Even if you've socked plenty of money away in your 401(k) plan and invested it carefully, some of your toughest decisions lie ahead. And don't expect much help or clarity from the government or your employer.
Strategies for drawing down lump-sum accounts in retirement — more important than ever in the 401(k) era — have received little attention from policymakers. For retirees, choices about how to spend a life's worth of savings are fraught with tricky calculations about financial risk, taxes and death.
Jim and Sue Cleary, both 69, are living through that now.
They have two homes, one in Florida and a second in western Michigan that keeps them close to five of their nine grandchildren. And yet, as they shuttle back and forth to watch their 7-year-old grandson play soccer, Jim said he knows they won't be able to maintain this lifestyle indefinitely.
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The Clearys cut out cruises to Alaska and Australia and they're spending down their retirement savings, aware that they may eventually have to sell one of their homes. Sue, a self-declared worrier who retired nine years ago from the utility industry, is confident in the T. Rowe Price Group Inc. plan they've been following that has 60 percent of their assets in stocks and mutual funds. Still, she recognizes that they are spending a bit more than they would prefer.
“That's kind of the main concern I have — are you going to outlive what you have?” said Jim, who retired eight years ago after a career in state environmental protection and private waste management.
It's a worry echoing across a baby-boom generation that includes the first retirees leaning heavily on 401(k)-style defined-contribution plans. They're learning on the fly to do what pension managers did for their parents.
That's challenging because the standard formula for squirreling retirement savings into bonds or certificates of deposit doesn't necessarily work in an era of increased longevity and depressed interest rates. American men who reach age 65 will live another 17.9 years on average, while women will live 20.5 years, according to 2012 data released Thursday today by the Centers for Disease Control and Prevention.
The Clearys are more fortunate than millions of Americans who are reaching retirement without enough savings. The couple has a clear financial plan, two years of cash available, long-term-care insurance and income from Social Security benefits and pensions. At the same time, they're not wealthy enough to focus solely on estate planning.
Jim and Sue grew up on the same block in Bay City, Michigan, and reconnected through their mothers when they were in their 40s. They're now steering their way through a challenge that requires morbid thoughts for people in their 60s and 70s.
Spend now to enjoy healthy years and risk running out of money? Or scrimp today for a tomorrow that may never come -- or come only when they're too infirm to savor it?
The drawdown phase is a piece of the U.S. retirement puzzle that's attracted little notice until recently.
Younger workers get clear, simple advice: Save as much as you can for as long as you can. Create a diverse portfolio of investments and hold on for the ride.
That's supposed to yield a pile of assets. When it's time to make that pile smaller, retirees are often overwhelmed by the choices and tax consequences.
The government, which helps workers accumulate money in tax-deferred accounts, offers little guidance for when it should be spent. The main requirement — annual distributions from tax-advantaged accounts — is designed to deplete the money, not to make it last.
The government “is increasingly focused on helping individuals manage those assets,” Mark Iwry, deputy assistant secretary for retirement and health policy at the Treasury Department, said in an e-mail. “There's plenty more that we can do, and there's a lot more that the private sector can do, and the best way is to do it together.”
The dilemma will become more pronounced over the next few decades as more workers retire without defined-benefit plans, instead operating in the do-it-yourself world of 401(k)-style defined-contribution plans.
“There's sort of a money illusion when you have a big lump sum of money sitting in your 401(k) account,” said Jonathan Forman, a law professor at the University of Oklahoma who studies retirement policy. “You think you're rich.”
For a 65-year-old man, $100,000 buys an annuity that pays out $572 a month for life, according to Hueler Investment Services Inc. That's often not what people see, however, and sometimes they don't think about the income taxes they'll owe when they take money out.
“We see situations where people at retirement look at this monster lump sum compared to, say, their annual income and they figure: There's no way I can ever spend all this money,” said David John, a senior strategic policy adviser at AARP. “I may as well do something that's a luxury.”
The government has taken a few limited steps to ease the spending-down phase of retirement. Still, Mr. John said, the U.S. lacks a “clear direction” for this phase.
The required minimum distribution rules for retirement accounts, which make retirees take taxable payouts starting after age 70 1/2, are designed to force spending and can cause problems for people who live longer than the average.
The rule acts for some like an income stream, because it's designed to mimic life expectancy. Without a policy to ensure that the tax break is recouped, the tax deferral would turn into an exemption and retirement accounts would become an estate-planning technique for wealthy households.
Earlier this year, the Treasury Department created a partial waiver to the required minimum distribution rules for people who purchase longevity annuities — ones that don't start paying out until age 80 or 85.
