The Retirement Savings Trap

Retirement savings requires more planning today due to low interest rates.

Many individuals retiring today drew up retirement plans expecting to withdraw 4% annually from their retirement account annually to live on. This is, after all, what financial advisers have been telling us for years. “As long as you take out 4%, your money will last forever.” Of course, that’s only assuming that your investments consistently get you more than 4%.

More than 52% of people who have bought into this theory will run out of money in retirement. This is due today to the double whammy of low interest rates and volatile market swings. Money tied up in CDs is yielding on average less than 1%, unless you want to tie it up for 5 years or longer. If so, then maybe, just maybe you might get more than 1%. The average inflation rate in the US from 1914 to 2014 has averaged 3.33%*. That means that CD buyers are guaranteed to lose money in an investment that banks tell us are the safest investments available. At today’s record low rates, retirement savings invested like this will decline in purchasing power even if there were no withdrawals.

Factor in planned withdrawals, rising expenses and rising retiree life expectancy and most people who have bought into this trap will continue to be broke long after that money is gone.

Many retirees recognize the risk of low interest rates and instead look to more aggressive investment strategies. Whether they put that money in individual stocks, mutual funds, ETFs, gold, silver, or commodities the values of those investments fluctuate over time. Those fluctuations can be devastating to a retiree who is relying on that income for their living expenses. The Dow is trading at record highs. If there is a major war in the Middle East or the government has a credit crisis it is very easy to see where another 25% market drop (or worse) could conceivably happen. Without that, even, the ups and downs of the market can be destructive for anyone who can’t truly afford to lose their savings.

For the person who won’t use that money for 20 years or more, market swings can be readily absorbed. For a retiree who lives off that money however the withdrawals that they need for their retirement living expenses are just as likely to occur on a day when the market is fluctuating down as when the markets are up. Many people who retired in the last ten years have seen their portfolios suffer far more than their broker had predicted when they sold them on their retirement plan.

Many investors see security in bonds, but even with those come risks. The biggest of these risks is that today’s record low interest rates are likely to change in the future and if that happens, today’s bonds will drop in value as investors opt for the new higher interest rate bonds of the day. A senior who needs to sell his or her bonds to finance the costs of retirement is likely to face periods where the market value of his or her bond holdings is going to be down increasing the burn rate on those savings.

Wiser financial advisers are beginning to take a more realistic view of current market conditions and are recommending that retirees should not exceed withdrawals of 2.8% per year at maximum. A withdrawal rate of just 2.8% however means that today’s retiree needs to have more money to retire than previously thought. A one million dollar retirement fund at a withdrawal rate of 2.8% means that there will be just $28,000 in annual retirement income plus social security. A more comfortable $56,000 a year would mean that $2 million would be needed.

That might be enough for many couples today; but ten or twenty years of accumulated inflation could substantially cut into what we think of as acceptable retirement income. It is also possible that future seniors could be paying for more of their healthcare costs (today’s Alabama seniors already spend more than $4000 of their own money annually on healthcare costs according to a 2012 AARP study) so a conservative retirement plan probably factor in for greater inflation.

For more information on retirement plans and how yours might stack up, contact one of our Money Coaches.

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