Make Your Savings Last through Retirement

Saving enough by age 65 to ensure that you can maintain your standard of living through a long retirement has become increasingly difficult. You will probably be responsible for the majority of your retirement income, whether you obtain that income from 401(k) plans, individual retirement accounts (IRAs), or taxable investments. Before retiring, you'll want to ensure that you have sufficient savings to support yourself for 20, 30, or even 40 years, depending on your age when you retire.

Deciding how much you'll need to accumulate by retirement age is difficult, since so many of the variables that go into that calculation are uncertain. To come up with an estimate, you need to make assumptions about your life expectancy, how much income you'll need during retirement, how much you'll receive from other retirement sources, when you will retire, your long-term rate of return on investments, future inflation, and future income tax rates. If your estimates are inaccurate, you could end up with little in the way of income in the later years of your life.

Because of all the uncertainty, it is typically recommended that you only withdraw modest amounts from your retirement savings, especially in the early years of your retirement. A common rule of thumb is to withdraw no more than 4% annually from your retirement funds. So if you want to withdraw $75,000 annually from your retirement assets, you need to accumulate $1,875,000 by retirement age.

But that 4% figure is based on the value of your investments when you are ready to make the withdrawal and is not a static number based on your savings when you retire. During periods of market volatility, your asset balances can fluctuate substantially, causing significant changes in the recommended withdrawal amounts. Market fluctuations are especially dangerous during the early years of your retirement, when it can be difficult to make up for market declines while you are withdrawing money from those reduced balances. If you aren't able to overcome market declines, you could be forced to drastically change your retirement plans.

How can you ensure that your retirement savings will last a lifetime? Consider these points:

Annuitize a portion of your retirement assets. This will provide you with a definite monthly income for the rest of your life. Annuities can be purchased with or without inflation protection. Since an annuity provides income for the rest of your life, it protects you from outliving your savings and from the risk that lower-than-expected investment returns will reduce your portfolio. Typically, the benefits will end once you (and your spouse if you elect joint benefits) die, although some annuities will pay a lump sum or periodic benefit to beneficiaries. Thus, it is important to understand that if you (and your spouse if you elect joint benefits) die at a relatively young age, your benefits may not equal the purchase price of the annuity. While you probably do not want to use all of your retirement assets to purchase an annuity, you may want to use a significant portion to purchase an annuity that will cover your regular monthly expenses.
Withdraw conservative amounts from your retirement assets. If you limit your withdrawals to 3% or 4% of your balance, the assets should last for decades. At least annually, reassess your retirement assets and make sure that your withdrawals are reasonable based on your current balances. Market fluctuations can cause your asset allocation to get out of line, so you should rebalance at least annually. Even during retirement, you should allocate your assets among a variety of investment types, ensuring that your allocation is appropriate for your specific situation.
Reach retirement with minimal expenses. Cut back on your living expenses before retirement, and try to enter retirement with as few debts as possible. Mortgage and consumer debt payments consume a significant portion of most people's income. Pay off those debts by retirement, and you can significantly reduce your cost of living. This can have a two-fold impact on your retirement. First, it frees up money to set aside for retirement. Second, you get used to a lower standard of living, which should also reduce the cost of your retirement lifestyle.
Work as long as possible. While there is something very alluring about totally retiring from the work force, the reality is that a long retirement is very costly. Working a few more years can go a long way in helping fund your retirement. Those years are typically your highest earning years, so hopefully you'll save significant sums during that period. Also, every year you work is one year you don't have to support yourself with your retirement savings. Once you are ready to retire, try to work at least part-time during the early years of your retirement. That doesn't mean you have to stay at your current job. You can find a totally different job or start a business. Even modest earnings can help significantly with retirement expenses.

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Debt's Role in Your Financial Plan

As nice as it may seem, achieving debt-free status isn't always the best way to reach your financial goals. "Smart debt" may actually help you with your goals.

What is "smart debt"?

