt to regain themomentum they had only moments ago.

For many physicians planning theirretirement, as well as some alreadyretired, the past 3 years have left them justas deflated as that airless balloon. Somehave seen their retirement assets decreaseby 40% or more. For them, it is a wholenew ball game—one that they'd rathernot have to play. And just like that baseballteam, what seemed like a winning situationfor many physician-investors hasrapidly turned into a potential loss.

"Physicians are afraid right now,"admits Kristina Sommerkamp, CFP®, ofSommerkamp Insurance and FinancialServices. "They're afraid to be in themarket. And when you get that conservative,it can significantly delay the pointat which you'll be able to retire."Retirement planning in a prolongedbear market has its share of challenges.But there are ways to rally and still pullout a win in the last inning.

1. Market Impact

When financial advisors talk aboutretirement planning today, theyacknowledge that the psychology ofsuch planning has changed dramatically.It wasn't long ago—when the marketwas returning 20% a year or more—thattalk of retiring as early as age 50 washeard often. Many doctors were movingup their retirement dates, or at leastfeeling very comfortable about theiroriginal plans for retirement. Today,however, many doctors are no longerconsidering early retirement, insteadthey're wondering how many additionalyears they may have to work.

According to a recent survey by theEmployee Benefit Research Institute,about 25% of workers age 45 and olderare postponing their planned retirementdate in order to increase theirfinancial security. This is compoundedby the continued lack of investor confidence in the integrity of financialreporting by public companies.

"Today's market and economy havehad a very significant impact on whatpeople need to save for retirement,"says Mark Papalia, CLU, ChFC, CFP®,founder and president of PapaliaFinancial Services (www.papaliafinancial.com). "Because of the return factor,some people are realizing theymight have to save as much as 50% oftheir income in order to reach theirgoal. Others are looking at laterretirement dates, or lowering theirspending habits in retirement, or acombination of each."

David Connell, senior vice presidentof Northern Trust Bank's Arizona WestValley Region, believes that individualshave gone from being way too positiveto being far too negative about the market.He suggests that it's time to look atthe market's historical norms, and pointsto data going back to 1925 showing thatS&P 500-type equity investments willprovide a compounded growth rate ofbetween 10.5% and 11%.

"If you go back to the market of theearly 1990s and apply an 11% compoundedreturn, you'll end up aboutwhere we are today," Connell says."Things do revert to the mean. We justneed to be realistic in our expectations."

That approach may not replace thesavings a down market has eaten away,but it is the approach many preretireesare taking. Karen Cunningham, a partnerwith the Oklahoma Financial Center,says that the statement she hears mostfrom her clients—and physicians representapproximately 80% of her clientbase—is that they cannot afford to loseany more money. Capital preservation,as opposed to seeking a 15% annualreturn, has become the new game plan.

"My clients have become much moreconservative," Cunningham explains."They are completely reevaluating notonly their investment portfolio allocationbut also how much they're havingto save toward retirement. The challengeis that in the past, that capitalbucket was not in a declining mode.Today, we're looking at projectedreturns of possibly 5% or 6%."

2. Investment Vehicles

The concern today among many thatare planning for their retirement isthat they will outlive the savings they'veaccumulated. That concern, combinedwith a desire to not see their nest eggdwindle any further, is enabling an oldidea to gain new ground. That idea is anannuity, which serves as a do-it-yourselfpension, guaranteeing a steady flow ofincome that retirees cannot outlive.

"Fixed annuities with a guarantee ofprincipal have definitely become a verygood investment for the conservativeinvestor," Papalia says. "They offer guaranteedminimum rates which are higherthan current CD rates. For someone seekingzero risk for their money, it's definitely a good alternative. If you're lookingto grow your assets toward retirementand need to save more than yourqualified retirement plan will allow, avariable annuity is a good option."

Kiplinger's Retirement Planning

Recent findings by the TIAA-CREFInstitute indicate that a retirement portfoliodivided between an annuity and amanaged portfolio could provide morecertain and larger payouts than a fullymanaged portfolio. An example inassumesa couple retires with $1 million. If theylimit initial annual withdrawals to nomore than 5% of assets, which is the recommendedfigure, they would withdraw$50,000 the first year of retirement.However, if they used half of the $1 millionto purchase an annuity that paysthem $3200 a month, or $38,400 a year,they could still invest the remaining$500,000. Withdrawing the same 5%would give them $25,000 on top of the$38,400 annuity payment, or a total of$63,400 a year—26% more than if theyrelied on straight withdrawals from their$1-million nest egg.

"Annuities have really made strides inrecent years," says Janet Fox, a financialconsultant and president of the ACHInvestment Group. "Some annuitiesoffer a rider whereby if you do not makewithdrawals during a 10-year timeframe, you can either double yourmoney or take the regular value of theannuity, whichever is higher."

Another consideration, Fox says, isgovernment bond funds. "I'm wellaware of the bond bubble, and it's oneof the things I caution investors on. Butthere are some bond funds with an averagematurity of 1.2 to 1.5 years, which isa fairly short return, so there isn't asmuch chance for volatility."

