Retirement Income: Strategies and Options Creating an appropriate retirement income strategy can be critical to a comfortable retirement. Two basic questions that have to be answered when creating a strategy are: How much can I spend? and How do I allocate my resources so that I will not run out of money? Below are a few strategies that you may wish to consider when answering these questions. HOW MUCH CAN I SPEND? To determine how much you will be able to spend, you may want to use any one or a combination of the options available, such as: Steady Withdrawal Rate Systematic Withdrawals Endowment Spending Steady Withdrawal Rate This strategy is implemented by calculating an initial withdrawal rate, generally between 4-5% of your portfolio s initial value. This withdrawal rate would then be maintained throughout your retirement, often with an increase for Cost of Living Allowances (COLA) or the Consumer Price Index (CPI). An example of how these distributions might look is illustrated below. Year Initial Account Balance Investment Return (40% stock / 60% bonds) 1 Withdrawal Ending Account Balance 1991 $1,000,000.00 22.8% $40,000.00 $1,188,000.00 1992 $1,188,000.00 8.0% $41,680.00 $1,241,360.00 1993 $1,241,360.00 9.9% $42,930.40 $1,321,324.24 1994 $1,321,324.24-1.6% $44,218.31 $1,255,964.74 1995 $1,255,964.74 26.2% $45,367.99 $1,539,659.51 1996 $1,539,659.51 11.2% $46,638.29 $1,665,463.09 1997 $1,665,463.09 18.9% $48,037.44 $1,932,198.17 1998 $1,932,198.17 16.0% $49,142.30 $2,192,207.58 1999 $2,192,207.58 7.9% $49,928.58 $2,315,463.40 2000 $2,315,463.40 3.9% $51,027.01 $2,354,739.46 2001 $2,354,739.46 0.1% $52,761.93 $2,304,332.28 2002 $2,304,332.28-2.5% $54,239.26 $2,192,484.71 2003 $2,192,484.71 14.4% $55,107.09 $2,453,095.42 2004 $2,453,095.42 7.2% $56,374.55 $2,573,343.74 2005 $2,573,343.74 4.0% $57,896.66 $2,618,380.83 2006 $2,618,380.83 8.8% $59,865.15 $2,788,933.19 2007 $2,788,933.19 6.5% $61,780.83 $2,908,433.01 2008 $2,908,433.01-11.9% $63,510.70 $2,498,818.78 2009 $2,498,818.78 14.9% $65,924.10 $2,805,218.68 2010 $2,805,218.68 10.4% $65,660.41 $3,031,301.01 This illustration assumes that annual withdrawals of 4% are distributed at year-end, adjusted for the previous year s CPI figure. The annual withdrawals are based on the previous year s ending account balance. This example uses 40% Russell 1000 Index and 60% BC Aggregate Bond Index calendar year returns from 1991-2010, which are rebalanced annually. Results would have been different with a different asset allocation or time frame. This example is for illustrative purposes only. Performance is historical and is not representative of future results. Individuals cannot invest directly in an index.