Smart debt is the kind that generates more advantages than disadvantages. Here's how to recognize it:

You already have the free cash flow or liquid assets to cover the required monthly payments. This means that you aren't counting on additional income from the asset you acquire to make the payments. While some people might find this advice too conservative, it's important to remember that the income an asset is supposed to generate can be speculative. If it's rental income, you might not find tenants or you might lose the ones already in place. If it's short-term proceeds from flipping a property, the market may not support the higher price you're hoping for. And if it's a new business, the customers might not be there in the numbers you need.
The payments don't prevent you from addressing important financial objectives. Debt that reduces the amount you can save for a child's education or your retirement may not be smart debt.
It's to cover the big-ticket items you need to earn a living. For most people, this means a reliable car. For the self-employed, it can also mean capital equipment, like computers and furniture, or an addition to your house for your business.
It's tax deductible. This generally applies only to mortgage interest, but not all of it all the time. The IRS doesn't let you take a deduction for mortgage debt beyond $1 million on a first or second home, and that's reduced to $500,000 if you're married but filing separately. It also disallows taking a deduction for interest on home equity loans totaling more than $100,000.
It preserves or improves the value of your home. Financing major repairs, remodeling, or making your home more efficient with debt can be a smart move, as long as it doesn't violate the principles suggested above.
It doesn't push your debt-to-income ratios too high. Financial experts and banks recommend keeping your total monthly debt payments (including rent or mortgage) at or below 40% of your monthly take-home income, and the payments that don't keep a roof over your head to a maximum of 20% of your monthly take-home pay. Go beyond these limits, and you may find it hard to be approved for a loan when you need it.
It doesn't reduce your credit rating. This comes into play chiefly as a result of credit card borrowing. Your credit rating suffers when your credit card balances come close to your limit. Consumer credit experts say you should aim to keep your balances at less than 35% of your credit limit to keep your FICO scores from being reduced.

Strategies to reduce debt

If your debt is out of hand, here are some steps you can take to make it more manageable:

Refinance your mortgage. If you haven't missed any payments and you have equity in your home (it's worth at least what you owe), you may be able to reduce your mortgage payments by refinancing. Even if you have to finance closing costs, mortgage rates might be so much lower than your current rate that you still come out ahead. You might even be able to cash out some untapped equity in your home and pay off some unsecured debt - replacing high-interest, non-deductible debt with low-interest, tax-deductible debt.
Reduce your spending on non-essential items. Cut as much out of your monthly budget as possible, like restaurant meals, entertainment, subscriptions, premium TV packages, and expensive mobile phone data plans. Trade a luxury car you're still making payments on for a less-expensive one.
Keep a record of every penny you spend. Incidentals you pay for with cash can add up without you being aware of just how much you're spending. Keeping a diary could help you find more ways to reduce that unnecessary spending.
Cut up your credit cards. This makes it nearly impossible to take on any more credit card debt.
Pay down high-interest debt first. Keep making the minimum payments on all of your debts, but find a way to make the biggest payment possible on your highest-interest card or loan first.
For federal student debt, apply for income-based payment relief. Since 2009, the federal Department of Education has been offering to make substantial reductions in required monthly payments on federal student loans based on your income. You may be eligible for the Income-Based Repayment plan if your required payments exceed 10% of your take-home pay, or if you hold a public service job.
Negotiate with your lenders. Call them to request a reduction in your interest rate, a waiver of late fees, or an affordable payment plan.

If your plan hasn't been updated lately to reflect current debt balances or you're not sure whether you're making the best use of borrowed funds to reach your goals, it's time for a thorough review.

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How Should You Evaluate Your Investment Results?

Marked by two recessions, the last decade was one of the weakest for stock returns in a generation, with steep losses in three years and average annual returns in the major indexes of less than 3% - six points below their long-term rates of return. On the other hand, if you look only at the last two calendar years, at certain indexes, stocks, and gold, things look good. If you were in the right investments, you may well have outperformed the Dow Jones Industrials and the S&P 500.

All of this suggests at least four different ways of evaluating how well your portfolio has performed. These include:

Focusing on only your short-term results.
Looking at each of your positions in isolation from the others.
Concentrating on how your results make you "feel."
Comparing your returns to some index as a benchmark.

