How to avoid outliving your money in retirementSubmitted by Retirement Choices of California on May 27th, 2019
One is the risk of outliving your assets; the other is the risk of losing your purchasing power. How you allocate your assets to manage and mitigate those risks matters. Put too much of your money in one place, and you run the risk of not keeping pace with inflation. Put too much in another place, and you run the risk of running out of money or, as some say, lifestyle.
What to do?
No quick solution
Longevity and inflation risks are serious challenges, and there aren’t simple answers, says Steve Vernon, author of "Retirement Game-Changers." “It will take awhile for people to understand the risks, learn about their options and make informed choices," he says. "You can’t do this in an afternoon.”
Delay claiming Social Security
If a retiree or near-retiree is worried about longevity and inflation risk, there is a silver bullet for this: Delay claiming Social Security retirement benefits. Social Security benefits are linked to inflation and guarantee income for life. The payout, or really the effective return, from delaying claiming Social Security retirement benefits is quite a bit higher than buying a private annuity today, so it should likely be the first place the retiree goes to look for additional guaranteed income.
Buy an immediate annuity
If you’re already collecting Social Security and are still worried about the risks of longevity and inflation, you’ve got options. A pure life immediate or deferred income annuity is an ideal tool to mitigate longevity risk, says Michael Guillemette, an assistant professor in the personal financial planning department at Texas Tech University.
According to Guillemette, if you need guaranteed income now, then an immediate annuity, which pays out right away, may be a good option. If, however, you have sufficient assets in your retirement portfolio to pay expenses early in retirement, then a deferred annuity, which pays out later in life, may be a better option, he says. "Annuities are superior to bonds in the academic literature because while bonds pay principal and interest, annuities essentially pay principal, interest and mortality credits,” Guillemette says. “The mortality credits help to mitigate longevity risk as the survivors who die early in the annuity pool subsidize the annuitants who live longer than expected.”
The downside of annuities is that they don't typically protect against inflation risk. Given that, Blanchette says you might consider an immediate annuity with payments linked to inflation or, better yet, an immediate annuity with a fixed cost-of-living adjustment, say 2 percent per year.
If you’re eligible for a traditional pension plan or cash balance plan, that plan will pay you a guaranteed source of retirement income for the rest of your life, no matter how long you live, Vernon says. Don’t, however, elect a lump sum payment if you’re offered that option, he says.
“Such a pension protects you against longevity risk but typically not inflation risk,” he says. “Still, you’re usually better off taking the annuity than investing the lump sum, which subjects you to longevity risk, inflation risk and investment risk.”
Buy Treasury Inflation-Protected Securities (TIPS)
If you don’t want to, or can’t, delay claiming Social Security and you don’t want to buy an annuity, Blanchett says a great investment for inflation, especially today, is Treasury Inflation-Protected Securities, or TIPS. TIPs are bonds, but unlike nominal bonds the principal is indexed for inflation, Guillemette says.