If you're like many people, you've put considerable time and effort into socking away money for retirement. But you've probably put less thought into how to spend the money in a way that will make it last, leaving you with a potential disaster.
A perfect storm has foisted this challenge on us. People are living longer. Fewer people have pensions and the 401k plans that more have come to rely on likely were decimated n the recent downturn. Further, assets in savings accounts may actually be losing value, thanks to short-term interest rates that are lower than the inflation rate. And the future of Social Security seems iffy.
There are steps you can take to make your money last. Spending less and working longer will help, of course. But even then you can't know how long you're going to live. All you have are the odds: For a married couple at age 65, there's a 58% chance one person will live to 90; a 50% chance one will live to 92; and a 25% chance one will live to 97.
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Savings accounts
If you have a Depression-era mentality, put your nest egg in savings accounts and certificates of deposit with no more than the FDIC-insured limit of $250,000 in any one bank. It's safe and will be there for you no matter what the markets do.Unfortunately, inflation may erode the value of such low-risk investments over time after inflation, and they are unlikely to generate much income. If you have a pot of money for getting you through your golden years, the most you should withdraw annually over a 30-year period is 5% (some people say 4%).
With current savings interest rates of around 2%, you would need to start with $5 million to generate $100,000 a year in income. And that doesn't even account for inflation pressures on your annual withdrawal, as the buying power of your $100,000 decreases.
A balanced portfolio
If you don't happen to have $5 million lying around, you'll need to accept more risk to have any chance of generating that $100,000 a year you desire. One alternative is to put money in a diversified portfolio of stocks, bonds and real estate that pays dividends. If you start with $3 million and the market performs as it has over the past 70 years, you should be in good shape. But if the market lags or companies cut their dividends, your money might not last.A recent white paper from Vanguard Group discusses making systematic, fixed, inflation-adjusted withdrawals from a balanced mutual fund of stocks and bonds. Adjusting your withdrawals based on the inflation rate might reduce the risk that you'll run out of money, but it won't eliminate it entirely.
Immediate annuities
With an immediate annuity, you put money in an insurance contract that usually pays a fixed rate of return (much like a certificate of deposit) and start receiving those payments within a year. How much income your lump sum will generate depends largely on how much you invest, your gender and age at the time you buy the annuity, and the prevailing interest rate environment (currently unfavorable to annuity buyers). A 65-year-old woman living in Illinois would need to plunk down about $1.5 million to generate $100,000 in inflation-adjusted annual payments for life.It pays to comparison-shop for immediate annuities, especially among low-cost vendors like Vanguard and TIAA-CREF. Also consider tailoring the annuity to your needs --by arranging for payments to continue until both spouses pass away, for example.
One downside is that an immediate annuity ties up your money, so you won't have access to it in an emergency or to pass on as an inheritance if you get hit by a bus the day after you buy it. It also locks you into the interest-rate environment at the time of purchase. You can get around this by buying separate annuities in chunks over several years. To lock in real, after-inflation income, opt for an inflation-adjustment rider, but understand that it will cut into how much you'll receive each month.