What's wrong with these? That's a question best answered by looking at the right way to assess your performance. The best way to tell how your investments are doing is a combination of two perspectives:

Concentrate on the performance of all of your positions as one investment program, and
Compare the value of your portfolio to how much your financial plan says you should have now.

Check your progress toward your goals

A properly constructed financial plan defines how much money you need to have on hand when it's time to begin paying for a goal - whether it's paying for your child's college education, buying a first or second home, or retiring. In addition, the plan should include tables that define, year by year going forward, exact target amounts for the value of your portfolio.

The reason for doing this is that your future doesn't depend on how well any single stock you own performs or whether your portfolio is doing better or worse than any particular stock index. Invariably, if your portfolio is properly constructed - which means it's properly diversified - it's always going to be underperforming some stock or index somewhere.

If you're the kind of person who just has to try to beat an index or enjoys bragging about some hot stock you saddled onto, do this: make sure that given how much you can save and how much money you have tucked away, you're on target for accumulating more than you need to meet your goals, then take some of the excess and play with it.

On the other hand, if your portfolio is currently behind your targets to meet your goals, you have some re-engineering to consider. You may need to adjust your investment strategy to achieve potentially higher long-term returns, save more, postpone the date of your goal, or lower your expectations for the future.

It's this kind of perspective that is the most useful for assessing your investment results. And that means that you should have a solid financial plan in place before you start investing.

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Inheriting Stocks

Typically, individuals who inherit stocks receive stocks that have increased in value over time. But what do you do if you inherit a stock that has decreased in value since the original owner purchased it?

First, let's review the basics of inheriting stocks. Inherited assets receive a step-up in basis to market value at the date of the original owner's death. Any gains from the sale of inherited stocks are subject to the long-term capital gains tax rate no matter how long you personally owned the stock. Thus, selling stock soon after you inherit it won't typically result in large capital gains taxes. However, what happens if the stock has declined in value?

Your basis in the stock still retains its market value on the date of the original owner's death, so you get no tax benefit from the loss in value. Your choices are to sell the stock at its current price with no tax deduction for the loss or wait until the stock rebounds, paying
capital gains taxes on the difference between your basis and your sales price. For example, assume you inherit stock purchased by your mother for $40,000 that has a current market value of $10,000 when she dies. Your basis in the stock is $10,000. If you sell the stock immediately for $10,000, you have no gain, but you also don't receive a deduction for the $30,000 loss in value. If you wait until the stock recovers and sell it for $40,000, you will pay capital gains taxes on $30,000.

To determine whether you should hold or sell an inherited stock, determine whether is it an appropriate investment for your financial goals. Would you purchase the stock yourself at current prices? If you wouldn't, consider selling it. Don't hold inherited stocks for sentimental reasons. You're not questioning the investment capabilities of the person you received the stock from when you sell.

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Market Timing vs. Buy and Hold

Market timing involves making financial market buy and sell decisions based on your prediction of the future performance of the market. A buy-and-hold investment strategy, in contrast, involves buying in to the market on a regular basis and holding your investments over time.

The fact is that the market is an incredibly complex system. Investment returns depend on a wide range of factors - from who the company's chief executive officer is to inflation in China. Economists suggest that stock prices exhibit what they call random walk behavior, meaning that future performance cannot be predicted based on past performance.

Market timers retort that they have built complex models that analyze all factors affecting a stock's price. Sometimes, these models do accurately predict the movement of a stock price. But too often, unforeseen factors can send a stock's price quickly up or down.

Also, market timing is a more time-intensive strategy. You need to monitor your investment closely to stay on top of all the factors that can affect it.

For the average investor, a buy-and-hold strategy is much more practical. While buy-and-hold investors will suffer in market downturns, by staying invested in the market, your investments will recover when the market recovers. While there is no guarantee that will happen, historically, the general direction of the market has been upward.

The benefits of a buy-and-hold strategy over a market timing strategy include:

It doesn't require constant monitoring of the market or the news.
It's less complex. You'll typically make far fewer trades with a buy-and-hold strategy.
There are fewer tax consequences. Since you have fewer trades, you'll have fewer taxable transactions.

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Copyright © 2012 Integrated Concepts. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

FR2011-1017-0154