Will you have enough to retire?

Steve Merrell |

The other day I had an interesting conversation with an old friend. My ears perked up when he told me he was taking a class to help prepare for retirement. When I asked him to tell me about it, he said, “According to my teacher, the secret is to create streams of income.” “That’s a great place to start,” I said, “but where do you go to find income?”

That question haunts me. In a world with near-zero interest rates, where do savers go to generate income? A quick example will illustrate what I mean. To make the math easy, let’s assume you have been able to accumulate $1 million in your 401k after a lifetime of careful saving. Upon retirement, let’s suppose you roll that million dollars into an IRA so you can invest it in “safe,” income-oriented investments. Here’s what you might earn given today’s interest rate environment.

Let’s suppose you want to be super safe, so you invest in FDIC-insured bank CDs. According to Bankrate.com, the average yield on a 1-year CD is right around 0.50 percent. At that rate, your $1 million will generate $5,000 per year of pre-tax income. That isn’t going to take you very far.

Let’s suppose you stretch a little on quality and maturity and invest instead in five-year investment-grade corporate bonds. This portfolio will earn about one percent on your money, or $10,000 per year before taxes. If you really go for it and buy junk bonds, your investments will yield around 3.25 percent, earning you $32,500 per year before taxes. Neither of those portfolios is going to buy you the “million-dollar” lifestyle. It’s like Howard Hughes once said, “A million dollars isn’t what it used to be.”

Of course, there are other options, including using a self-directed IRA to buy rental property. However, as we have discussed in other columns, investing your IRA in real estate can be treacherous. It is very easy to inadvertently run afoul of prohibited transaction rules which can have extreme consequences for IRA owners. Can you imagine receiving a letter from the IRS informing you that your retirement account violated some arcane rule and, as a result, you now owe taxes on the entire value of the account?

The dearth of income opportunities makes retirement planning trickier than ever. As the example shows, you can’t just save a bunch of money and assume you are going to be okay. You have to think your retirement through carefully. You need a plan.

When I help people build their retirement plans, I try to help them understand how their investment portfolios should be structured to accomplish their goals. We also look at how their portfolios will need to amortize in order to support their desired lifestyle.

Amortization refers to the process of gradually eating into your principal over the expected lifetime of the investment. In the case of retirement planning, this requires that we make an assumption about how long you expect to live. Of course, none of us really knows how long we will live, so we look to actuarial data to help us understand probabilities. For example, actuaries at the Social Security Administration tell us that a 65-year-old woman has a 34 percent chance of living to age 90. A 65-year-old man has only a 22 percent chance. In our planning, we generally assume clients live to age 100, something that is 6 percent likely for 65-year-old women and 3 percent likely for men.

With a horizon established, we can look at investment options and spending assumptions to see how quickly the portfolio might draw down over the retiree’s remaining life. Investment options include a variety of asset mixes with various allocations to stocks, bonds, real estate and cash as well as other possible investments. We also consider various levels of inflation protection.

I agree with my friend’s teacher—finding streams of income is an important part of retirement planning. But the problem is so much more complex. Unless you have massive wealth, your portfolio simply cannot generate enough income to support a reasonable retirement lifestyle. For most of us, it pays to take the time to carefully plan how you will amortize your capital over your remaining life.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.