9/14/2011 2:09 PM ET|
Income for life, guaranteed (sort of)
For many retirees, reeling in a check that's reliable and sufficiently large to pay the bills is beginning to seem like an impossible dream. Here's a playbook for today's reality.
"Your check is in the mail."
American investors have seldom seemed more eager to hear those words -- especially when it comes to locking in income for their older years. Ever since the 2008 crash, when Joe and Mary Mainstreet lost faith in the stock market, millions of people have poured their savings into investments that return some kind of regular paycheck, whether bonds, annuities or (for the bold) stocks that pay dividends.
And the hunt for income has only become more intense as the enormous baby boomer demographic bulge reaches retirement age, with some 10,000 boomers turning 65 each day.
Indeed, converting savings into a living has become "the holy grail of every working stiff," says Dan Culloton, the associate director of fund analysis for Morningstar.
And yet, in one of the biggest frustrations facing retirees today, reeling in a check that's both reliable and big enough to pay the bills has begun to seem like a pipe dream. Increasingly, alarmed investors are finding that "guaranteed" payouts offer only penny-ante 1% and 2% returns -- or involve unpalatable risks.
It's hard to fathom, but not that long ago, a soon-to-be-retired couple could scoop up safe Treasury and corporate bonds that paid 7% or 8%. Today, it takes a gambler's heart and a taste for junk bonds to come close to that.
Dividend stocks? On average, they pay barely half of what they did in the 1990s. As for annuities, some widely advertised products pay nothing until the buyer turns 85. And as we all learned this summer, even Social Security, the once untouchable retirement-backup plan, is now in play, a bargaining chip in the ongoing political wrangle over government spending.
Of course, retirement investments have always gone through cycles, and the conditions that are making things so harsh today could change quickly. But advisers say they can't remember a time that was quite so tough for cash-flow hunters -- and it only got tougher after this summer's market gyrations. After all, even the most prudent income-generator can't get far in retirement if his portfolio gets whacked.
Instead, the pros say, a generation whose parents retired on a low-maintenance cushion of bonds and bank CDs needs a new playbook for today's reality.
Bonds and dividend stocks
When it came to turning savings into income, generations of retirees relied on two main pillars: bonds, which gave them a stream of interest payments from loans to governments and corporations, and stock dividends, a share of the revenue of solid, cash-rich companies.
Bonds were seen as an almost-sure thing, because corporations virtually never defaulted or missed a payment (since 1981, the default rate on corporate bonds is under 2%), while the likelihood of a government default was even more remote. As for dividends, they were a staple of stock investing for most of the 20th century, and since 1926 they've accounted for 42% of the total returns from stocks, according to research firm Ibbotson Associates.
The good news is that those sure-thing payments are still flowing; even a nasty bout of political brinkmanship over the debt ceiling couldn't shut off the Treasury stream.
The problem is, the paychecks these days amount to bupkes. Bond interest -- or "yield" -- has skirted record lows, driven down by heavy demand from safety-seeking investors. And dividends have dropped steadily in recent years as well.
Right now, the dividend yield of the Standard & Poor's 500 Index ($INX) sits at 2.2%, barely half its historical average. Though corporate profits have rebounded, many companies are guarding their cash for another rainy day or using it for acquisitions. All that shrinkage has created a painful contrast for retirees. If a couple had retired in 1991 and put $1 million in 10-year Treasury bonds, they would have received annual payouts of around $84,000. A couple trying the same maneuver this summer would reap only $22,400 a year.
That same million invested in the S&P 500 would have generated about $57,000 in dividends in 1982; today it's more like $22,000. Factor in taxes and inflation, and investors in either scenario could be effectively losing money.
"You're getting your pocket picked," says Mark Kiesel, the global head of corporate bonds at investment giant Pimco.
Interest-rate increases in the United States could actually help some income investors, by giving them a chance to buy new bonds with higher yields. But with the economy rocky, that seems unlikely to happen soon, so many investors are looking abroad to find bonds that are less stingy.
William Larkin, a fixed-income portfolio manager for Cabot Money Management, likes inflation-protected bonds issued by foreign governments. The exchange-traded fund SPDR DB International Government Inflation-Protected Bond (WIP) invests in bonds from countries like Brazil and France, and typically yields between 4% and 5%; its yield will go up if inflation rises near São Paulo or the Seine.
