Product
Solutions: Retirement Planning
While many products are touted as retirement
savings vehicles, tailoring a retirement savings
plan to individual circumstances and preferences
goes far in motivating savers to participate in
accumulating a retirement nest egg. An integrated
approach to developing a retirement portfolio
includes paying attention to estate and tax issues,
investment and withdrawal time horizons, risk
acceptable to the investor, and income requirements
of the portfolio.
Often it is helpful to determine a base income
that includes survivor, safety and a portion of
the freedom budgets (see the section on budgeting
for further information the referenced budgets).
Once the base income is determined, a plan to
accumulate sufficient assets and income sources
to provide that base income seems prudent. Lifestyle
enhancements such as travel, capital purchases,
philanthropy, etc., may then be addressed separately.
Care should be taken when determining how to integrate
governmental entitlement programs and pensions
into a retirement income plan, as they are vulnerable
to being decreased or eliminated. Ideally, base
income should be generated primarily from private
savings rather than from third party income sources.
Professional practitioners and small business
owners necessarily commit a substantial amount
of their current and future net worth to their
business. Real estate investors often rely on
future appreciation and cash flow from their properties
to provide security during retirement. Developing
a exist strategy from properties and businesses
is essential to successfully realizing a dependable
retirement income. Business owners (primarily)
have the option of devising defined benefit plans
designed to provide an income stream based on
a formula of earnings while employed. Such plans
can be tax-qualified or non-qualified. These plans
must account for company assets and cash flows
as well as tax effects on funds to both the company
and individuals participating in the plan. Defined
benefit plans are often funded by fixed investment
options such as insurance contracts (i.e., life
insurance policies or annuities), although other
options are available.
Tax-qualified defined contribution plans are
the most common retirement savings vehicles. These
plans include traditional and Roth IRAs, 401(k)s,
Profit Sharing Plans, Simplified Employee Pension
Plans (SEPs), Deferred Compensation Plans for
public employees, 403(b)s (also known as Tax Sheltered
Annuities (accounts) or TSAs, and others. The
feature that differentiates these plans from traditional
pension plans and government entitlement programs
(Social Security, etc.) is the investment risk
being borne by the individual participant, not
the business or sponsoring organization. This
is an important distinction because the decision
as to where funds are invested falls to the participant,
not a professional hired by the company who is
compensated to manage the account and ostensibly
has expertise in managing retirement funds.
Traditional and Roth plans offer different income
tax benefits. Governmental regulations allow for
income tax breaks either when funds are deposited
into a designated retirement savings account (traditional)
or when funds are withdrawn (Roth). Only rarely
are benefits available on both ends, and governmental
agencies work aggressively to close any “loop
holes” in regulations that allow for what
they consider to be excessive income tax breaks.
Developing pools of money that have different
tax treatment is a prudent strategy for accumulating
a nest egg. Tax qualified plans, tax deferred
savings vehicles, tax-free investments, assets
producing capital gains and other tax-favored
approaches should be considered. Please refer
to the section on tax-planning for additional
information.
While often a desirable place to save for retirement,
tax-qualified plans are not the only choices for
retirement savings. Cash value life insurance
policies, non-qualified annuities, bank certificates
of deposit, tax-free bonds, dividend-paying stocks,
and many other investment vehicles are available
to fund a retirement nest egg. The overriding
issue with purchasing any investment, whether
for retirement or not, is understanding the benefits
and potential risks associated with that investment.
There is a growing propensity among purveyors
of financial products to attach “bells and
whistles” to products, ostensibly addressing
multiple financial planning concerns within a
single product. For example, since it is essential
to consider the impact of potential long-term
care expenses and medical costs in conjunction
with retirement, “asset-based” products
exist to provide both retirement income and long-term
care funding in the same contract. Another common
feature used in retirement accounts is some sort
of income guarantee underwritten by counterparty,
most often an insurance company. The effect of
an income guarantee is to transfer investment
risk to that third party. Sometimes these guarantees
are referred to as private pension plans, since
the benefits somewhat mirror defined benefit plans.
Life expectancy is another factor that must be
addressed in a comprehensive retirement plan.
One approach to deal with an extended life expectancy
is to purchase a longevity income vehicle, such
as an annuity that beings to pay out only after
age 80. Laddering portions of the retirement nest
egg to produce income during subsequent income
phases allows for better portfolio positioning
to achieve both growth and distribution of assets
within appropriate risk parameters.
Asset allocation in retirement accounts should
reflect the time horizon until money will be withdrawn
from the account as well as the risk tolerance
of the investor. Given recent capital markets
history, it is difficult for many savers to muster
the optimism to commit their money towards the
types of investments that may best fit the timeframe
and risk parameters necessary for long-term investing
success. For those with more than ten years remaining
before they will begin spending from their next
egg, as well as for funds for current retirees
that will be accessed more than ten years in the
future, long-term market returns matter. Too often
retirement nest eggs have too little exposure
to asset classes (i.e., stocks) that can provide
the returns necessary to accumulate sufficient
retirement assets. To be sure, investment risk
management is important—a relatively new
metric for evaluating a manager’s value
is upside vs. downside capture ratios, which measure
how that manager’s risk management techniques
reduce declines in poor market conditions as compared
to a benchmark (as well as gains achieved during
positive markets against the same benchmark).
Ultimately, portfolios must have returns sufficient
of provide an increasing income stream that accounts
for inflation as experiences by seniors (not just
the US Government version of CPI inflation). Portfolios
must also reflect the risk tolerance of the saver.
That risk tolerance should be expressed numerically,
not simply in the relative terms of conservative,
moderate, or aggressive.
Time horizons of less than ten years must necessarily
be evaluated differently. Rather than investment
returns measured in long-term market averages,
the sequence of returns becomes much more relevant
in shorter time frames, since a significant decline
in portfolio value immediately prior to withdrawals
or while funds are being spent from the account
could mean failure of the next egg to provide
the amount or length of income required.
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