This strategy should generate income and, depending on your asset allocation and portfolio performance, may provide growth to help keep pace with inflation while still providing full flexibility and access to your savings. It may, however, require hands-on attention over time, and the amount and longevity of income cannot be assured. Systematic Withdrawals The systematic withdrawal strategy assumes that you will be able to live on a set percentage of your pre-retirement income. A popular percentage used is 80% of pre-retirement income. Depending on how you choose to implement the strategy, you can provide for COLA or CPI adjustments. A sample of how the systematic withdrawals strategy might look for a person earning $62,500 in pre-retirement income is illustrated below. Year Initial Account Balance Investment Return (40% stock / 60% bonds) Income Needs Social Security Payments Withdrawal Need after Social Security Ending Account Balance 1991 $1,000,000 22.8% $50,000 $16,822 $33,178 $1,194,822 1992 $1,194,822 8.0% $52,100 $17,326 $34,774 $1,255,634 1993 $1,255,634 9.9% $53,663 $17,846 $35,817 $1,344,125 1994 $1,344,125-1.6% $55,273 $18,081 $37,192 $1,285,427 1995 $1,285,427 26.2% $56,710 $18,623 $38,087 $1,584,122 1996 $1,584,122 11.2% $58,298 $19,182 $39,116 $1,722,428 1997 $1,722,428 18.9% $60,047 $19,757 $40,290 $2,007,677 1998 $2,007,677 16.0% $61,428 $20,350 $41,078 $2,287,827 1999 $2,287,827 7.9% $62,411 $20,961 $41,450 $2,427,115 2000 $2,427,115 3.9% $63,784 $21,590 $42,194 $2,479,579 2001 $2,479,579 0.1% $65,952 $22,238 $43,715 $2,438,344 2002 $2,438,344-2.5% $67,799 $22,905 $44,894 $2,332,492 2003 $2,332,492 14.4% $68,884 $23,592 $45,292 $2,623,079 2004 $2,623,079 7.2% $70,468 $24,300 $46,168 $2,765,772 2005 $2,765,772 4.0% $72,371 $25,029 $47,342 $2,829,061 2006 $2,829,061 8.8% $74,831 $25,780 $49,052 $3,028,967 2007 $3,028,967 6.5% $77,226 $26,553 $50,673 $3,175,177 2008 $3,175,177-11.9% $79,388 $27,350 $52,039 $2,745,292 2009 $2,745,292 14.9% $82,405 $28,171 $54,235 $3,100,106 2010 $3,100,106 10.4% $82,076 $29,016 $53,059 $3,369,458 This illustration assumes that annual withdrawals of $33,178 are distributed at year-end, adjusted for the previous year s CPI figure. The annual withdrawals are based on the previous year s ending account balance. This example uses 40% Russell 1000 Index and 60% BC Aggregate Bond Index calendar year returns from 1991-2010, which are rebalanced annually. Results would have been different with a different asset allocation or time frame. Social Security payments are estimated using a Social Security Benefits calculator from KJE Computer Solutions, LLC. These payments were determined using a 65 year old one year out from retirement with annual earned income of $62,500. This example is for illustrative purposes only. Performance is historical and is not representative of future results. Individuals cannot invest directly in an index. In general, with this strategy, you will likely be able to maintain a similar lifestyle to that of your pre-retirement lifestyle. However, because there is no adjustment for down years, there is a greater risk that you will deplete your assets. In addition, inflation may outpace your withdrawals, greatly reducing your purchasing power. Although this is typically a simple strategy to calculate and follow, it may be simple and may not take enough variables into account when estimating the sustainability of your retirement assets. 2
Endowment Spending One of the problems with using straight withdrawal methods, either through a steady withdrawal or through systematic withdrawals, is that they don t take account value fluctuations into consideration. This means that you could potentially draw down your assets too quickly, or you could potentially be too frugal with your distributions. Another strategy, referred to as endowment spending, is becoming popular because it takes both a spending rate and your annual account value into consideration when calculating the amount you are able to withdraw annually. As the name implies, this method uses a formula similar to that of an endowment fund and blends a spending percentage with a portfolio percentage. The spending rate is the percent of money that you withdraw from your retirement savings to cover expenses and fund your retirement. The smoothing rule component is the control that takes account value fluctuations into consideration. Both aspects of the calculation work together. In your first year you would calculate the percentage you want to spend from your portfolio and then limit your spending to that amount. Your initial spending percentage would be recalculated each subsequent year to incorporate the smoothing rule, thereby making appropriate adjustments for your portfolio s performance and COLA or CPI adjustments. An easy way to calculate your initial spending percentage is to project your retirement spending need for your first year of retirement and divide that by your entire portfolio value. For example, if your portfolio is worth $1,000,000 and your projected spending needs are $50,000, your initial spending rate would be 5%. To implement this strategy, you would first have to determine what smoothing rule you will use. The smoothing rule is designed to adjust each year s spending by just enough to keep your portfolio sustainable, but not too much that it will greatly alter your lifestyle. To make this strategy work for you, you will