(Bloomberg) — Even if your clients have socked plenty of money away in their 401(k) plan and invested it carefully, some of their toughest decisions lie ahead. And don’t expect much help or clarity from the government or your employer.
Strategies for drawing down lump-sum accounts in retirement — more important than ever in the 401(k) era — have received little attention from policy makers. For retirees, choices about how to spend a life’s worth of savings are fraught with tricky calculations about financial risk, taxes and death.
Jim and Sue Cleary, both 69, are living through that now.
They have two homes, one in Florida and a second in western Michigan that keeps them close to five of their nine grandchildren. And yet, as they shuttle back and forth to watch their 7-year-old grandson play soccer, Jim said he knows they won’t be able to maintain this lifestyle indefinitely.
The Clearys cut out cruises to Alaska and Australia and they’re spending down their retirement savings, aware that they may eventually have to sell one of their homes. Sue, a self-declared worrier who retired nine years ago from the utility industry, is confident in the T. Rowe Price Group Inc. plan they’ve been following that has 60 percent of their assets in stocks and mutual funds. Still, she recognizes that they are spending a bit more than they would prefer.
“That’s kind of the main concern I have: Are you going to outlive what you have?” said Jim, who retired eight years ago after a career in state environmental protection and private waste management.
It’s a worry echoing across a baby-boom generation that includes the first retirees leaning heavily on 401(k)-style defined-contribution plans. They’re learning on the fly to do what pension managers did for their parents.
That’s especially challenging because the standard formula for squirreling retirement savings into bonds or certificates of deposit doesn’t necessarily work in an era of increased longevity and depressed interest rates. American men who reach age 65 will live another 17.8 years on average, while women will live 20.3 years, according to the Centers for Disease Control and Prevention. The Clearys are more fortunate than millions of Americans who are reaching retirement without enough savings. The couple has a clear financial plan, two years of cash available, long-term care insurance and income from Social Security benefits and pensions. At the same time, they’re not wealthy enough to focus solely on estate planning.
Jim and Sue grew up on the same block in Bay City, Michigan, and reconnected through their mothers when they were in their 40s. They’re now steering their way through a challenge that requires morbid thoughts for people in their 60s and 70s.
Spend now to enjoy healthy years and risk running out of money? Or scrimp today for a tomorrow that may never come — or come only when they’re too infirm to savor it?
The drawdown phase is a piece of the U.S. retirement puzzle that’s attracted little notice until recently.
Younger workers get clear, simple advice: Save as much as you can for as long as you can. Create a diverse portfolio of investments and hold on for the ride.
That’s supposed to yield a pile of assets. When it’s time to make that pile smaller, retirees are often overwhelmed by the choices and tax consequences.
The government, which helps workers accumulate money in tax-deferred accounts, offers little guidance for when it should be spent. The main requirement — annual distributions from tax-advantaged accounts —` is designed to deplete the money, not to make it last.
The government “is increasingly focused on helping individuals manage those assets,” Mark Iwry, deputy assistant secretary for retirement and health policy at the Treasury Department, said in an e-mail. “There’s plenty more that we can do, and there’s a lot more that the private sector can do, and the best way is to do it together.”
The dilemma will become more pronounced over the next few decades as more workers retire without defined-benefit plans, instead operating in the do-it-yourself world of 401(k)-style defined-contribution plans.
“There’s sort of a money illusion when you have a big lump sum of money sitting in your 401(k) account,” said Jonathan Forman, a law professor at the University of Oklahoma who studies retirement policy. “You think you’re rich.” Purchasing Annuities
For a 65-year-old man, $100,000 buys an annuity that pays out $572 a month for life, according to Hueler Investment Services Inc. That’s often not what people see, however, and sometimes they don’t think about the income taxes they’ll owe when they take money out.
“We see situations where people at retirement look at this monster lump sum compared to, say, their annual income and they figure: There’s no way I can ever spend all this money,” said David John, a senior strategic policy adviser at AARP, the Washington-based advocacy group for older Americans. “I may as well do something that’s a luxury.”
The government has taken a few limited steps to ease the spending-down phase of retirement. Still, John said, the U.S. lacks a “clear direction” for this phase.
The required minimum distribution rules for retirement accounts, which make retirees take taxable payouts starting after age 70 1/2, are designed to force spending and can cause problems for people who live longer than the average.
The rule acts for some like an income stream, because it’s designed to mimic life expectancy. Without a policy to ensure that the tax break is recouped, the tax deferral would turn into an exemption and retirement accounts would become an estate planning technique for wealthy households.
Earlier this year, the Treasury Department created a partial waiver to the required minimum distribution rules for people who purchase longevity annuities — ones that don’t start paying out until age 80 or 85.
“For the first few years of retirement, many people feel that they can manage their assets,” Iwry said. “Protection against the risk of running out of assets in the out years is a kind of risk protection that people particularly appreciate.”
Other potential steps by the government remain incomplete.
The Labor Department has been looking at requiring 401(k) providers to show people how long their money will last, which many providers already do. The department said in 2013 that it would propose formal rules; it hasn’t done so yet.