Longevity Risk and Retirement Income

How long might you live in retirement? Think carefully. Your answer could influence whether you have enough money to enjoy a comfortable retirement and leave a desired financial legacy.

According to pension mortality tables, at least one member of a 65-year-old couple has a 72% chance of living to age 85 and a 45% chance of living to age 90.This suggests that many of us will need to plan carefully to ensure that we don’t outlast our assets.

Live Long and Prosper

The first step in tackling longevity risk is to figure out how much you can realistically afford to withdraw each year from your personal savings and investments – something a Madison professional will be happy to assist you with.

One strategy is to withdraw a conservative 4% to 5% of your principal each year. However, your annual withdrawal amount will depend on a number of factors, including the overall amount of your retirement pot, your estimated length of retirement, annual market conditions and inflation rate, and your financial goals. For example, do you wish to spend down all of your assets or pass along part of your wealth to family or a charity?

Protecting Your Retirement Paycheck

No matter what your goals, there are ways to potentially make the most out of your nest egg. The remainder of this “Insight” examines how a strategy might play out with assets held in taxable accounts.

First, you’ll likely need ready access to a cash reserve to help pay for daily expenditures. A common rule of thumb is to keep at least 6 – 12 months of living expenses in readily available funds, though your needs may vary. Then, consider refilling your cash reserve bucket on an annual basis by selectively liquidating different longer-term investments, timing gains and losses to offset one another whenever possible.  This strategy, often referred to as the “Bucket Approach” to withdrawing retirement funds, provides steady cash flow in good and bad times and helps prevent having to sell long-term assets (equities) at an inopportune time.   This method can also offer peace of mind to retirees worried about short-term volatility in the stock market.  Again, we encourage you to lean on your Madison team to help guide you through this process.

Developing a Diverse Income Strategy

Responding to the current interest rate environment is one way to potentially squeeze more income from your savings and stretch out the money you’ve accumulated for retirement. For example, if rates are trending upward, you might consider keeping more money in short-term fixed income instruments. The opposite strategy may be employed when rates appear to be declining.

Most retirees need their investments to generate income. Bonds may help fill this need. “Laddering” of bonds can potentially create a steady income stream while helping reduce long-term interest exposure (see illustration on the reverse.

“Laddering” bonds is a popular strategy used by income investors. This strategy involves buying an assortment of bonds of different maturities and staggering the maturities over time. In the above example, an investor initially buys bonds with maturities of one, two, and three years. As each bond matures, it is reinvested in another three-year bond to retain the staggered bond ladder. Total yield (income) is potentially higher than if continually reinvested in one-year maturities. Risk is also potentially reduced due to investing in a mix of maturity rates.

Another way to help temper investment risk is to spread it out by diversifying among different types of securities. A retiree seeking income can use the same strategy by adding dividend-paying equities to his or her portfolio.

These stocks potentially offer the opportunity for supplemental income by paying part of their earnings to shareholders on a regular basis.  Another potential attraction?  Qualified stock dividends are currently taxed at a maximum rate of 20%, rather than ordinary federal income tax rates, which currently run as high as 39.6%.

Accounting for Growth

Finally, be cautious about being overly conservative with your investments. Many people may live 30 or more years in retirement. Therefore, your portfolio may need a boost of stocks to outpace inflation over the years. These are just a few ideas for developing an adequate income plan during retirement.  Please discuss your individual situation with your Madison professional to receive tailored advice to meet your unique retirement goals and objectives.

Important Note: The content of this Insight is attributed to the Financial Planning Association and edited by Madison for our readers’ use. This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Madison Wealth Management does not provide tax, legal or accounting advice. Actual economic or market events may turn out differently than as presented above.