have to determine how much fluctuation you are comfortable with in your annual spending allowance. A common smoothing rule is 80/20. This means that 80% of your spending allocation is constant (based on your previous year s spending amount) and 20% of your spending allocation will be subject to fluctuation based on your portfolio s performance and COLA or CPI adjustments. For example, assuming you decided on an 80/20 smoothing rule, you would calculate your current year s spending by taking 80% of your prior year s spending and adding to that 20% of your portfolio s current value multiplied by your spending rate. For example, if your portfolio is worth $950,000, you have a 5% spending rate, and your spending amount last year was $50,000, your present year calculation might look like this: Portfolio value: $950,000 Prior-year spending: $50,000 Spending rate: 5% Portfolio value adjustment: $950,000 x 20% = $190,000 x 5% = $9,500 80% of prior-year spending $ 40,000 20% portfolio value adjustment +$ 9,500 Current year spending amount $ 49,500 The appeal of this approach is that it will ebb and flow with the value of your portfolio, making it more likely that your assets will last through retirement. Adjustments that are made due to fluctuations in your portfolio s value are based on a smoothing rule so any adjustments to your spending, while varying from year-to-year, would be somewhat gradual helping to minimize the changes to your lifestyle. HOW DO I ALLOCATE MY RESOURCES? Allocating your resources so that you can meet your spending needs and sustain your spending throughout your retirement is the next step in creating your income strategy. To help you maintain a regular flow of money for short and long-term spending needs, retirees may want to consider a cash flow reserve strategy supported by a timesegmented approach to investing your retirement income assets. 3
Cash Flow Reserve This strategy is set up to give you paychecks similar to when you were working. When implementing this strategy, you break your portfolio into multiple separate accounts: a checking account, a cash flow reserve account, and investment accounts. You would keep about an average of two years of cash reserves in your cash flow reserve account where a paycheck would be distributed each month (or at intervals that work for you) into your checking account. The remaining assets would be retained in an investment portfolio with assets being liquidated at opportune times to keep the cash flow reserve at roughly two years. For example: Moved at set intervals for paycheck Assets moved when appropriate to keep Cash Flow Reserve Account at 2-years worth of income Checking Account Cash Flow Reserve Account Investment Account This is where your paychecks are deposited. You provide for your immediate spending needs from this account. Two years worth of income is maintained in this account. At set intervals a paycheck is distributed to your checking account. This account is invested in short-term fixed income investments. Your remaining portfolio is invested with longer term assets as is appropriate for you. These assets that would be invested in separate accounts or investments, as outlined below. This strategy can help you to keep the rhythm of receiving a paycheck and budgeting accordingly, and can help prevent being forced to sell your retirement assets at inopportune times. The Bucket Approach This approach is designed to segment your assets into time-segmented buckets based on when you may need them. These buckets can typically be arranged in 5 to 10 year time spans. You would then withdraw a sustainable rate, derived from the spending strategy you choose to implement, from a specific bucket throughout your retirement. That withdrawal amount is re-calculated periodically based on your needs and the applicable bucket s performance. As time moves on, your buckets get drained and you move on to the next one in line. For example, if you were planning for 20 years or more of spending, your different buckets might look like this: Bucket I: Years 1-5 Money Market Funds Savings Account Short-term bonds CDs Bucket II: Years 6-10 Short-term bonds Intermediate bonds Dividend paying stocks Bucket III: Years 11-15 Intermediate bonds High yield bonds Dividend paying stocks Bucket IV: Years 16+ Intermediate bonds High yield bonds Dividend paying stocks Growth Stocks Alternative Investments* As assets in each bucket get drained, you would replenish it from the bucket immediately after it, moving the most aggressive assets into the most conservative assets over time. 4
With the bucket approach you are likely to make adjustments to your spending in the short-term without affecting your savings for the long-term. Although your spending amount will generally fluctuate throughout retirement, since each bucket is invested based on a set time horizon, you can better allocate your assets according to your projected needs at a specific point in retirement, and liquidate securities at opportune times. Additional Considerations When creating your retirement income plan, there are a few additional considerations you may wish to take into account. For example, you might not need your buckets to cover all of your retirement expenses, as most individuals should have Social Security benefits and annuity investments as part of their overall retirement income plan. In addition, as with any stage of life, it is wise to plan