Financial planning needed to avoid retirement shortfall |

Financial planning needed to avoid retirement shortfall

Jeffrey Apps and Tracy Tutag

Last week this column examined several misconceptions Americans have about preparing for retirement, issues to be considered during the “accumulation phase,” while they’re still working and saving. It concluded with the concept of longevity risk – the possibility that you will outlive your money. Now let’s look at planning for the “distribution phase,” – when you will depend on your nest egg for income.How much money should you save?Many financial professionals believe that people should plan to replace at least 70 percent of pre-retirement income when they stop working. According to the National Retirement Planning Coalition (NRPC) 2002 Survey of Prospective Retirees, people feel they need to replace, on average, only 60 percent of their pre-retirement income. Furthermore, only 58 percent of NRPC’s respondents said they had actually attempted to calculate how much money they would need to save. More revealing is the finding that among those who tried to do the calculation, 39 percent either could not actually do the calculation or could not interpret the results.The calculation can be complex. It is not simply a matter of adding up projected expenses and multiplying it by a number of years. Factors to consider include market volatility, inflation and now, longevity. The effect of recent stock market volatility on retirement savings demonstrates the seriousness of this risk. Asset allocation strategies, a topic beyond the scope of this article, can help to manage that risk.Inflation – compounding in a bad wayWhat makes inflation so potent a threat is the fact that is compounds over time. Perhaps you decide to retire at 65 and estimate that you need $50,000 a year to support your lifestyle. At 3 percent inflation (the average over the last 20 years), by age 89 – and remember, there’s a good chance you’ll live that long – you would need $100,00 a year to maintain the same standard of living. At 6 percent inflation, your $100,000 would last until age 77. The longer you live, the more inflation will consume the value of your retirement dollars.The downside of longevitySimply living longer can add significant expenses. Medical advances may have reduced the incidence of fatal illnesses, but longer lives are often beset with chronic health problems requiring prescription drugs, medical treatments or periodic hospitalizations – sometimes all three. In its Guide to Long-Term Care Insurance, America’s Health Insurance Plans (AHIP) states that people new 65 years old face a 40 percent lifetime risk of entering a nursing home sometime during their lives. AHIP also notes that the likelihood of entering a home, and staying for longer periods of time, increases as people age.In the field of health care, inflation and longevity combine in an especially insidious way. The cost of medical care, prescriptions and long-term care are rising faster than the general inflation rate. The longer you live, the more you could be affected.Distribution choicesWhen discussing retirement, emphasis is usually placed on saving and accumulating assets. In fact, when people reach retirement, key decisions must be made about how to distribute funds accumulated in retirement accounts. Choices made at this time may determine whether those assets will provide lifelong income.A U.S. Government Accounting Office (GAO) study found that defined benefit plans and defined contribution plans offer markedly different distribution choices. Defined benefit plans tend to offer annuities that provide guaranteed income for life. Defined contribution plans, on the other hand, tend to offer lump sum distributions or the option to keep assets in the plan. The GAO further reports that a growing number of plan participants who have a choice of benefit payouts take lump sums or leave or leave their money in the plan rather than receive an annuity. How are they making those decisions? Plan sponsors usually provide ample information about investing, but surprisingly little information about taking distributions. Prospective retirees often are not given the assistance needed to assess the advantages of different distribution options. Develop a retirement resource planWhen developing a retirement resource plan, you should consider a number of factors. First and foremost, do not underestimate your life expectancy. Other considerations include: your housing needs, health and long-term care insurance; provisions for dependent care, funding a child’s education, perhaps travel expenses. It’s your future. Careful planning now can ensure that your money will last throughout your lifetime.Jeffrey Apps and Tracy Tutag offer securities and investment advisory services through AXA Advisors LLC. They can be reached at 926-0601 or Vail, Colorado

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