“For the first few years of retirement, many people feel that they can manage their assets,” Iwry said. “Protection against the risk of running out of assets in the out years is a kind of risk protection that people particularly appreciate.”
Other potential steps by the government remain incomplete.
The Labor Department has been looking at requiring 401(k) providers to show people how long their money will last, which many providers already do. The department said in 2013 that it would propose formal rules; it hasn't done so yet.
President Barack Obama has proposed eliminating the required distributions for people with account balances of less than $100,000, a plan that would simplify the system and save taxpayers $484 million over the next decade. That proposal has stalled in the broader debate over revamping the U.S. tax code.
Another issue is that the minimum distribution tables, which can be altered without congressional action, haven't been updated since 2002. Since then, average life expectancy at age 65 has increased by 10 percent for men and 7 percent for women.
A change to the tables isn't listed on the Treasury Department's priority guidance plan this year.
For any individual, however, the right decision on how much to withdraw depends on his or her desired retirement lifestyle, risk tolerance and life expectancy.
The hottest debate among investment advisers and policy makers is over the role annuities should play, with the Government Accountability Office and the Treasury Department nudging some Americans toward the insurance.
Here's the key question: Should retirees continue the do-it-yourself approach from their working years by switching to more conservative investments and making routine withdrawals?
Or should they turn over some of their money to an insurance company to create an income stream that will last as long as they do?
“Individuals have a preference for control, and that means they want to manage it themselves,” said Chip Castille, who heads the U.S. retirement group at BlackRock Inc. “But they also want security.”
Total annuity sales were $230 billion in 2013, according to the LIMRA Secure Retirement Institute, a trade association for insurers. That's up 5 percent from 2012, though still below the 2008 peak.
“People are living longer and obviously as people live longer, they're going to need that money spread out and they're not necessarily planning for that,” said Jim Poolman, executive director of the Indexed Annuity Leadership Council, whose members include Eagle Life Insurance Co.
Annuities have their detractors. They're often accompanied by high fees, and today's historically low interest rates depress payout rates. Also, Social Security already creates a steady income stream for many people.
“It's important that we don't overannuitize people,” said Doug Fisher, a senior vice president at Fidelity Investments. “You don't want to lose the market potential.”
Annuity providers have responded to the criticism in part by adding features to products to make them more attractive. They aren't as simple as they used to be, with a lump sum up front and a monthly payment until death.
Some offer continued exposure to equity markets. Others allow — for a price — retirees to ensure their heirs can get a partial return of the premium as a way to hedge against the risk of early death.
“We have a kind of financial peace of mind that that's going to be there,” said Steve Leavitt, a 62-year-old construction manager from Des Moines, Iowa, who has a deferred annuity with Acuity Financial Inc. that's scheduled to start paying out in December 2016.
Annuities are also becoming available inside some 401(k) plans, though that's still rare. An Aon Hewitt survey of plan sponsors found that 20 percent offer managed accounts with drawdown features and just 8 percent offer annuities.
“The real question is educating participants about what their options are,” said Brian Graff, executive director of the American Society of Pension Professionals and Actuaries. “If there was a demand for annuities, then 401(k)s would generally offer them.”
Beyond annuities, retirees entering the drawdown phase of financial planning face a much different set of challenges than they did while working.
Retirees' lifestyles for decades can be damaged by a few bad years of investments just before or after they stop working — with little chance to recover.
Russell Investments prepared an exhibit showing sequential risk that gave hypothetical retirees with a $1 million account and identical withdrawals the same set of annual returns, just in reverse order.
The one with positive investment returns in the first years after retirement had $1.7 million left after 20 years. The one with negative returns at the start ran out of money by year 19.
Retirees, especially those who can't go back into the workforce, also have to think about the effects of inflation, what they want to leave for their children and how much they will spend on health care.
Those who retire at 65 will pay an average of $220,000 in health care — excluding nursing home or long-term-care costs, according to a Fidelity survey.
This situation is complicated by older workers' tendency toward caution about investment choices and lack of preparation for post-retirement spending, said Janice Scherwitz, a benefits specialist at a hospice in Florida who has been trying to help employees get ready.
“They are probably going to have to end up being in the workforce a lot longer than they would like,” she said. “We have a whole new group of people who don't even have a clue of what they need to live on, and are going to come to a terrible realization some day.”
And then there's the most important and touchiest issue of all.
“People are undercalculating the level of risks and longevity they need to save for,” said Sri Reddy, head of full-service investments at Prudential Financial Inc. “The age-old question that people are often asked and they seldom have the answer to is: When are you going to die?”