Yahoo Finance How to Extend Your Investment Portfolio's Life Span
Most of us intuitively like the idea of extending our time on earth. However, for most Americans, there's a downside to a longer life span: A person who lives to 85 needs more money for living expenses than a person who only makes it to 75.
The Society of Actuaries, which tabulates and analyzes mortality data on a regular basis, updated its U.S. life expectancy tables in 2014. Among its findings: The life expectancy of a man in the U.S. rose from 84.6 years to 86.6 years from 2000 and 2014. For a woman, the life expectancy increased from 86.4 years to 88.8 years.
For most Americans, retirement income sources include Social Security and savings in the form of qualified or taxable brokerage accounts. While corporate pensions are rapidly becoming a thing of the past, many federal, state and local government retirees continue to receive pensions.
However, U.S. retirement savings rates are notoriously low. In addition, the majority of Americans claim Social Security benefits at age 62, meaning they receive less than the full amount to which they are entitled. Those two factors add up to underfunded retirements for people with an ever-growing life expectancy.
"Retirement and retirement planning look very different today than just 10 years ago," says Stephanie Mackara, principal wealth advisor at Charleston Investment Advisors in Charleston, South Carolina.
Today's retirees must be more self-reliant. "The question we all face is: Will my money outlive me or will I outlive my money? The stock and bond markets are unpredictable, so relying solely on market returns is not a good plan. There are, however, some strategies that can help extend the life of a portfolio. Investors must focus on the factors they can control: saving, spending and taxes," Mackara says.
Americans typically work for about 40 years, and then spend as much as 30 years, or even more, in retirement without a paycheck from work, she says. While investment industry commercials often promote retirement as nothing but carefree walks on the beach, Americans' meager savings rates mean such portrayals are essentially fiction.
"The truth is, investors must increase their savings rates in order to build up a big enough nest egg to last over 30 years," Mackara says.
While nobody can control market performance, investors can control other aspects of their retirement-savings ability. In addition, retirees can use some strategies to mitigate tax consequences as they withdraw money.
"When investors begin to draw income, it is imperative they understand the tax impact of taking from a retirement account paying income tax versus a taxable account paying capital gains tax, or a combination of the two," Mackara says. "A sound investment and income plan will have a built-in annual strategy designed to stretch income and investment returns while minimizing taxes. That saves thousands of dollars a year, extending the longevity of a client's portfolio."
Social Security income is also taxed. However, the timing of Social Security benefits is critical. For every year that a retiree delays Social Security until age 70, he or she earns an extra 8 percent. A strategy known as "file and suspend," used by some married couples to maximize benefits, will no longer be available after April 30, 2016.
File and suspend, which in practice was utilized by relatively few Americans, became a popular topic with financial planners, whose clients often have the resources to delay benefits. The strategy allows one partner in a married couple to file for his or benefit at full retirement age, and then suspend it until age 70. That allows the benefit to grow to 132 percent of the full retirement amount. Meanwhile, his or her spouse could claim a benefit based on the primary earner's higher amount.
Although Congress is putting a halt to that practice, retirees still have options for increasing their benefits.
View Social Security as insurance. Mindset is important when approaching Social Security, says Russ Hill, CEO of Halbert Hargrove in Long Beach, California. For example, many people use a break-even calculation to justify taking their Social Security benefit as early as possible. The "break even" is the date at which a recipient gets back the benefits he or she delayed claiming earlier.
The break-even calculation tends to focus people's thinking on the possibility of dying too soon without ever having taken their benefit.
While it's not easy to feel as if you are leaving money on the table by delaying benefits, many experts say Social Security is best viewed as insurance against living too long. That's increasingly important given increasing U.S. life expectancies.
"That's a very different way of thinking than people are accustomed to," Hill says. "Social Security is an inflation-adjusted, creditworthy income stream. The default view should, indeed, be that it is protection against living too long."
In some cases, Hill says, individuals may be well-suited to take the benefit early. "Especially when there is no dependent or spousal coverage, a bird in the hand can make a more filling meal than one in the bush," he says. Delaying Social Security is not necessarily the correct course of action for everyone and depends on one's circumstances.
Michael Delgass, managing director of Sontag Advisory in New York, also says retirees must give careful consideration to their Social Security strategy.
"Social Security is an important hedge against increased longevity. The fact that it is inflation-adjusted means that -- at least in most years -- it provides an increasing base of income that retirees can rely upon. Even though recently there have been some significant regulatory steps to prevent seniors from exploiting some particularly useful planning schemes that further increased these benefits, like the so-called file-and-suspend strategy, it still is usually most beneficial to take benefits later," he says.
How much should you withdraw in retirement? Looking at all one's retirement resources is key to developing a retirement income plan that takes longevity into account. The financial planning industry has devoted attention to exact portfolio withdrawal calculations, but that may be missing the point, Hill says.
"The 'how much to withdraw' portion has been the subject of many studies, which we believe have generated detailed answers to the wrong question," he says.
Hill recommends a detailed look at resources, which include not only portfolio assets but future income streams, such as Social Security and pensions. Along with this evaluation, Americans should be honest about their future spending, which includes living expenses and actual liabilities, such as mortgages. This should be compared with one's desired spending.
For example, it's one thing to dream of luxurious travel, but perhaps that vision needs to be adjusted to match the financial resources available.
Finally, advisors recommend that retirees understand the levels of risk within their portfolio. The old advice about automatically increasing fixed-income exposure as one ages doesn't necessarily apply to everyone. Because stocks are, historically, a better inflation hedge than bonds, retirees should carefully consider whether they want to cut stock exposure and risk that they might outlive their portfolio assets.
"Most of the time, retirees will discover that they need to take more investment risk than they expect," Delgass says. "The most effective way to hedge against increased longevity is to take that longer time span into account and use it to one's advantage. The longer time horizon will allow for more investment risk, which in turn should ultimately bear fruit with higher returns."
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