Index funds are another consideration.Although the indexes have sufferedin recent years along with the market asa whole, indexers historically have beattwo thirds of other investors. They mayonly strive to be average, but if a conservative,preservation approach is theinvestment approach you seek, youmight want to consider index funds.

Of course, one of the basic strategiesis asset allocation. Proper asset allocationand a more conservative allocation,Papalia says, will definitely protectagainst economic fluctuations. "Lastyear, a conservatively balanced account,which has maybe 30% to 35% in thestock market, returned 2% to 3%, comparedto a market that was down 20%.Correct asset allocation enables investorsto better maintain principal."

3. Is It Enough?

Determining how much moneyyou will need to fund your retirementis not an easy proposition. Everydoctor's situation is different. And thevariables, from when you plan toretire to how long you might live, plusfactors like living expenses and inflation,make a definitive answer diffi-cult. Still, careful evaluation is important.Studies indicate that half thepeople who take the time to do thecalculations realize that they need tosave more if they plan on achievingtheir retirement goals.

One of the long-time rules ofthumb is that you will need 70% to80% of your present income to maintainyour same lifestyle in retirement.The philosophy here is that someexpenses, such as taxes, mortgagepayments, and the amount you'reputting away toward retirement willdecrease. Others, such as health care,will increase. But will 80% beenough? Will it be too much?

"A key question to ask yourself iswhat are you going to do in retirement?"Sommerkamp suggests. "Ifyou're going to sit on the porch andread books, you'll need less moneythan someone who wants to travel.You may, in fact, need 120%." Theproblem, she adds, is that people saythey know what they want to do, butnever sample that lifestyle until theyretire. "I had a client who said he wasgoing to retire and sail the ocean.When it got time to retire, he woundup getting seasick."

Where you plan to live is also animportant consideration. For example,there's no state income tax inFlorida, and the cost of living is higherin Chicago than it is in many smallercities. The geographic factor can playan important role in how much retirementincome you have to work with.

Another key factor is at what ageyou plan to retire. As doctors, youare well aware that new medicalprocedures and medications areenabling people to live longer. Thelonger you live and the earlier youretire, the more money you will needto fund your retirement. In today'seconomy, that might mean retiringat age 55 is no longer a consideration.But according to Cunningham,many of her physician-clients actuallychoose to work longer.

"I have physician-clients in their70s who still work a 60-hour week,"she explains. "Many of them are inrural communities where they'velived and worked for 40 years.They're not working because theyhave to financially, but because theystill live by their Hippocratic oath."

4. Making it Last

One of the greatest challenges inretirement planning is ensuringthat you don't outlive your savings.There are many variables that impactyour ability to make your savings last.The key factor, according to experts at T.Rowe Price, is to focus on what you cancontrol, and manage what you can't. Inother words, investment returns and lifeexpectancy are out of your control. Butyou can control your spending rate.

Online financial planning tools, suchas the T. Rowe Price Retirement IncomeCalculator (www3.troweprice.com/ric/RIC), use simulation analysis to help providea more realistic reflection of whatthe future may hold and how your withdrawalrate will impact your savings. Forexample, an investor retiring in 1972with a $250,000 investment balance, anexpected 30-year retirement period, anda balanced portfolio, would see theirnest egg last only 16 years if an 8%withdrawal rate were used. But, if therate were reduced to 6%, the portfoliowould last the entire 30-year period.

It is also suggested that you makewithdrawals from taxable accounts first.That way your tax-deferred accountscan grow tax-deferred for as long aspossible. In addition, your tax-deferredaccounts will be taxed at ordinaryincome tax rates, so the longer you waitto tap into these accounts, the loweryour income (and tax rate) is likely to be.

Beyond withdrawal rates, one way topreserve savings is with long-term careinsurance. The majority of our health carespending occurs during the final years ofour lives. If those years are spent in anursing or assisted living facility, even asizeable nest egg could be wiped out.

"We talk more and more with ourclients about long-term care, bringing itup when they're 45 years old,"Sommerkamp explains. "And whereaffordable, I recommend limited payplans for long-term care. It means youcan pay up the policy in 10 years, or bythe time you're age 65." The reason, shesays, is basic: It guards against premiumsincreasing when you're older and haveless income to pay for the coverage.

Papalia echoes those thoughts, pointingout that the cost of long-term careinsurance is more affordable when you'reyounger. Often, he says, people don't considerlong-term care insurance until age70, and by then the premiums can beexpensive. He also suggests purchasing apolicy containing an inflation rider.

"Today the cost of care could be $5000a month, but in a few years it could be ashigh as $10,000 a month," Papalia says."The inflation rider guards against thosecost increases." Above all, Papalia suggests,reevaluate your retirement planannually. Markets change, as does life.Reevaluating your retirement plan on aregular basis will help keep you ahead ofthe curve.