Retirement Income Visions

Your Social Security Retirement Asset – Part 2 of 3

Part 1 of this post last week made the point that Social Security, which has historically been taken for granted as a retirement income source, is also a retirement asset, specifically, an annuity. The post explained how Social Security, while not in strict compliance, comes pretty close to fulfilling most of the various attributes of an annuity.

If Social Security is, in fact, an annuity, then why isn't it included as such on personal financial statements? If you own a variable or fixed annuity that hasn't been annuitized, the life insurance company from whom you purchased your annuity periodically makes available to you a statement that includes the current value of your investment as of a specific date. The annuity and its value is routinely included as an asset in the nonretirement or retirement section of your personal financial statement, depending upon whether it's nonqualified or qualified. Nonqualified annuities are generally owned by individuals whereas qualified annuities are owned by retirement plans, including 401(k) plans, traditional IRA's, SEP-IRA's, Roth IRA's, etc.

Your Social Security Retirement Asset – Part 1 of 3

This is Part 1 of 3 of the final post in Retirement Income Visions™ series about Social Security. Since its inception on September 27, 2010, the series has focused on Social Security retirement income planning strategies. What most people don't realize is that Social Security is more than an income stream. It's an asset - perhaps your most important retirement asset.

Retirement Income Visions™ Celebrates 1-Year Anniversary!

It's hard to believe that a whole year has gone by since Retirement Income Visions™ initial blog post, but it has! This marks Retirement Income Visions™ 52^nd post since it debuted on August 16, 2009 as a weekly blog, with new posts published each Monday morning.

As stated in the initial post, Retirement Income Visions™ Makes Its Debut, the blog, and the associated importance of retirement income planning as a separate and distinct niche, was inspired and motivated by my clients' experience during the October, 2007 – March, 2009 stock market decline.

Retirement Income Planning – The End Game

If you're a subscriber to Retirement Income Visions™, you may have noticed that, although there have been nine posts prior to this one, none of them has stayed true to the theme of this blog, i.e., Innovative strategies for creating and optimizing retirement income. This post will be no exception. As the saying goes, there's a method to my madness. In order to understand and appreciate the strategies and apply them to your situation, it's important to understand the origin of retirement income planning, including the limitations of the retirement asset planning approach.

As explained in The Retirement Planning Paradigm Shift – Part 2, retirement planning is undergoing a paradigm shift. Instead of relying on retirement asset planning as a solution for both the accumulation and withdrawal phases of retirement, people are beginning to recognize, understand, and appreciate the need for, and value of, employing retirement income planning strategies during the withdrawal phase. No doubt about it, per Retirement Asset Planning – The Foundation, retirement asset planning is the way to go in the accumulation stage to build a solid foundation for a successful retirement plan. However, as discussed in The Retirement Planning Shift – Part 2, as a result of the uncertainty of traditional retirement asset planning as a solution for providing a predictable income stream to match one's financial needs in retirement, retirement income planning was born.

Safe Withdrawal Rate – A Nice Rule of Thumb

Last week's post, The Sequence of Returns – The Roulette Wheel of Retirement, showed how "luck of the rate-of-return draw" can have a dramatic affect on a retirement asset plan in determining whether you will outlive your investment portfolio. In two scenarios where the retirement age (65), portfolio beginning value ($500,000), average rate of return (7%), withdrawal rate (5%), and inflation factor applied to the withdrawal rate (3%) were identical, and the only variable was good vs. bad early years, there were quite different results. With the "Good Early Years" scenario, after 25 years, at age 90, distributions totaled $964,000, the portfolio earned $1.385 million, and the portfolio value was $921,000. Under the "Bad Early Years" scenario, the portfolio was depleted after 16 years at age 81 after taking distributions totaling $541,000 and the portfolio earning $41,000.

