Monday, September 27, 2010

Is Knowing How Much Important to Your Retirement Plan?

It no longer is how much you have.  Now it is whether what you have will be enough.  From the age of accumulation, the twenty or so years prior to this, when growth was rampant, portfolio values seem to take on an endles stream of gains, and the opportunity to retire seemed within everyone's grasp, we now have the age of decumulation.  This newer word in the retirement planning world applies to the simplest of concepts: how much will I need each month.

Decumulation, as described in a recent New York Times article by Jennifer Saranow Schultz, is the ability to pay for a "similar quality of life, keeping financial autonomy, leaving money to children, philanthropy, hanging on to money to cover health expenses or a combination of these options or others". It's not that we weren't focused on those things before, running simple calculations in our heads and using online calculators.  But with so many of us seeing portfolio declines that we hadn't expected, and entertaining the possibility that we would see them again, possibly at the very moment we retired, knowing exactly what we could expect has suddenly popped to the front and center of every discussion.

There is much more to consider than in the previous decades.  Without ever swelling balances, the predictions of what may happen have become much more difficult.  News reports suggesting that we will live longer, that the cost of health care in retirement will eat away at those balances, and the potential of declining cognitive abilities all need to be considered -even if we can't put a price tag on any of them.  Simply suggesting that we will work longer or even work in retirement if needed do not satisfy the question of decumulation with any accuracy.

Does that mean we will all need an annuity?  According to Eric Johnson, a professor of marketing at Columbia Business School, annuities are still a hard sell to retirees who do o=not want to hand over a huge chunk of their retirement portfolio to one firm in exchange for a steady check.  If their annuity is to cover your spouse in any way, the cost goes up while the monthly payout goes down.

What do we know about annuities aside from the hybrid investment, part-insurance, part mutual fund aspect of the purchase?  There is also the actuarial element - how long you will live is calculated into the payout and if you include your wife, with her potential to live longer than the husband, the payout drops even further.

There is a behavioral aspect to the purchase of an annuity, most often bought at retirement when the defined contribution plan pay the retiree in a lump sum.  What many economists who study this event have found is not really surprising.  People make their decision of whether to buy or not using the last six months of the stock market as their best indicator.

The mention of cognitive decline also worries financial professionals and the government as well.  The older you get, the less likely you will be able to make the right decisions with whatever remaining wealth you might have. This sort of problem can occur only ten-years after retirement and with anyone overseeing the decisions - which get more complicated - there is good chance that the wrong one will be made.

Annuities are a hard sell based on what experts call mental accounting.Once you begin thinking in terms of different baskets for your money, spending what is needed often becomes a question of selling more investments than might be prudent.  Your retirement budget will change with time.  Studies have begun to suggest that in the first years, liesure spending will be far higher than it willbe just ten-years after you retire.  Annuities don't address this, often giving retirees too little money in the beginning and too much when they don't often have the ability to spend it.

Some believe that a self-examination of what you see in the future - based on who and what you are now - might be helpful.  Others disagree suggesting that if that were the case, and everything about the future seems to be not-so-bright, retirees might take an opposite stance and spend it now.

The best solution, which seems to be gaining ground it building the purchase of annuity right into the person's 401(k) plan.  This would allow them to see exactly how much they would get if they retired.  This would induce them to invest more, learn to budget now and possibly enter into retirement with fewer financial burdens. It would also benefit women who retire allowing them to get a clearer picture of what they will get based on what they have invested for the future.

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