for the unexpected. Having an emergency fund available can help you take any surprises in stride. Social Security Most individuals who have been employed in the U.S. during their career, or who are married to an individual who has been employed in the U.S. during their career, will receive some form of Social Security benefits. Though a number of factors that go into determining when an individual will choose to start taking their Social Security benefits (generally date of birth, marital status, and employment status), most individuals will begin receiving these benefits between the ages of 62 and 67. Social Security benefits should be factored into your retirement income plan. Because this is a steady, predictable stream of income, your Social Security checks would generally be deposited directly into your checking account while your remaining income needs are provided for through your portfolio, bucket, investments. For more information on Social Security and what benefits for which you may be eligible, ask your Oppenheimer Financial Advisor for a copy of An Overview of Social Security for Retirees. To estimate what your Social Security benefits may be, you can access the Social Security Administration s Benefits Planners online at www.socialsecurity.gov/planners. As an alternative, you can look at your individual Social Security Statement. This is a concise, easy-to-read personal record of the earnings on which you have paid Social Security taxes during your working years and a summary of the estimated benefits you (and your family) may receive as a result of those earnings. This statement is generally available online for workers, and former workers, age 25 and older. You can review this statement annually. Annuities In its most basic form, an annuity is an insurance contract that provides an income stream in return for an initial payment. For many retirees, annuities will be an integral part of their retirement plan. As with Social Security benefits, annuity income will generally be a steady, predictable stream of income which you could deposit directly into your checking account. When creating your retirement income plan, you should speak with your Oppenheimer Financial Advisor who will work with you and the experts in our Annuity Department to help you determine what the best retirement income model is for you. Emergencies Emergencies, they can t be avoided, no matter how thoroughly you plan. However, you can plan for the unexpected! It is almost always a good idea to work a little cushion into your retirement income plan. This way, if you have a sudden hospital visit, your car breaks down, you decide that you need that emergency trip to visit the grandkids, or any other unplanned for event, you can still keep your retirement income plan intact. A few suggestions on how to plan for the unexpected include: Allow for a specific emergency bucket in your retirement income plan Allocate earnings that exceed expectations to an emergency fund In more drastic cases, re-create your retirement income plan based on your new circumstances 5
However you decide to prepare for your emergencies, be sure to discuss your plan with your Oppenheimer Financial Advisor to make sure that the appropriate allocations are made. How to Implement Your Strategy The strategies outlined here are just a few of the options you may want to consider when creating your retirement income plan. Your Oppenheimer Financial Advisor can help you determine which strategy, or combination of strategies, may be right for your specific situation. In addition to helping you create an appropriate strategy, your Oppenheimer Financial Advisor can also help you determine how to invest those assets to help make your strategy successful. To help in projecting the likelihood of outliving your retirement assets, Oppenheimer & Co. Inc. has financial planning tools available. Contact your Oppenheimer Financial Advisor today for more information on these tools and retirement income! The Russell 1000 index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market. The Russell 1000 Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are reflected. The BC Aggregate Bond Index is an index comprised of approximately 6,000 publicly traded bonds including U.S. government, mortgage-backed, corporate and Yankee bonds with an average maturity of approximately 10 years. The index is weighted by the market value of the bonds included in the index. This index represents asset types that are subject to risk, including loss of principal. * Alternative Investments, such as Hedge Funds and Fund of Funds are made available only to qualified investors and involve varying degrees of risk, including the possible loss of principal invested. Oppenheimer & Co. Inc. 85 Broad Street New York, NY 10004 800-620-OPCO 212-668-8000 www.opco.com 2013 Oppenheimer & Co. Inc. Transacts Business on All Principal Exchanges and Member SIPC. All Rights Reserved. The information contained herein is general in nature, has been obtained from various sources believed to be reliable and is subject to changes in the Internal Revenue Code, as well as other areas of law. Oppenheimer & Co. Inc. does not provide legal or tax advice. Please contact your legal or tax advisor for specific advice regarding your circumstances. No part of this brochure may be reproduced in any manner without the written permission of Oppenheimer & Co. Inc. RS051513RM1