Between defined contribution plans, new and improved options for medical and long-term care insurance and the myriad options for Social Security collection, there are plenty of ways for pre-retirees to ensure ample, stable incomes in retirement. However, the complexities of these options, along with the decline of pensions and other defined benefits plans, are requiring far more planning and forethought from clients and their advisers.
Ultimately, misinformed decisions regarding defined contribution collection, investments and insurance are leading many retirees to spend too much and collect too little over the courses of their 20-plus year retirements. Fortunately, a little extra due diligence and help from experienced advisers can help them to preserve their living standards as they end their careers.
Defined Contributions and the Sequence of Returns
The 401(k) and IRA are the most common defined contribution plans among today’s retirees, and while most clients understand the need to contribute throughout their careers, many fail to realize that their principles may not convert to a given yearly income as reliably as they expect. “Your statement shows the value of your investments, but what it doesn’t do is translate that investment into income,” said John Bucsek, Managing Director at MetLife Solutions Group. “You need to keep clients focused on the income figure. Don’t look at a million dollars, for instance; look at that as $40,000 per year.”
One factor that can make or break a client’s long-term defined contribution income is the sequence of returns. “If you don’t re-balance risks, you can’t take the same income out, and you’ll have to reduce your withdrawal rate,” Buscek said. “Otherwise you’ll be taking a higher percentage out and face a greater likelihood of self-liquidation.” As we saw during the last financial crisis, a failure to respond to market fluctuations can leave retirees high and dry if they enter retirement on a downturn, especially considering today’s long and ever-increasing lifespans.
While those fluctuations may have lead some seniors to avoid high-yield investments, too great a focus on fixed income investments could actually be more risky than a diverse portfolio, particularly in our current low-interest environment. “If you sell all the stocks in your portfolio and just hold low-interest bonds, it’s kind of a recipe for disaster, especially if you end up living 30 or 35 years,” said Steve Elwell, vice president of Schroder, Braxton and Vogt, Inc.