In the dividend universe, the average yield for emerging-market stocks sits at a shareholder-friendly 2.6%. For those who'd rather invest onshore, sector strategist Nicholas Bohnsack, of investment advisory firm Strategas Research Partners, likes cash-rich U.S. companies that have signaled plans to increase their dividends, including tech stalwarts Cisco Systems (CSCO, news) and Microsoft (MSFT, news). (Microsoft is the publisher of MSN Money.)
Build a ladder: Investors can help protect their bond income from inflation by setting up a "bond ladder" -- essentially, a portfolio of short-term bonds that lets them gradually replace low-yielding bonds with higher-paying ones if interest rates rise. Advisers warn, however, that the strategy tends to work only with portfolios of six figures or more, and that the frequent trading involved can generate high transaction fees.
Don't take every TIP: Inflation-protected bonds, whose yields rise when inflation climbs, were designed to help investors weather rising rates. But rates are so low in the United States that some TIPS -- the Treasury Department's version of the bonds -- currently have negative yields. For now, some advisers are steering assets toward inflation-protected bonds issued by foreign governments; these days, some of them yield more than 5%.
Shop the world: Many foreign companies have seen their earnings grow faster than those of their U.S. counterparts, and they're giving more back as dividends. The average emerging-market stock now pays a yield of 2.6%, a more generous rate than the S&P 500. Dividends in Europe are even higher, but investors like David Ruff of the $6 billion Forward Funds think Europe's economic woes make those stocks a risky bet.
Look beyond the dividend: A regular check isn't the only way a dividend-paying stock can benefit retirees. Recent research by Michael Goldstein, a finance professor at Babson College, shows that dividend stocks as a group outperform nonpayers over time, in both up and down markets. Goldstein points out that dividend-paying companies tend to be more financially sound, which may account for the outperformance.
Social Security and pensions
It felt a bit like amputation without anesthesia, but Americans eventually got used to the decline of the private-sector pension. Over the past two decades, the number of defined-benefit plans offered by employers fell by two-thirds, to 48,000 in 2008, and a new generation of retirement savers learned to manage their own nest eggs. Still, it came as a shock to many this summer when President Barack Obama and Congress proposed cutting Social Security while grappling with an out-of-control debt load.
After all, even affluent retirees rely on federal checks for about a quarter of their income, advisers say. The Social Security Administration says the average recipient gets about $14,000 a year from the program. A retiree who made more than $100,000 a year toward the end of her career could wind up collecting more than twice as much.
Suffice it to say, the thought of losing even part of that safety net makes retirees (and their planners) reach for the Maalox. Evelyn Zohlen, a money manager at Inspired Financial of Huntington Beach, Calif., whose clients include several retirees, estimates that if someone's expected Social Security benefits were reduced by $1,000 a month, that person would have to save an additional $180,000 to $205,000 before retirement to make up the difference.
For now, actual cuts in benefits have been kicked down the road, and it's likely that any changes will have the greatest impact on people who are under 50 today. But one change under consideration for all recipients would revise Social Security's inflation-adjustment formulas.
Dean Baker, the director of the Center for Economic and Policy Research, says that, in practice, many retirees would see smaller inflation increases. That galls some critics who believe benefits already fail to keep up with retirees' costs. Federal beneficiaries didn't receive an inflation-related increase in their benefits in 2009 or 2010, for example, but over that same stretch, Medicare premiums rose 15%. (The Social Security Administration says its benefit increases track an index of inflation that didn't rise in those years.)
Still, investors and their advisers are starting to grapple with the unthinkable: coming up with at least a partial Social Security replacement. For many, that means relying more heavily on bonds and annuities, which have pitfalls of their own. Others are biting the bullet and investing more aggressively in other assets.
To help retirees deal with inflation, Mark Cortazzo, whose Parsippany, N.J., financial advisory, Macro Consulting Group, oversees $600 million, has begun hedging clients' portfolios with floating-rate bonds, whose payouts rise when interest rates do. Also popular: foreign bonds, which pay higher interest rates and are sometimes insulated from economic problems in the United States.
And many advisers think that if Social Security becomes less generous, retirees may have to invest more aggressively in stocks and other higher-risk assets -- anything to give that portfolio a chance of continuing to grow.
