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For investors, 2008 was one of the worst years since the 1930s. How this market dive affects your retirement plans depends largely on your stage in life. Young workers If you are 15 or more years from retirement, recent market turmoil actually may be beneficial. There are several reasons for this counterintuitive result: 1. Modest losses. Many young workers have used their earnings to repay student loans, save up to buy a house, and pay the expenses of starting a family. As a result, they may have only small investment portfolios. The less you had invested prior to last year’s crash, the less you have lost, in absolute dollars. 2. More time for recovery. With 15 or more years to retirement, you probably will have ample time for your investments to recover before you’ll tap your portfolio. If markets stay down for some time, you’ll have an extended opportunity to invest at low prices. By investing regularly, perhaps through a 401(k) plan, you can build up a low-cost portfolio in anticipation of the next bull market. 3. Lessons learned. Investment markets’ performance in 2008 illustrates the importance of diversification. You should not load up on shares of your employer because that company stock could fall sharply. Also, you should include not only stocks but also high quality bonds or bond funds in your portfolio because each bonds provided a valuable cushion last year. Pre-retirees The closer you are to retirement, the more you’ll feel the impact of a plummeting portfolio. You may have suffered greater losses after many years of investing, and you’ll have fewer years to rebuild your retirement fund. As you approach retirement, your planning becomes a numbers game. Will you be able to stop working and still afford your customary lifestyle? One way to approach this calculation is to assume you’ll need as much spending money in retirement as you need before retirement. You won’t have to save for retirement, however. Example #1: Kim Grant, age 62, earns $100,000 per year and contributes $20,000 to her 401(k) plan. Once Kim stops working, she won’t continue those contributions. Thus, Kim figures she can retire comfortably on $80,000 per year. Kim calculates how much she can expect from Social Security by looking at the estimates of benefits she receives each year from the Social Security Administration. Then Kim eyes other likely sources of retirement income: a pension, earnings from part-time consulting, and so on. Kim then can estimate the amount she can safely withdraw from her investment portfolio. Many financial advisors tell people retiring in their mid-60s to start with a 4% withdrawal. Then retirees can increase the annual withdrawal amount to keep pace with inflation. Such a strategy probably will keep an investment portfolio intact for 25-30 years. Example #2: Suppose that Kim Grant estimates she will receive $30,000 per year from Social Security and other non-portfolio sources of income. Her retirement fund is now $500,000. Withdrawing 4% of $500,000 in Year 1 of her retirement would give her $20,000. Altogether, Kim can count on $50,000 of cash flow when she retires. Assuming she wants $80,000 of cash flow to maintain her lifestyle in retirement, Kim might have to keep working for several more years. Extending her career may increase Kim’s Social Security benefits and allow her to make substantial contributions to her retirement fund. Example #3: Assume the same facts as in Example 2, except that Kim has a $1 million portfolio. If she retires now and withdraws $40,000 (4%), Kim will have $70,000 of cash flow in Year 1, close to her $80,000 target. Thus, Kim may be able to retire in a few years if she puts more money into her retirement fund and her investments recover to some extent. If you are thinking about retiring soon, our office can go over your specific situation and help you decide if you need to keep working in order to build a larger retirement fund. Retirees If you already are retired, you may have been tapping your portfolio for spending money. Your previous actions probably will influence what you can do in the future. Example #4: Larry and Jill Martin retired a few years ago with $1 million in investments. They started with a $40,000 (4%) portfolio withdrawal and have increased that withdrawal each year to match annual inflation rates. After last year’s bear market, the Martins’ portfolio is down sharply. If they keep up their practice of increasing withdrawals to match inflation, their 2009 withdrawal will be about 5.5% of their portfolio. Although cutting their withdrawals may help in the long run, the Martins can maintain their spending if they’d like. The so-called “4% rule,” based on historic patterns of investment returns, generates a high probability that a portfolio will remain intact for 25-30 years. On the other hand, suppose that the Martins started with a $70,000 (7%) withdrawal and have made similar withdrawals during their retirement. With their depleted portfolio, keeping up this pace of withdrawals might mean spending over 10% of what’s left this year. If they continue to spend at that level, the Martins run a risk of depleting their retirement fund. Again, our office can help you determine a reasonable level of portfolio withdrawals during your retirement. “This article is displayed by permission of the CPA Client Bulletin. The Bulletin carries no official authority. Its contents should not be acted upon without specific professional advice from a certified accountant. Copyright ©2009, American Institute of Certified Public Accountants.” |
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