When Charles Burchett> accepted an early retirement package a few years ago, he plunked the payout from his employer into a mix of stocks and bonds, and for a while it worked just fine. "I was quite happy with the way things were moving along," says the former chemical engineer. Then the financial crisis sent the portfolio into a tailspin, slicing his seven-figure nest egg down to six figures. It was time to move to Plan B: He stashed his money in a so-called stable-value fund, hoping the income would be enough for him and his wife, Barbara, to enjoy a comfortable retirement on their five-acre Colorado farm. That plan went down the drain after the Federal Reserve's move to slash interest rates sent his returns to about 2 percent. "It was not going to hack it," says Burchett, 66.
Now it's time for Plan C, and it begins with an A, as in annuities. Not long ago, Burchett's financial planner would have turned up his nose at the idea of putting retirement funds into these insurance contracts. Annuities can be expensive and confusing, and the stock market seemed like a much better deal. "Stocks were in the middle of a 17-year bull market, and 15 percent gains were the norm," says the planner, Jim Saulnier. "Who needed any guaranteed income?" Today, of course, plenty of folks need it, including Burchett. He plowed $250,000 into an annuity that promises to pay him $1,885 a month for the rest of his life.
We've been hearing it almost since the day Lehman Brothers flopped. We're going to have to save more and put in extra years on the job three, five or even more if we want a decent retirement. And advisers have no shortage of other tips on postcrash strategies that, at least so far, haven't exactly been a roaring success. (Muni bonds, anyone?) A small but growing group of retirement experts are zeroing in on a handful of tactics and investment products aimed at reaching the ultimate goal for the golden years: a source of steady and, dare we say, sufficient income. The names of these products, from annuities to reverse mortgages, aren't exactly headline grabbers, but at least for some, they could be lifesavers. "It just involves thinking outside of your box," says Eleanor Blayney, president of McLean, Va., financial advisory firm Directions.
To hear financial advisers tell it, more people are willing to do just that these days. After all, the stock market's rebound from its recession lows isn't making them feel much better about their retirement prospects. And it's not just middle- and lower-income groups fretting about the future. Some 13 percent of Americans in the top-earning quartile and 29 percent in the next-highest quartile are on track to run out of money in their first two decades of retirement, according to the nonprofit Employee Benefit Research Institute. When that happens, they're forced to slash their personal spending, rely on Social Security or go back to work if they can find jobs. Health costs such as nursing-home care are a big reason for the shortfalls, but shockingly low interest rates and a still-shaky economy also share the blame. "Falling short is a major problem for the boomers," says Anthony Webb, economist at the Center for Retirement Research.
Then there's the problem of lousy timing. Consider two $500,000 portfolios invested in Standard & Poor's 500-stock index, with a retiree taking out $40,000 a year. Someone who retired in 2000 would have started the decade with three straight years of losses and run out of money by 2010. But if the returns are flipped and those losses occurred at the end of the first decade of retirement, the retiree would still have $130,454, according to financial planner Harold Evensky. The problem today is compounded by low interest rates. With most government bonds yielding less than 4 percent, some retirees have to dig deep into their principal if they want to withdraw money at the 4 percent annual rate recommended by many planners.
Some of the new alternatives have drawbacks, of course. Fees on products like reverse mortgages and annuities are declining, but they can still be high. The products can also be complex and come with a slew of conditions. Still, "you have to give something up to stretch your money," says Jason Scott, managing director of the retiree research center at advisory firm Financial Engines. "The question is, what are you willing to give up?"
Re-creating the Pension
The insurance industry might want to send a thank-you note to the Obama administration. In early 2010 the White House Middle Class Task Force said income annuities could be a good way to reduce the risk that retirees will outlive their money. Suddenly, more people were talking about this much-maligned insurance product as a viable alternative for investors (on Google, searches for annuity had a big, though brief, spike). But while sales of variable annuities jumped 8 percent in the first nine months of 2010, many financial planners say investors looking for secure retirement income should take a look at its slower-growing, lower-cost cousin: fixed-income annuities.
The old rap against annuities was that they were too complicated and costly. But while many planners are still wary of some of the more complex versions, they say immediate-income annuities are worth a fresh look, especially since financial firms like Vanguard and Charles Schwab are offering more-straightforward products at lower cost than what was available just a few years ago. Evensky used to steer clients away from annuities, because he figured investors could get higher income from a portfolio of high-quality bonds. But with interest rates near record lows and retirees afraid of running out of money, the Florida planner now says immediate annuities are the "single most important product of the next decade for retirees."
By creating a steady base of income similar to a traditional pension, annuities allow investors to take more risk with their other funds. Larry Petrone, a senior consultant at Financial Research Corp., ran hundreds of scenarios looking at 65-year-olds withdrawing 4 percent a year from a $500,000 portfolio. A retiree who put $200,000 of his nest egg into an immediate annuity with some inflation protection and invested the rest in a mix of 70 percent stocks and 30 percent bonds ended up with more than $500,000 at age 92. But a retiree who ignored annuities and invested in a bond-heavy mix of 65 percent bonds and 35 percent stocks ended up with just $300,000.
Variable annuities are more complicated, since their value fluctuates with the underlying investments in a portfolio. And while they still draw plenty of fire for their costs, financial planners say some of the products such as those with guaranteed withdrawal benefits work for their clients. "We see annuities as a vehicle that gets people through very difficult times in the market," says Dean J. Catino, managing director of Monument Wealth Management in Alexandria, Va.