Whip inflation now: Some retirees complain that Social Security benefits already do a poor job of keeping up with inflation, especially where health care costs are concerned. To combat that problem, investors can hedge their portfolios with assets like floating-rate bonds. Some stocks and commodities also tend to do well when inflation spikes, although they can have some very volatile ups and downs.
Don't panic about income: Some investors, worried about their pension benefits, have put too much money in short-term cash-generators like bonds and annuities -- not a great strategy right now, says money manager Zohlen, "when income sources are such stinkers." She and other advisers are reminding their clients to keep their portfolios diversified, with assets like stocks that are oriented for long-term growth.
Wait to cash in: Even if lawmakers do cut Social Security benefits, they're expected to keep current rules that entitle workers to higher payments if they wait longer to collect. For a man who's currently 62 (the minimum eligibility age), waiting until age 66 to retire rather than retiring right now would increase his monthly benefit by 36%. Waiting until age 70 would increase it by 83%.
Annuities and all-in-one funds
Annuity providers offer a sales pitch that's hard to resist in a time of alarming markets: In return for an investor's lump-sum payment, annuities offer a lifetime paycheck that's more or less guaranteed. In recent years, more investors have drunk the Kool-Aid: Since the beginning of 2008, Americans have poured $342 billion into fixed annuities, according to Limra, an industry trade group.
But as many new customers learn, the annuity promise comes with off-putting fine print. To get the top payout, customers must agree to forfeit their lump sum when they die, even if they pass away before collecting much. If they want an heir or a spouse to recover money, retirees have to accept smaller paychecks. And annuity assets are mostly invested in bonds, which means their payments are distressingly low right now. The result: A 65-year-old man who put $100,000 in an immediate annuity this summer would be getting 12% less income annually than he would have if he'd bought five years earlier.
To get around this stinginess, some investors exploit a quirk in the annuity business -- the longer you wait for payments to begin, the less you have to fork over up front.
Michael Davis, a financial consultant in Jacksonville, Fla., says he builds his clients a kind of annuity ladder: They tap a new annuity every five years, gradually increasing the size of their payout. "We're buying time," Davis says.
Retirees who fear their savings will last a while but not long enough can also buy "longevity insurance" -- an annuity that in many cases won't kick in until the investor is 85. On its face, the concept sounds odd: "Pay us now and you won't see a cent for 30 years!" But if a 55-year-old couple wanted an annuity from the Hartford that would pay $2,000 a month starting at age 85, they'd owe $36,500 right now for the product -- 84% less than they'd owe for a policy that offered the same benefits starting at age 65.
Some analysts think fixed annuities will keep gaining traction because they're an all-in-one product that doesn't require consumers to make choices.
Many investors have gotten used to just that, in the form of target-date funds, which now have $361 billion in assets -- more than four times as much as five years ago. These funds were supposed to take the guesswork out of investing, by reallocating money from stocks to bonds as investors aged. But the funds don't include any automatic mechanism that allows retirees to convert them to income. To help with that transition, some fund companies in recent years launched "managed-payout" funds, designed to turn assets into an income stream.
So far, however, those products haven't caught on widely. The real danger with all-in-one investments, says Robert Pozen, a senior lecturer at Harvard Business School and a former executive at fund company MFS Investment Management, is that "you're under the illusion you're being taken care of, so you don't have to think."
Go "fixed": Variable annuities, which combine an annuity with mutual-fund-style investments, are lucrative for financial-services companies -- annual fees average 2.5% -- and they're often pitched to high-earning boomers. But even planners who like these products say they're better for building up savings than for turning them into income. For the latter, cheaper fixed annuities are often the better option.
But watch for better deals: Because interest rates are unusually low, many annuities are currently issuing smaller-than-average checks to policyholders -- a potential problem if inflation surges. Investors can hedge against inflation by buying deferred annuities, which start paying later but pay more generously. There are also annuities whose payments rise with inflation, though investors in those products have to accept lower payments up front.
Play the long game: For near-retirees whose nest eggs are good but not great, some annuity providers are pitching "longevity insurance" -- annuities that cost little up front but may not start paying you until you're 85. Dallas Salisbury of the Employee Benefit Research Institute says he bought such a policy in part because both his parents lived to be 94 -- he sees it as a safety net for the last years of his life.
