2731: [Part 1] Running Low in Retirement - Income Strategies by Darrow Kirkpatrick of Can I Retire Yet

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[00:01:08] disease. This is Optimal Finance Daily Episode 2731. Running Low in Retirement, Income Strategies,

[00:01:17] Part 1 by Darrow Kirkpatrick of CanIRetireYet.com. And I'm your host and personal finance enthusiast,

[00:01:24] Diana Merriam. Thanks again for joining me once again on Optimal Finance Daily,

[00:01:30] this time for a two-parter. So with that, let's jump right into part one and start optimizing

[00:01:35] your life. Running Low in Retirement, Income Strategies, Part 1 by Darrow Kirkpatrick of

[00:01:46] CanIRetireYet.com. Running out of money before you run out of life. It's the biggest fear many

[00:01:55] retirees face. And for baby boomers and succeeding generations without guaranteed pensions, it's not

[00:02:02] just a night terror, it's a realistic concern. Without adequate savings, a prudent lifestyle

[00:02:08] and regular financial checkups, running low in retirement is a very real possibility.

[00:02:14] I previously reviewed two fundamental solutions when you find yourself running low in retirement,

[00:02:20] reducing expenses and increasing income. In that article, I went deeper into the two most powerful

[00:02:27] expense strategies, cutting discretionary spending and downsizing your home. These are major levers

[00:02:35] you can throw on the expense side to modify your lifestyle and salvage a financially independent

[00:02:40] retirement, but they might not be enough or you might want to go further to ensure your comfort

[00:02:46] or security. So in this article, I'll explore the income-based solutions to running low in retirement.

[00:02:53] As I've said, to be realistic, a retirement backup plan needs to be entirely under your control.

[00:03:00] It can't rely on good fortune, the benevolence of others or external economic conditions.

[00:03:06] So we won't be discussing either working or inheritances here. Maybe you could return to

[00:03:12] some work in retirement, but that generally requires a cooperative economy or employer,

[00:03:18] and it may not be physically possible for older retirees. Or maybe you can count on inheriting

[00:03:24] some family wealth eventually, but inheritances are dictated by the lifespan and spending habits

[00:03:31] of others. You shouldn't pin your baseline retirement comfort on factors you can't control.

[00:03:37] If you have investments, you may be tempted to try picking better ones that would outperform

[00:03:42] the market, but decades of research prove that it is impossible to consistently beat the broad

[00:03:48] market indexes. Not only do the majority of active stock pickers fail, but they usually

[00:03:55] generate higher expenses along the way, a major headwind to success. If your investment portfolio

[00:04:01] is very conservative, largely in cash, CDs or bonds, you could allocate more to stocks to increase

[00:04:08] returns, but holding more stocks than is suitable for your risk tolerance is a dangerous game.

[00:04:15] You might bail out at a loss when the going gets tough, and it will get tough, because to

[00:04:20] potentially increase returns, you must be adding volatility to your portfolio to take on more risk

[00:04:26] of reducing returns. Selling at a loss would damage your perilous retirement finances even further.

[00:04:33] Fortunately, you can still access a couple of powerful income-based strategies. You needn't

[00:04:40] go back to work, hope for an inheritance, pick stocks, or change your asset allocation.

[00:04:45] There are other legitimate and safe approaches to increasing retirement income, but they carry

[00:04:51] a critical prerequisite. You must have some assets, either investments or a home, to begin.

[00:04:58] Annuitizing. The first strategy for safely increasing retirement income is to purchase

[00:05:05] a fixed annuity. I prefer the plain vanilla single premium immediate annuity. With this type of

[00:05:12] annuity contract, you pay the insurance company a lump sum, and they then pay you a monthly income

[00:05:19] for life. There's no variability, no upside or downside in the income stream other than perhaps

[00:05:26] inflation adjustments if you pay for those, and costs are easy to assess because you know

[00:05:31] precisely what you'll pay and precisely what you'll get back and when. Fixed annuities are

[00:05:37] generally invested in bonds, yet they can pay more than the going rate on a typical bond fund.

[00:05:43] That is, they can substantially increase your investment income over what you could accomplish

[00:05:48] with your own investments, given a similar level of risk. How do they do that? The first reason is

[00:05:54] simple. An annuity returns some of your principal to you along with interest payments. That means

[00:06:00] you are consuming principal. When you purchase an annuity, you give up control over your principal.

