Saving enough money to support yourself in retirement isn’t the only retirement challenge you will face. Retirement savers must also manage their investments throughout an unknown number of retirement years. A recent Government Accountability Office report identified strategies to ensure that you will have income throughout retirement. Here is how to prevent outliving your nest egg.
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Systematically draw down your savings. Plan to draw down your retirement savings at an annual rate, such as 4 percent of the initial balance each year, with adjustments for inflation. Using this strategy, an individual with $100,000 saved for retirement could safely spend $4,000 the first year and then increase withdrawals by 3 percent each year, resulting in a $4,502 withdrawal in year 5 of retirement and a $7,014 distribution in year 20.
Annual withdrawals of 3 to 6 percent of the value of your investments in the first year of retirement, with adjustments for inflation in subsequent years, will help ensure that you don’t deplete your savings too quickly, GAO found. The Congressional Research Service estimates that a draw down rate of 4 percent on an investment portfolio with 35 percent in U.S. stocks and 65 percent in corporate bonds would be 89 percent likely to last 35 years or more. However, if you withdraw 6 percent annually, the probably that your money will last 35 years drops to 39 percent. And the historical rates of return used in the analysis are not a guarantee of future investment performance. Also, it’s important to keep an emergency stash of immediately available cash so that unexpected events such as high medical costs don’t disrupt your draw down strategy.
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Convert a portion of your savings into an income annuity. An alternative to managing investments and taking periodic distributions from your savings is to use a portion of your nest egg to purchase an immediate annuity from an insurance company, which guarantees income for life. An immediate annuity can protect you from the risks of underperforming investments, outliving your assets, and some annuities also offer inflation protection. However, annuities can be expensive and often come with high fees. The money you use to purchase an annuity will also generally not be available to cover large unplanned expenses or to pass on to children. There’s also the possibility that the insurance company could default on its obligation to make annuity payments.
GAO recommends that a middle class household without a traditional pension that has $191,000 saved for retirement consider using a portion or even as much as half of its financial assets to purchase an inflation-adjusted annuity. At current annuity rates, a $95,500 annuity would provide $355 per month ($4,262 in the first year) until the death of the last surviving spouse, and include annual increases tied to the Consumer Price Index. This immediate annuity provides slightly more money than the annual income provided by a 4 percent draw down strategy, according to GAO calculations.
Avoid lump sum pension payouts. Some employees with traditional pensions get a choice between taking a lump sum or a lifetime retirement income stream. Opting for the monthly payments for life is likely to provide more money over your lifetime than using the lump sum to purchase an annuity from an insurance company outside the plan, GAO found. A traditional pension also significantly reduces your exposure to investment risks and the possibility of outliving your savings. However, most private sector pensions do not provide inflation protection. For example, an income of $1,000 per month in 1980 would have purchasing power closer to $385 a month 30 years later in 2009, GAO found. Retirees with traditional pensions should take care to select investments with some inflation protection outside their retirement plan.
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Delay claiming Social Security benefits. The age you first sign up for Social Security is one of the most important retirement decisions you will make. To get the full amount you are entitled to you will have to wait until your full retirement age, which is typically age 66 or 67 depending on your year of birth. If you sign up earlier your benefits will be reduced. Retirees born in 1943 who claimed Social Security benefits when they turned 62 passed up increases of at least 33 percent in their monthly inflation-adjusted Social Security benefit levels that would have been available to them if they waited until their full retirement age of 66, GAO found. The benefits you are entitled to continue to increase for each month you delay claiming up until age 70.
Delaying Social Security benefits allows individuals to boost their retirement income at a lower cost than purchasing an immediate annuity, GAO found. The money you would forego by waiting until age 66 to claim is less than the amount necessary to purchase an annuity contract that would provide an amount equal to the larger Social Security payments gained by waiting to claim. Social Security payments also provide valuable inflation protection and generally increase each year to keep up with rising costs.
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