Get Smart With Your Money

From: AARP Bulletin, June 2006
By Jane Bryant Quinn

When you retire, everything changes. During your working life, you focus on putting money into the financial system, through savings, investments and your Social Security taxes. When your paychecks stop, you have to switch to taking money out. What's the best way to do that? And how can you make your money last? Here are some simple strategies for the three stages of your retirement life:

Five Years Before You Retire
These are the planning years. The more you learn, the more comfortable your later life will be. First ask whether you can afford to retire. What appear to be giant nest eggs may actually be quite modest, stretched over a life span. Eight planning steps:

1. Take a first pass at a retirement budget. What will it cost to live?
2. Estimate your future income. There's Social Security (which notifies you every year how large your benefit is). Maybe a pension (public-sector pensions are safe, but some companies are freezing payouts, so go by the amount you've accumulated so far). Rents from investment real estate (if they're not covering your costs, maybe you should sell). Don't include interest and dividends from your financial investments. That's part of the next step.
3. Add up your savings and financial investments. This includes your 401(k) or 403(b), individual retirement account (IRA), other tax-deferred savings and taxable accounts (stocks, bonds, mutual funds). You'll have to draw on savings conservatively to make them last for life. Financial planners advise you to reinvest all interest and dividends—don't try to live on just the income (it won't keep up with inflation). For expenses, draw a fixed annual amount from the total pot. The first year of your retirement, take no more than 4 percent (with a $200,000 nest egg, that's $8,000). In the second year, increase your withdrawal by the inflation rate, and continue that way in following years. If you take more than 4 percent, your chance of running out rises sharply. Keep in mind that this low withdrawal rate doesn't allow for big-time purchases.
4. Think about how to handle your house. You can't count its equity value toward your retirement pot unless you cash out in some way—by moving to a cheaper place or taking a reverse mortgage (best used later in life as a cash reserve—see below).
5. Consider the cost of health insurance. Where will you get it if you retire before 65, when Medicare clicks in? Your current plan (or COBRA) may not cover you if you move to another state. You might have to shift to a new health plan at a higher price.
6. Look into long-term care insurance, especially if you're married. You don't want to stick the spouse at home with a huge cash drain if the other one needs care. But don't spend more than 6 percent of your retirement income (not working income) on premiums. To cut a policy's high cost, increase the waiting period before benefits are paid or limit the number of years you're covered.
7. Adjust your investments. In your 50s, a comfortable allocation would be 60 percent stock-owning mutual funds (U.S. and international) and 40 percent bonds or bond funds. If your 401(k) is loaded with company stock, start getting rid of it. You can't afford the risk.
8. If your income won't cover your expenses, rethink. Can you pare expenses? Move to a cheaper city? Stay on the job a few more years or work part time? Sell your house and rent? Planning helps you get the right answers.

When You Retire
These are the "what-next?" years. You have the joy of fewer responsibilities and more free time—and questions about your standard of living in the years ahead. Five readjustment steps:

1. Decide what to do with your 401(k). If you worked for a company with a good plan, it might pay to stay with it. Check on your options for drawing the money out. If you die, your spouse can treat the 401(k) as his or her own, with all the choices you have now. Otherwise, roll the money into an IRA. If you're leaving the money to your heirs, IRAs have an advantage: Children can take it gradually, over their lifetimes. This gives the bulk of their inheritance years to grow, tax-deferred.
2. Decide when to take Social Security. If you start at 62, the earliest age, your benefit drops by 25 to 30 percent and your spousal benefit drops even more. But you'll collect the income for an extra four or five years. Here's how to decide: Start young, if you need the money and earn only a modest income (when earnings top more than a certain amount—$12,480 this year—the benefit is reduced). Or wait until full retirement age (for boomers, that's 66 to 67)—the best choice for most of us. You'll get a larger benefit with no reduction for earnings. Or wait until 70, when you'll get an even larger check. That's generally not worth it. It takes 15 years or more to make up for all the checks you could have received before.
3. Invest more conservatively. You may have 30-plus years to live, which means you need long-term growth. But stock markets spike and dip. If you have to sell stocks to pay bills when the market falls, you'll find it harder to make your savings last. Holding a mix of short-term and intermediate-term bonds or bond funds gives you a fairly stable source of cash. Many planners suggest a 50-50 balance between stocks and bonds when you're 60 or 65. Some advise no more than 40 percent stocks. And by the way, that means well-diversified stock-owning mutual funds, not individual stocks. Single stocks are far too risky. As for tax-deferred annuities, they're a bad buy. Their costs are too high, you pay through the nose for performance guarantees, and you don't even need guarantees when you're investing for 20-plus years.
4. Don't rely only on income investments. Yes, you can get 4 percent, right now, from bonds alone. But you can't get 4 percent plus the compounded rate of inflation every year for the next 30 years without cashing in. Your portfolio will shrink every year and may not last for life.
5. Track your resources carefully. If money flees your account too fast, maybe you can earn some extra money. Now's the time, not 10 years from now.

Later in Retirement
Now you're consolidating. It's normal for expenses to decline (who needs more "stuff"?). If you think you might run short, you have a few options.

1. Cash out your house. Think about downsizing to a rental apartment or condo or moving to an assisted living community. If you don't want to sell, look into a reverse mortgage or line of credit. They're expensive (you won't believe the fees!), but they let you tap into your home equity. The older you are when you take the loan, the more you can get from your home and the less you'll pay compared to the size of your loan.
2. Consider using part of your cash to buy an immediate annuity. It pays a monthly income for life and can be a great comfort at a later age (75 to 80). The older you are when you buy, the higher the income you can command and the less time inflation has to reduce the value of your payout.
3. Invest even more conservatively and trim spending. You can't afford risk. Learning to manage a fixed pot of resources is a challenge for anyone. But by keeping on track, you will succeed.

Jane Bryant Quinn is a columnist for Newsweek and Good Housekeeping and author of the new book Smart and Simple Strategies for Busy People.