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Answering retirement questions

If you’re approaching — or already have crossed — the finish line to retirement, you should focus on meeting two goals: providing yourself with an income that will let you live comfortably and making certain your retirement resources will last for your lifetime.

Today, when your retirement savings are apt to have been diminished by the market downturn, meeting those goals is a greater challenge than ever.

Here are a few of the questions that you are likely to be asking yourself:

What resources should I tap?

The main sources of funds to generate retirement income are the retiree’s taxable investment portfolio and tax-qualified retirement plans [an IRA or 401(k) plan, for example]. These sources supplement Social Security benefits or a pension, or both. The rate at which a retiree makes withdrawals and the portfolio return each have a role in determining how long a retiree’s savings will last.

From a tax perspective, continuing to shelter retirement assets from tax for as long as possible should be the best approach, tapping taxable accounts first, followed by traditional IRAs and then Roth IRAs. (If all the requirements are met, Roth IRA withdrawals are tax-free.) In a study, Baylor University Professor William Reichenstein kept the asset allocation and withdrawal rate constant. Withdrawals came in this order: (1) the minimum amounts required to be distributed from a traditional IRA or company retirement plan, generally beginning at age 70-and-a-half; (2) bonds and then stocks from taxable accounts; (3) stocks and then bonds from Roth IRAs; and (4) stocks and then bonds from the balance of the tax-qualified plans. This strategy consistently extended the life of retirement resources from roughly two to five years longer than a strategy that tapped retirement accounts first.

Although this order offers a reasonable rule of thumb, it may not apply for every retiree every year. For example, in a year when a retiree has extensive tax-deductible expenses that reduce taxable income significantly, his or her tax rate may be low. It then may make sense to take advantage of it by tapping taxable accounts first. The game plan of taking the minimum required amount from an IRA may be revised, too, to include larger withdrawals in order to take advantage of the low rate.

How much should I tap?

Studies have suggested that, with a 4 percent withdrawal rate and 3 percent annual adjustment for inflation, retirees stand an excellent chance of having enough savings to last for 30 years.

Suppose Retiree had $1 million in savings during his or her first year of retirement. Using the 4% rule of thumb, he or she withdraws $40,000 and $41,200 in year two. But what if year two was 2008, and Retiree experienced losses that reduced his or her savings to $800,000? Using the same withdrawal strategy, the odds of draining his or her resources rise dramatically.

According to T. Rowe Price research, if Retiree’s portfolio is invested 55 percent in stocks and 45 percent in bonds, and the market gains an average 4 to 6 percent a year over the next five years, that 20 percent drop in savings leaves Retiree with a 49 percent chance of depleting his or her savings prematurely. With a 30 percent loss, the number rises to 79 percent.

What can retirees do while awaiting better times? Choices are limited, and not the most pleasant. If a retiree enjoys being busy, perhaps part-time employment, or, if possible, omitting a withdrawal in a down year. If a withdrawal is necessary, expenses should be reduced accordingly.

Jeff Francis is vice president and senior investment officer for First Tennessee Brokerage. For more information about this and other personal finance issues, call 865-971-2321.


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