Here are ways retirees can protect nest eggs

Global Courant 2023-05-26 00:36:48

Getty | mihaimilovanovic

The impasse of the federal debt ceiling and the specter of a possible recession on the horizon could mean turbulent times for the stock market – and that is especially worrying for retirees who depend on their investment portfolios for income.

Retirees are generally advised to hold some stock as part of their nest egg. Stocks serve as a long-term growth engine, helping to beat the negative impact of inflation after decades of retirement in a way that cash and bonds generally cannot.

But taking too much money out of stocks during periods of sustained losses can be dangerous for retirees. The risk is especially acute for people who have recently retired.

More from personal finance:
Credit card debt is approaching $1 trillion
Get started with investing, budgeting
How much emergency savings you really need

Fortunately, there are ways retirees can reduce that risk.

“You really have two defenses when you’re retired and pulling money out of your wallet for a living,” says Christine Benz, director of personal finance and retirement planning at Morningstar.

One such defense is to change the source of withdrawals, for example by withdrawing cash or bonds instead of stocks. Ideally, retirees would draw from an asset type that has not depreciated, Benz said.

That’s sometimes a tough proposition: 2022 was a rare instance of both stocks and bonds taking significant losses.

The second defense is to reduce the total dollar amount retirees withdraw from their investments, Benz said.

Why retirees should be careful

Here’s the crux of the problem: when the stock market pulls back, investors have to sell more of their stocks to generate the same income. When the market eventually stabilizes and fluctuates positively, the portfolio has less room for growth.

If retirees aren’t careful, this dynamic could lead them to run out of money sooner than expected in their later years.

Here’s one way to think about it: Retirees often tie the amount of their annual withdrawal to a percentage of their portfolio, maybe somewhere between 3% and 5%.

For example, if a retiree continues to pull the same dollar amount out of that portfolio after stocks have fallen for an extended period of time, that stock could rise to 7% or 8% — a perhaps unsustainable amount that inadvertently hampers the portfolio, said David Blanchett, chief of pension research at PGIM, the asset management division. of Prudential Financial.

The key is flexibility, to the extent that retirees have leeway, he said.

Economy, market pullbacks are not certain

There are many caveats here.

First, a short-term stock market pullback is not guaranteed. US lawmakers could agree on a debt ceiling in early June and avert it probably financial chaos.

And while Federal Reserve economists expect the US to slide into a mild recession later this year, that is not guaranteed. Nor is a stock market pullback if an economic downturn occurs; while stocks often shrink during recessions, there are instances (such as in the early 1980s and 1990s) where they didn’t, according to a Morningstar analysis.

Further, adjusting withdrawal behaviors is more important for younger retirees — especially healthier ones who expect to tap into their nest egg for decades.

You really have two defenses when you’re retired and pulling out of your wallet for a living.

Christine Benz

director of personal finance and retirement planning at Morningstar

Consider this illustration by Charles Schwab, who examines two newly retired individuals with $1 million portfolios and annual withdrawals of $50,000 (adjusted for inflation).

The only difference between them is when each experiences a portfolio loss of 15%. One suffers a 15% decline in the first two years of retirement, and a 6% gain each year thereafter. The other has an annual gain of 6% for the first nine years, a negative return of 15% in years 10 and 11, and an annual gain of 6% thereafter.

Here’s the kicker: the first investor would be out of money after 18 years, while the second would have about $400,000 left.

It may also be easier for some retirees to be flexible than others.

For example, some may cover all or most of their needs (such as food and housing costs) from guaranteed sources of income such as Social Security, a pension, or an annuity. They may be more able to reduce spending from stocks or a broader investment portfolio if they are largely tapped only for discretionary purchases such as vacations and entertainment.

How to be flexible

Marko Geber | Digital vision | Getty Images

There are retirees can take a variety of approaches to being flexible with withdrawals, such as a “guardrail” strategy or forgoing inflation adjustments in bad years.

Here’s a simple rule of thumb: Use your personal life expectancy to determine whether you’re withdrawing a safe amount from year to year, Blanchett said.

(There are many online calculators that estimate how long you’ll live — and therefore how long you should let your retirement savings last. Blanchett recommends the Actuaries Longevity Illustrator from the American Academy of Actuaries and Society of Actuaries.)

The calculation is simple: divide 1 by your life expectancy, which gives a reasonable starting point (in percentage terms) for safe portfolio withdrawal.

For example, if a retiree determines their lifespan to be 20 years, they use this calculation: 1/20 X 100. That yields a withdrawal rate of 5%.

“It’s very important to continuously measure the temperature of the uptake rate,” Blanchett said.

Here are ways retirees can protect nest eggs

World News,Next Big Thing in Public Knowledg