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Uncertainty in retirement

By Barbara Whelehan · Bankrate.com
Friday, July 15, 2011
Posted: 2 pm ET

To ensure financial peace of mind, you need to accumulate as much wealth as possible, right? The two ideas are inextricably entwined, I've always thought. But SunAmerica's recent poll segregated the two concepts and asked people age 55 and older which of the two more closely described their financial goals. Most of them -- 82 percent -- said they want to save enough to have financial peace of mind, while just 13 percent said they want to accumulate as much wealth as possible.

More interesting, perhaps, is that about two-thirds of the respondents (65 percent) said that when they think about ideal products for a secure retirement, those guaranteed not to lose value are absolutely essential or very important. And 60 percent said they want products that protect income from market losses and guarantee it for life. Only 26 percent indicated they want retirement products with the potential to provide higher returns, even if they come with higher risk.

It's a drumbeat that insurance companies have been sounding loudly in recent months. Based on this survey, you would think hordes of people would embrace immediate annuities. But the GAO's recent report indicates that only 6 percent of Americans convert their 401(k) money into an annuity.

There is resistance to handing over a big chunk of money in exchange for a steady stream of income for life. I would like to have my cake and eat it, too, rather than give it away and just get small bites of it back at a time. However, managing your own retirement income by relying on equities for growth is fraught with risk.

Study flouts conventional wisdom

If you opt to keep your chunk of money and draw 4 percent of income from it during retirement, considered safe according to conventional wisdom, you may run out in as few as 20 years, according to a new study in the current issue of the Journal of Financial Planning. The study's authors found that the 4 percent withdrawal rate can result in failure 18 percent of the time -- higher than previously thought. Failure occurs when a portfolio runs out of money before 35 years elapses in this study.

The authors created 100 scenarios using random returns like those retirees can expect to experience over 35 years with a 60/40 portfolio of equities and bonds. The portfolios are worth $1 million at time of retirement, and the retirees withdraw $40,000 each year in these scenarios. The study found that the portfolios can fail prematurely or succeed spectacularly. The results ranged from one portfolio down to nothing after only 20 years to another worth $12.8 million after 35 years. You might see these types of outcomes at a roulette table in Las Vegas.

The authors say the safe withdrawal rate for all 100 scenarios turns out to be 2.52 percent, adjusted for inflation -- significantly less than the 4 percent withdrawal rate widely believed to be safe. But in practice, that would mean getting retirement income of $25,200 per year plus whatever Social Security provides to be safe. Someone who accumulates $1 million during their working years would have to step down to a more subdued lifestyle in retirement than the one to which they'd been accustomed.

There is a safer option: The portfolio could last for 35 years with no volatility at all if it invests in risk-free securities generating annual real returns of 2 percent -- that's 2 percent above the inflation rate. But at the end of 35 years, the portfolio would be depleted, leaving nothing for heirs.

Certainty comes at a price, but uncertainty could well be unaffordable.

No one claims retirement planning is easy. ...

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3 Comments
Your Own Retirement
July 18, 2011 at 1:25 pm

With our current state of the economy financial institutions are getting more and more creative with financial products designed for early retirement candidates. Raising the debt ceiling is not going to do anything but prolong the inevitable and stray away from retirement programs based on a sound financial foundation.

Barbara Whelehan
July 18, 2011 at 12:35 pm

Michael -- I had acknowledged the error in a rejoinder to a comment, but a correction should have been more prominent. I have made a correction in the relevant blog post.

While it's true the debt level climbed much higher since 2008, remember that our country (and for that matter, the world) was on its knees, thanks to the financial crisis. Does that mean U.S. citizens should tolerate these outrageous levels of debt now? Absolutely not. And I hope Congress, along with President Obama, can effectively address this problem. But so far it's not looking good.

Nevertheless, thanks for writing.

Michael Gaff
July 17, 2011 at 1:47 am

Barbara's credibilty with numbers is suspect. In an apparent leftist swipe, she stated in the "Doomsday Debt" column,that the debt under Bush climbed from 4T to 10T. According to easily accessed figures, the debt climbed under Bush from ~5.5T to ~10.3T.
Under Obama, the debt has risen from 10.3 trillion to 14.5 trillion in just 2 1/2 years. Why did she ignore a 4.2 trillion rise in 2.5 years while being seemingly appalled at a 4.8, not 6 trillion dollar rise, in 8 years?