Retirement tips for post-career savers

Pension decisions

A defined benefit (traditional pension) plan is becoming a rare benefit for employees. Many companies are freezing their existing defined benefit plans and moving to defined contribution plans to reduce the costs associated with funding a retirement benefit for current employees.

With a defined benefit plan, your pension benefits are typically based on both your age and years of service. Age is important because the younger you are when you start receiving pension benefits, the longer the time period you're expected to receive those benefits.

Pensioners often have to make an upfront decision at retirement on whether to take a single life annuity, a joint life annuity, a life annuity with a period certain benefit, or a lump-sum payment. These choices may be restricted by applicable law or the terms of the pension plan.

It's an important decision, especially because of the potential financial impact of this decision on the pensioner's spouse or partner. Different life expectancies for men and women, improved health care, and more active lifestyles make longevity risk an important consideration in choosing the payment stream paid by the pension. Comparing your annuity options within the plan versus the cost of an annuity outside of the plan may reveal that the plan's annuity option is the better deal.

It may be tempting to take the lump sum and invest it on your own, knowing that you can always use part of the money to purchase an annuity. It may also be tempting to spend some of the lump sum on a new bass boat! By this stage of life you should know yourself well enough to decide whether you can manage your finances and investing the lump sum might make sense.

Nest egg

Retirement planning is often referred to as a three-legged stool, where one's financial stability in retirement was based on the stool's three legs: pensions, government benefits and personal savings.

Post career your investment portfolio moves from accumulation to distribution mode. Along with managing how the portfolio is invested, managing distributions out of the portfolio can stretch out the life of the portfolio.

Big risk:

Inflation can erode your purchasing power, so make sure some of your retirement income is indexed to inflation.

How you choose to invest your retirement portfolio should be influenced by the other income payments you receive. Social Security income, for example, is indexed to inflation, but your pension income may or may not be pegged to it. Since the erosion of purchasing power due to inflation is a big risk in retirement, you want to have some of your retirement income indexed to inflation.

Your retirement savings may be in a potpourri of different accounts, from traditional and Roth IRAs, to 401(k), 403(b), tax-deferred annuities and taxable accounts. Your investment options, especially in 401(k) and 403(b) accounts, may be very limited. Rolling 401(k) and 403(b) monies into an IRA rollover account can expand that list of investment options.

Required minimum distributions (RMDs) dictate how money must be distributed out of retirement accounts. The starting date for these distributions varies, depending on whether the account is an IRA, 403(b) or 401(k) account.

Whether it makes sense to tap taxable accounts before tax-advantaged accounts is debatable. Tax-advantaged accounts come in two flavors, tax-deferred and tax-free. With tax-deferred accounts, you'll owe ordinary income taxes on the distributions.

The topic is complex enough that a simple rule of thumb won't do. Talk to your tax professional.

Annuities

Immediate annuities involve the conversion of a lump sum into an income stream over the life of the annuitant or, in the case of a joint life annuity, over the lifetimes of both parties. Options vary by provider but may include inflation-adjusted cash flows or a guaranteed minimum payment stream. You can get a quick, no obligation quote on www.immediateannuities.com.

Deferred annuities have an accumulation, or savings, period followed by the annuity period. Contributions can be made as a single payment or over a period of time. Deferred annuities can be either fixed or variable or a combination of the two types. Variable annuities invest in mutual fund-like portfolios called sub-accounts. A fixed deferred annuity provides a guaranteed income stream, and may be purchased with such options as inflation protection, but the payments don't start until a later date.

Consumers purchasing deferred variable annuities pay an annual mortality and expense charge (M&E) for the insurance component of the annuity along with portfolio management fees on the sub-accounts. M&E charges have historically averaged between 1 and 1.5 percent per year. Add portfolio management fees on top of that and you've created quite a drag on portfolio returns. There are some low-cost providers making an impact in this market -- Vanguard, Fidelity and TIAA-CREF, among others -- that offer low M&E and management expense ratios.

It's typical for annuities to have surrender charges of 7 percent to 9 percent that phase out after a holding period of five to seven years or longer. Change your mind about owning an annuity, and you'll take a financial hit to get out of that purchase. Buying an annuity is a big commitment. Get professional advice from a fee-based financial planner and get a second opinion if you can't get comfortable with the purchase.

Social Security

Deciding when to start taking Social Security payments depends on a host of factors. If you're still working and haven't reached full retirement age, then you need to be aware of how payments are reduced by $1 for every $2 you earn over the annual earnings limit. The Social Security publication, "You can work and get Social Security at the same time" explains this in greater detail.

Did you know?

Your Social Security payments may be cut significantly if your earnings exceed a certain amount. If you plan to work in your 60s, consider putting off collecting it until full retirement age or later.

If you're concerned about longevity risk, then there's an argument for waiting until full retirement age, or even until age 70 to start receiving Social Security benefits. You'll increase the size of your monthly payment and payments in future years will be inflation adjusted based on this larger amount.

Financing the income needed while you're waiting to draw Social Security benefits can come from the purchase of an immediate annuity with an inflation-adjustment option. Or you could tap your retirement savings. The Web site AnalyzeNow! has in its free programs tab a link to an Excel worksheet that can help you decide between taking Social Security at age 62, 66 or 70.

Every year the Social Security Administration sends workers over the age of 25 a statement providing them with a history of their reported Social Security earnings. Verifying the information in the statement is important because benefits are calculated based on that information. It's also useful to help with retirement planning when used in conjunction with the benefit calculators on the Social Security Administration's Web site.

Reverse mortgage

For many retirees, the possibility of borrowing against their home's equity without making monthly payments on the loan is a great backstop against income shortfalls. It is reason enough to make paying off the mortgage a pre-retirement goal.

There are shortcomings, including higher closing costs than a traditional mortgage, and the requirement that the mortgage balance be paid after both borrowers pass away or move out of the home. As more retirees tap their home's equity in this manner, the closing costs should become more competitive. One common misconception is that the homeowner gives up any remaining equity in the home when taking out a reverse mortgage. That's not true. Any equity that remains after the reverse mortgage is paid off belongs to the homeowner (or heirs, as the case may be).

Besides the no-monthly-payment aspect of a reverse mortgage, the flexibility associated with how homeowners can tap their home's equity in retirement is also an attractive feature. The homeowner can take out a lump sum, receive a monthly payment, or hold money in reserve with a line of credit. (The line of credit option may require an initial draw on the account at closing.)

The FTC's publication, "Reverse Mortgages: Get the Facts Before Cashing In On Your Home's Equity," provides the key features of reverse mortgages. Also, AARP offers a reverse mortgage calculator.