Many people would argue that 5% seems like a reasonable withdrawal rate, however, as we saw, under the "Bad Early Years" scenario, this proved to be too aggressive. The financial planning industry, after many years of debate, has settled on a rule of thumb of 4% as a "safe withdrawal rate." That is to say, you can withdraw 4% of the value of your portfolio in your first year of retirement and then increase your withdrawal amount by an inflation factor in subsequent years without depleting your portfolio during your lifetime. As an example, assuming a portfolio value of $500,000 at retirement and a 3% inflation factor, you could withdraw $20,000 ($500,000 x 4%) in Year 1, $20,600 ($20,000 x 1.03) in Year 2, $21,218 ($20,600 x 1.03) in Year 3, etc.

The Sequence of Returns – The Roulette Wheel of Retirement

So here you are, crossing the threshold from earning a living to going into retirement. You worked hard for many years. You built a sizeable, diversified investment portfolio. You hedged your bet by purchasing life insurance and long-term care insurance. Your will and other estate planning documents have been updated to reflect your current goals and financial situation. Everything's in place, or so you think.

Welcome to the roulette wheel of retirement, otherwise known as the "sequence of returns." If you haven't planned for this financial phenomenon, your retirement could be quite different than you envisioned. To illustrate this important concept, let's take a look at three hypothetical scenarios. In each one we'll use the following five assumptions:

Withdrawal Drag – The Silent Killer

As you approach retirement, are you aware of the silent killer lurking on the horizon? Let's call our silent killer "W.D." When you enter the retirement zone, W.D. will be right behind you, looking over your shoulder, waiting to spring into action. When you dare to take your first withdrawal from your portfolio, W.D. will pounce – only you won't know it. You will continue on, as if nothing happened, innocently taking your withdrawals each month. As each deposit hits your checking account, W.D. will extract a toll on your portfolio, one that will increase in size with each transaction. And guess what? You will never know what hit you. You see, W.D., or "Withdrawal Drag," is the ultimate portfolio silent killer.

Before we expose the secrets of "withdrawal drag," first some background. When you're saving for retirement, or you're in the "accumulation stage," as we retirement income planners like to refer to it, assuming that you take no withdrawals from your portfolio, you realize the beauty and grace of compounding rates of return. To appreciate compounding, let's start with simple interest.

Retirement Asset Planning – The Foundation

Last week, in Retirement Planning Risks, I discussed six risks associated with retirement planning in general. In order to understand and appreciate the value and importance of retirement income planning and its associated strategies, let's take a closer look at retirement asset planning.

As was presented in The Retirement Planning Paradigm Shift – Part 2, the focus of retirement asset planning is on the accumulation and "spending down" of one's assets. The accumulation phase is common to various financial planning areas, not just retirement, including house purchase planning and education planning, to name a couple. With most types of planning, you're typically designing a plan for the purpose of accumulating funds for either (1) a single expenditure at some specified, or target, date, in the future, e.g., a down payment on a house, or (2) a series of expenditures for a limited and specified series of target dates, e.g., a four-year college education.

Is Your Retirement Plan At Risk?

Before I write about the specific risks associated with retirement asset planning and the strategies that retirement income planners use to address, and, in many cases, mitigate, these risks, let's take a look at risks that are common to all retirement planning. While many of these are uncertain and/or uncontrollable, each of them needs to be addressed in a retirement plan.

The risks that will be discussed are as follows, with the first three common to all types of financial planning, and each one intended to be a brief introduction vs. a comprehensive discussion:

1. Inflation 
2. Investment
3. Income tax
4. Longevity
5. Health
6. Social Security benefits reduction
   

The Retirement Planning Paradigm Shift - Part 2

I hope that you've had a chance to read The Retirement Planning Paradigm Shift - Part 1. If not, please take the time to do so. This is a continuation, promoted at the end of Part 1 as "Return of the Blog." Have no fear. While it's definitely more technical than Part 1, it's not scary. Break out the popcorn and read on.

Similar to the scientific breakthroughs that Thomas Kuhn discussed in his 1962 landmark book, The Structure of Scientific Revolutions mentioned in Part 1, retirement planning is undergoing a paradigm shift. This is quite natural given the fact that financial planning as a profession is still in its infancy. Its origins trace back just 40 years when Loren Dunton, the father of financial planning who is credited with coining the term "certified financial planner," set up the Society for Financial Counseling Ethics with a meeting of 13 individuals at Chicago's O'Hare Airport in 1969.