But for retirees and near retirees, 1997 is raising nerve-racking questions. You’re old enough to remember that markets can actually go down, not just up. You’ve heard Fed chairman Alan Greenspan, the one man whose opinion on the market really counts, issuing not-so-thinly-veiled warnings. And you recently received a lovely invitation from the Internal Revenue Service to withdraw a big chunk of your retirement money without paying a special tax that’s normally levied.
What to do? Slink out of the stock market while the bull is still running? Or swallow hard and repeat the buy-and-hold mantra whenever nerves fray? Insulate investments in a retirement account-or cash out to avoid the excise tax? For investors who’ve been particularly diligent or lucky, there’s a pressing new question: should you start diverting your retirement savings to a non-401(k) account (page 86)? Here’s a guide to help you find some answers:
Chuck Zender is barely into his 50s, but even with an investment horizon of 25 to 80 years ahead, he’s leery. ‘You couldn’t get me to put a substantial amount of money in the stock market to save my soul," he says. And he’s a pro, manager of Leuthold Asset Allocation Fund in Minneapolis. It isn’t that Zender knows the future; it’s that he knows himself and his account balances all too well. He doesn’t want a big bet on a frothy market to dictate whether he retires in Palm Springs or Hoboken.
Before you turn tail, you should determine how badly you need the stock market. Ask yourself two questions. First, are you on track in reaching your retirement goal? If you’re well within reach of your number, you can probably reduce your exposure to the market. Do the calculations to be sure your retirement pot will last at a lower rate of return. Should you get out of the market altogether? You’d have to comb the country to find a financial adviser who’d say yes. The traditional reason: inflation is poison to nest eggs, and stocks are the only antidote. But now there’s a new alternative-a Treasury bond that’s indexed to inflation. Currently yielding more than $ percent, 10-year inflation-indexed bonds are no substitute for the after-inflation growth you could get from the stock market. But don’t turn up your nose. These bonds are the first no-risk alternative to stocks that’s protected from inflation. If your retirement pot is big enough, you could move completely into these securities and have total peace of mind. For most people with less amply endowed accounts, these bonds are a good place to park money siphoned off from stocks.
The second question: do you have enough time to recoup from a bear market? It took 15.$ years to break even after the 1929 crash, but only 8.6 years or less to recover from the eight declines since. Sounds reassuring, but those figures don’t tell the whole stow. If you’d invested $200,000 in Fidelity’s Magellan Fund at the beginning of the 1973 bear market, for example, you’d have had just $83,520 by the end of 1974. No problem. Magellan bounced back and you had your $200,000 again by 1978. But what if you’d been withdrawing $20,000 a year to live on? Between withdrawals, adjusted for inflation, and market losses, your balance would have fallen to zero by 1978, according to H. Richard Dobson, president of American Financial Management, a financial-planning company in Cedar Falls, Iowa.
The moral: The market does come back–but not necessarily on your timetable. With 15 to 20 retirement years ahead, you can maintain a 40 percent to 60 percent exposure. After that, maintain your portfolio’s diversification, but start ratcheting down the equity component. With five to 10 years left, it’s time to put the bulk of your money into less volatile securities.
The government, in its wisdom, has decided how much you should live on each year in retirement. If you take out more than that–$155,000 last year-from your IRA, Keogh or 401(k), you have to pay an excise tax of 15 percent on it. Now through 1999, though, that so-called success tax has been suspended. Don’t be tantalized by this apparent freebie. Keep the money in your account and you get a powerful compounding machine, thanks to tax deferral. Take it out, and you’ll be socked by federal and state income taxes, leaving you with a much smaller chunk of money to invest and taxable gains thereafter.
There are only three reasons to extract a big sum from your account during this three-year window: if you’ve amassed enough money that you’ll be whacked by the excise tax every year, if your account balance is so large you’ll be hit by another “excess accumulation” tax or if you’re planning a big expenditure within the next six or seven years. If your retirement home or boat purchase won’t occur until later, keep the money stowed in your retirement account. If you earn 7 percent or 8 percent return over that period, “you’re going to benefit enough from tax deferral to pay the excise tax and still be ahead of the game,” says Joan Vines at Grant Thornton in Washington, D.C.
Once you hit 59% you can dive into your retirement accounts without penalty. But try not to. Your nest egg is probably nearly’ as big as it will ever get. The longer you refrain from spending it, either by working or by using funds outside your retirement accounts, the more tax deferral boosts your investment returns. You can also give your outside accounts a similar shot in the arm by putting the money in tax-efficient investments like municipal bonds or growth stocks that don’t pay dividends. If watching your accounts gyrate with the stock market unnerves you, make your withdrawal from a stock account once a year and move the proceeds into a money-market fund.
Now’s the time to give some hard thought to what your expenses are really going to look like. It’s silly to assume you’ll need a fiat 75 percent of your annual income during your working years. Typically, retirees spend more in the early part of their retirement. And though total expenses taper off, some items rise substantially. People between the ages of 56 and 64 spent just over 6 percent of their income on health care in 1994, while folks 75 and older devoted more than twice as much-more than 14 percent.
In planning your withdrawal strategy, remember that even a small miscalculation could haunt you. Just as a 1/2 percent or 1 percent hike in your returns could dramatically boost the size of your account over 80 years of investing, a slightly oversize withdrawal pattern will drastically shorten the time your money lasts if it continues over several decades. So don’t overestimate how much you can take out each year or let expenses dictate the size of your withdrawals, two common mistakes. “Many people take out dividends and interest not realizing that they need to reinvest to make up for inflation,” says Jim Sullivan, a principal at Arthur Anderson in Chicago.
At 70 1/2 the Internal Revenue Service not only demands that you tap your retirement accounts, but it’s fussy about how you do it. The trick is to keep the number as low as possible because you want to continue to defer those taxes. But remember, you’re calculating the minimum-you can always pull out more if you need it.
Here are your options: take out equal installments over your remaining years or recalculate the distribution amount annually. It’s boring, but believe it or not, it matters. The first thing you can do to reduce the required distribution, under either method, is name a beneficiary, such as a spouse or a child. Then, both lives are taken into consideration and the estimated life expectancy is stretched out. But take note: there’s no advantage to naming a nonspouse beneficiary who’s 20 years younger, because the biggest age difference allowed is 10 years.
Next, look at the actual calculation options. If you take out equal amounts–the term-certain method-the money will flow out of the account relatively quickly. The recalculation method is a better bet for most folks with net worths under $600,000: it slows down the outflow, because your life expectancy rises for every year you live. This method’s drawback is that if you die prematurely your beneficiary is likely to see a big jump in required withdrawals.
Is figuring out any of this stuff fun? No. But getting it right is even more important now than it was when you had plenty of income-generating years ahead. A bull market may be a young person’s game, but that doesn’t mean you can’t play it your way.