X-ray your target-date fund: Target-date funds get more conservative with time, moving money from stocks to bonds. But there are huge differences in how each fund defines "conservative." According to Morningstar, current bond allocations among 2010 target-date funds, whose investors planned, in theory, to begin retiring in 2010, range from 32% (too low for risk-averse retirees) to 89% -- which may be too much at a time when bond yields are low.
This article was reported by Reshma Kapadia and Elizabeth O'Brien for SmartMoney.
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I paid into SS for over 40 years...
Wish our government had not replaced Our SS money with an IOU..stolen..?
Also don't think Illegal's in the USA should be able to get a dime of it....
Why are Illegal's in America..?...thats breaking United States laws....?
j j m ciny: I have read your post, found it to be very interesting ! However I do not agree with your thoughts.
So you think the " baby boomers" are the generation to blame for the mess bestowed upon this great nation, so what about the greatest years of progress this nation has seen, ( in the years of the baby boomers) what about the fourty- fifty
years of work and paid income taxes, state taxes,,sales taxes, property taxes medicare and S.S. taxes and so on. Does that not matter now that we may be retired ? We have paid our dues into the system for many years, and now you say we are asking for handouts.
You are inept in your assestment that the "boomer" is at blame and the people you are referring to is the middle and lower class workers, not the billionaires,millionaires,big corporations, big banks, bail-outs- which we will never get back and overspending of the government that you have elected in the pass four terms.
That ( my friend) is why our economy is in shambles and our jobs have been shipped over seas!
If you voted in the election of one or more of the past and present governments then you can share the blame. Do not put all the blame on "boomers" though we share the blame.
So the baby boomers inherit worlds greatest economy and in 20 years ruin it by moving all the production offshore to save money and now this writer is suggesting that these same people take whatever they have left and invest it in foreign companies and nations to make a higher yield on their retirement savings.
I hope you people realize what a mess you've left for your children and grandchildren. You've left them with a bankrupt government, a bankrupt retirement system that your expecting us to carry, a health care system that is in shambles, a collegiate system that forces a young man or women into great indebtedness to obtain a degree that often has little value and no factories left to support us.
We've now had three baby boomer presidents who all have a less than stellar track record and the congress, primarily made up this same generation, is in near total gridlock.
The generation that came before you was entitled by someone the "greatest generation" . My guess is history will not look nearly as kindly on the Boomers.
there is no such thing as "articles".these are glorified advertisements...as is ALL of the content on these so called news websites..its all data mining, tracking, sucking up to the ad dollars
this is yet another shill piece.....just to pacify their advertisers......scotttrade.e-trade.etc
ANNUITY IS NOTHING BUT A RIP OFF FOR THE INSURANCE COMPANIES THAT SELL THEM.
WHY WOULD SOMEBODY SAVE THEIR MONEY FOR MOST OF THEIR LIFE AND TURN AROUND AND GIVE IT TO AN NSURANCE COMPANY TO GIVE IT BACK TO THEM IN BITS & PIECES. ITS LIKE COOK YOUR FOOD & THEN ASK SOME BODY TO SPOONE FEED YOU WITH YOUR OWEN FOOD.,
I have found that one's own business, if it is normally successful, can provide income well into retirement. No one should sell a good business just to retire. Get a partner to do the work if you can, and let them buy you out over time. Stocks are still the best investment, provided you pick the right ones. Market swings can be hedged by you if you have two investment accounts, one dormant until it's short time in a down market. This will minimize losses in the long account when you don't have time to stop out right away. Options work too, but you should develop that skill solidly before trying it.
I think what the article is saying is diversify your income sources. If you have a pension, great, but don't rely on it completely. If you're getting SS, great, but same caveat. I read a study that tracked how to finance your retirement with the least chance of running out of money at some point and it was a mix of pension/SS, annuity, and stocks/bonds. Don't have just one.
Social Secutity could work, the biggest mistake was to allow the politicians to stick their hands in the pot, with promises of payback. Now there is no money to pay back and there is nobody to be responsible for the money they took or how it was spent. Many people became rich with that money but for the ones who paid there is just one thing to say "we are sorry"
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