When it comes to the best way to invest for retirement, most families are focused on all the wrong numbers, such as rates of return, fees and net worth. In the final analysis, the most vital issue is whether you will have a sufficient, dependable stream of income that you cannot outlive.
OneAmerica Financial Partners recently commissioned a study by Wade Pfau, professor of retirement income at the American College for Financial Services. He concluded that a strategic combination of life insurance, annuities and traditional investments could provide the best way to invest retirement money.
Where to Invest Retirement Money
This study on how to invest retirement money included two couples, one 35 and one 50. Each family started with $15,000 per year in gross income to build their retirement fund. In one scenario, each took a more traditional approach of buying term insurance and only investing in a 401(k), and a second approach used a combination of a 401(k), whole life insurance and a single-life income annuity.
Some significant difficulties came to light regarding the traditional approach. Specifically, sequences of return risk, inflation and longevity risk combine to present an unacceptable level of threat to both principal and earnings.
Sequence of return risk is the risk of poor market returns in the early years of retirement that deplete funds, resulting in reduced retirement income. Longevity risk recognizes the potential for retirees to outlive their resources.
Weighing these risks in light of simulations that follow the concept that no more than 4 percent of your account balance should be withdrawn annually from traditional investments, Pfau’s study found it unlikely that either couple could support a reasonable lifestyle.
Related: How to Update Your 401K
The Winning Strategy: Whole Life, Single-Life Annuity and a 401(k)
The winning strategy included purchasing a whole life insurance policy that would be paid up at age 65 and purchasing a single-life annuity at age 65, maximizing the annuity payout. The whole life policy insures the person assigned the single-life annuity benefit.
The remainder of the annual $15,000 was invested, via the 401(k), in relatively safe, traditional market instruments. This strategy was most beneficial for both couples, regardless of the 15-year investment window difference.
If the person with the annuity lives a long life, the family will have regular income from the annuity the entire time. If the person assigned the annuity benefit passes away, the whole life policy death benefit will be used to purchase another single-life annuity for the remaining spouse, thus ensuring an uninterrupted stream of retirement income.
In addition to the annuity payments, each couple also withdrew 3.5 percent annually from their 401(k) account. For the younger couple, the study showed a 40 percent increase in annual retirement income over the traditional 401(k) and term insurance approach, and it was a 45 percent increase in annual income for the 50-year-old couple.
The estate value for the heirs of both couples also increased. The 35-year-old couple realized an increase of 228 percent, while a 451 percent increase in estate value was achieved for the 50-year-old couple by age 100.
With the assurance for stable lifetime income in conjunction with the inflated estate values for heirs, the strategy goes a long way in addressing where to invest retirement money.
How to Invest Money Wisely
“Losing money can be disastrous to people that are relying on that money for retirement,” said Vance Howard, CEO of Howard Capital Management. “In 2000-2002 and 2008, we saw that people couldn’t retire because of drops in the market. Personal savings were cut by over 40 percent. Losses like that are devastating to a retired person.”
Howard Capital utilizes a strategy called tactical money management. The focus isn’t to chase a rate of return but to minimize the effects of sudden and/or drastic market downturns. For example, the goal is to capture 80 percent of the rate of return as the market goes up, while avoiding in the range of 80 percent of the market decline during downturns.
“Protecting your money is paramount and very much achievable with this strategy,” he said. “It’s hard to retire when you lose a large portion of your money. This strategy protects your capital while allowing for a solid return, based on market performance.”
He said tactical money management gives the money manager the ability to move your portfolio to cash once or twice a year if he sees that the market is declining. The money manager isn’t concerned with daily fluctuations but is more concerned with corrections of 10 percent to 20 percent.
How to File for Social Security
Another vital piece of the retirement income puzzle is how and when to file for Social Security. With more than 500 ways to file, this issue can make retirement planning seem overwhelming. According to the Government Accountability Office, 42 percent of people file for Social Security at age 62. For most families, delaying Social Security could significantly increase Social Security benefits and the strength, longevity and number of options for their other retirement accounts.
A Journal of Financial Planning study by William Meyer and William Reichenstein quantified delayed Social Security benefit payments to determine the effect on the longevity of retirement portfolios. By delaying from age 62 to 64, 66, 68 or 70, a retiree with $1,000,000 in retirement assets and just $1,500 per month in Social Security could extend their portfolio’s longevity by as much as five years.
A Secure Stream
There are many schools of thought on the best way to invest retirement money. However, when a secure, lifetime stream of income is of high value, a strategic combination of products that provide safety, longevity of income and potential for asset growth can prove to be the most productive course.