[00:06:06] And in return, the insurance company returns portions of it to you over time to increase

[00:06:12] returns. But you probably won't get it all back unless you live longer than expected.

[00:06:18] The second reason that an annuity can enhance returns is more complex. It's called mortality

[00:06:24] credits, the technical term for the benefit you get by pooling your money with a large group of

[00:06:30] other people. Individuals don't know their lifetime in advance. If you're managing money on your own,

[00:06:36] you must spend conservatively to ensure you don't run out. By contrast, an insurance company can know

[00:06:42] the statistical lifetimes of a large group quite accurately. That means the company can pay

[00:06:48] everybody a better income than they could afford on their own, confident that some individuals will

[00:06:53] die earlier than the average, leaving assets to pay the incomes of those who live longer.

[00:06:58] Add up both of these factors and you get a powerful result. When you purchase an annuity,

[00:07:03] you can usually increase your effective investment income yield by several percentage

[00:07:08] points depending on your age. As a rough example, consider that as I write this, the SEC yield on

[00:07:15] Vanguard's Intermediate Term Bond Index Fund is about 2.5%. Yet ImmediateAnnuities.com reports

[00:07:23] that an equally safe fixed immediate annuity can pay a 65-year-old couple about 5.7%,

[00:07:30] more than three percentage points higher. So your liquid assets, whatever they may be,

[00:07:35] can go much further in providing retirement income as an annuity. Just understand that an annuity is

[00:07:42] not like your other investments. You don't have access to your principal. So the downside if you

[00:07:48] must put most of your assets into an annuity is that it reduces or eliminates your cash reserve

[00:07:54] for dealing with unexpected expenses or leaving a legacy. But your heirs would probably prefer

[00:08:01] that you be self-supporting, even if it means they lose out on an inheritance. And an annuity

[00:08:06] can be instrumental in achieving that primary objective, baseline retirement security.

[00:08:13] Reverse Mortgages. What if your investment assets are minimal or you've already maximized your

[00:08:20] income from annuities? Is there somewhere else you can turn to produce more retirement income?

[00:08:26] Yes, if you own or have substantial equity in your house, there is. It's a somewhat complex

[00:08:33] and checkered financial product that has recently become more palatable. As noted retirement

[00:08:39] researcher Wade Vow writes, quote, recent research has demonstrated how financially

[00:08:44] responsible individuals can improve their retirement sustainability with a reverse mortgage.

[00:08:50] End quote. To be continued. You just listened to part one of the post titled Running Low in

[00:09:01] Retirement Income Strategies by Darrow Kirkpatrick of CanIRetireYet.com. And I'll be right back with

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[00:10:59] free trial. Coincidentally, my mom recently asked me about annuities and I attempted to do some

[00:11:06] research on her behalf. But I have to admit guys, I am finding the topic a bit overwhelming. So I'm

[00:11:13] going to tread lightly here. If I was seriously considering an annuity, I would talk to a flat

[00:11:19] fee fiduciary who doesn't sell annuities and who could advise me on how they might fit into my

[00:11:25] overall plan. However, an explain like I'm five definition of an annuity is a fixed sum of money

[00:11:32] paid to someone each year, typically for the rest of their life. By this definition, social security

[00:11:38] and pensions are annuities. Annuities are insurance products with contracts issued by

[00:11:45] life insurance companies. So it's more of a risk transfer strategy than it is an investment.

[00:11:51] And many people don't consider it an investment because when you buy an annuity, you immediately

[00:11:57] turn over 100% of your principal to purchase upfront the right to collect an amount of income

[00:12:03] from the insurance company for the rest of your life. From what I can see, annuities are pretty

[00:12:09] complex, but there are certain situations where they appear to be beneficial. Annuity products fit

[00:12:14] well into a plan when the retiree's savings aren't sufficient to weather market volatility

[00:12:20] and meet basic living expenses simultaneously. So they may be most appropriate for people who

[00:12:27] are worried that they could live longer than their money will last. There are many different

[00:12:32] types of annuities and riders that can be added for additional costs to customize them.

[00:12:37] Because it's an insurance product that is often layered with complexity and fees, annuities are

[00:12:43] often criticized for the high commissions sellers of annuities receive. So if you're curious about

[00:12:50] annuities, it could be worth your time to consult with a flat fee advisor. Well that should do it

[00:12:56] for today. Have a happy rest of your day and I'll see you on the Monday show tomorrow where we'll

[00:13:01] finish up this post and where your optimal life awaits.