To critics, immediate annuities also have a big drawback: They lock up money for life. And unless the buyer opts for a lower-paying annuity that leaves money to survivors, the payments stop at death. Even some fans of annuities say it might be best to wait until interest rates start rising and the industry starts offering fatter payouts. But some financial planners say an alternative is to buy them in chunks of, say, $100,000 and to buy more as interest rates move higher.
For some investors, annuities are worth the trouble particularly if they can ease their fears of running out of money. When Dick Copper, of Mount Shasta, Calif., started fretting about how long his $1 million nest egg would last, he put some of it into an annuity and used the rest to buy dividend-paying stocks. That way, he figures he's not left out if the market goes up, but he can also remain calm if stocks tumble. "If the market goes down 300 points, it doesn't affect my sleep anymore," says Copper, a retired salesman. "You don't have any idea what a relief that is."
Taking Cash out of the House
Not long ago, reverse mortgages were seen by many as a way for unscrupulous salespeople to take homes away from senior citizens. But something unusual has happened lately: Thanks in large part to a move by the federal government, sky-high fees on some of these products have fallen sharply. Suddenly, the red light for some seniors considering reverse mortgages has turned to yellow (or even green). "A lot of the advice people are getting about reverse mortgages is outdated," says Barbara Stucki, vice president of the home-equity initiative at the nonprofit National Council on Aging, which helps counsel seniors on their use.
Despite their confusing name, reverse mortgages are basically a way for people over 62 to turn some of their home equity into cash and still stay in their home. In a standard reverse mortgage, the bank gives a homeowner a lump sum or stream of income, such as monthly payments, with the amount depending on things like the borrower's age, the level of home equity and the type of reverse mortgage. Jeff Lewis, chairman of reverse mortgage distributor Generation Mortgage, says a 70-year-old man with $300,000 in home equity could get $200,000 at recent rates of about 5 percent. Once the borrower leaves the home or fails to pay homeowners insurance or property tax, the loan and interest come due, and the house is sold to pay off the loan. If it fetches less than the amount owed, the bank eats the loss.
Fees have been the biggest drawback, with borrowers coughing up 2 percent of the home value up front, on top of other fees. But in the fall, the Federal Housing Administration, which insures most reverse mortgages, introduced a product (dubbed The Saver) that essentially acts like a home-equity line of credit and charges just 0.1 percent of the home value up front. The trade-off: Borrowers can tap roughly 10 to 20 percent less than they could under previous reverse mortgages. So-called origination fees have also fallen, and some lenders even waive them entirely, which industry analysts say should boost future demand. Sales of reverse mortgages have already more than doubled from 2007 to 2010, to 413,000. And while reverse mortgages are likely to remain a niche product, retirement experts expect the changes and the increased need for cash by many seniors to lead to even higher demand.
Reverse mortgages are still subject to abuse, of course. The Government Accountability Office said in a 2009 report that 26 firms had engaged in potentially misleading advertising practices, ranging from characterizations of reverse mortgages as a source of lifetime income (in fact, the money runs out once the amount that can be tapped is reached) to suggestions that it's not a loan (it is). Those kinds of problems have led the U.S. Department of Housing and Urban Development to bolster the counseling required for prospective buyers; counselors can go so far as to withhold the approval needed for a reverse mortgage if they think the borrower doesn't know what he's doing.
Despite the caveats, Nancy Stern sees few other options. The San Diego businesswoman says she was left with a battered portfolio and dwindling corporate marketing customers just as she was about to retire. She's already purchased an annuity, and a reverse mortgage is next on the list. "It is the only thing I see to get through this," Stern says.
Squeezing More From Uncle Sam
At a time when traditional pensions are falling by the wayside and many retirement accounts are still on the skimpy side, one of the best ways to boost retirement income is to do nothing at least when it comes to collecting Social Security. Waiting until age 66 instead of retiring early at 62 boosts the average monthly benefit by 33 percent; holding out until age 70 means a 76 percent increase compared with what an early retiree would get. Try finding an investment like that in today's market, especially one with built-in inflation protection (Social Security payments increase along with the cost of living).
That's why some planners are telling clients to consider withdrawing from other accounts for any needed income before collecting Social Security leaving, of course, enough cash for an emergency fund. Christine Fahlund, a financial planner at investment firm T. Rowe Price, suggests selling stock in taxable accounts, especially since the extension of the Bush tax cuts has left the capital-gains tax rate at just 15 percent for the next two years. And Ron Courser, a planner in Grand Rapids, Mich., tells retirees to first tap investments that are taxed at a lower rate, such as dividends from stocks or real estate investment trusts.
While it generally makes sense to delay pulling money out of tax-deferred accounts like 401(k)s or IRAs, investors who have stashed hundreds of thousands of dollars in these accounts may want to start tapping them before age 70, when they will be required to take minimum distributions that could push them into a higher tax bracket. And once retirees start collecting Social Security, planners say they might want to supplement that income using withdrawals from a Roth IRA to minimize the tax hit (Roth withdrawals aren't taxed).
Of course, with mounting concerns about the gap between what workers pay into Social Security and what retirees collect, some retirees are tempted to grab Social Security while they can. But despite all the anxiety over a looming Social Security crisis, the latest projections show that there's enough money to fund full benefits until 2037. Even if nothing is done to close the gap, retirees beyond that point would still get 78 percent of their benefits.
For some, waiting isn't a viable option. In 2009, about 2 million Americans tapped Social Security early, 8 percent more than before the financial crisis many because they lost their jobs. But anyone who takes Social Security early and then finds a job can suspend future benefits, essentially pressing "pause" and allowing work credits to plump up future Social Security checks. Delaying the payouts, says Jean Setzfand, director of financial security at senior group AARP, is the "best annuity deal on the block."