In almost 30 years of working in the financial services field, I’ve learned that Wall Street and the big financial institutions are really good at promoting planning ideas that benefit them, and not necessarily you. On the surface, what they say can make a lot of sense, but when you look behind the curtain like the “Wizard of Oz” their advice turns out to be more show than reality.
The following is the first in a two-part series on seven different “lies” that you might be hearing about retirement income planning.
1. You should follow the 4 percent rule.
The 4 percent rule states that if you invest your money in a “balanced” portfolio (defined as roughly 50 percent of your money in stocks and 50 percent in fixed income), you can withdraw 4 percent each year for income and it should last for your lifetime. On the surface, that seems to make some sense. In reality, you need to know that this approach only works when markets are making money.
In the 1980s and 1990s, this approach worked really well. Then again, what didn’t? However, in the 2000s, it completely fell apart. T. Rowe Price has issued a study that details the failure of this approach in the 2000s. (T. Rowe Price Investment Services Inc., Distributor 0297 1/2011)
This rule works great for Wall Street and the big financial institutions as you keep your money invested with them. But how do you feel about your income lasting based on what the markets might or might not do? Surely, we can find better answers than that!
2. A “balanced” portfolio makes sense for a retiree.
This is related to the previous lie, but it has a different slant. Wall Street would prefer that you keep as much money invested in the markets for as long as possible. This is how they make money. But the Putnam Institute recommends a different approach. (https://content.putnam.com/literature/pdf/PI001.pdf)
According to research from the Putnam Institute, a retiree should have no more than 25 percent of their money in the markets, because you no longer have the time to make up for the potential market losses. In other words, the risk of the markets is no longer worth the potential return.
In fact, the Putnam Institute concludes that if you are between the ages of 65 and 85, and if you want to make sure that you protect your principal, take income, and never run out of money, then you should only have 5 to 10 percent of your money in the market. That’s it, no more.
You can be sure that Wall Street isn’t excited about getting this study in your hands!
3. Your IRA (includes 401k, 403b, 457, etc) is a great retirement asset.
This statement would be true if it said “your IRA is a great pre-retirement asset”. The problem is that the moment you retire, this terrific pre-retirement asset becomes the absolute worst account you could have as a retiree. Here are a few reasons why:
• Every withdrawal is taxed at your highest tax bracket.
• Withdrawals often push you into higher tax brackets.
• Withdrawals count against you when calculating how much of your social security is subject to tax, meaning that you pay tax on your withdrawal, and then you pay more tax on your social security income, leading to double taxation.
• It is the only asset you own that forces you to take distributions, whether you want to or not.
• Every time congress increases taxes, your net value decreases permanently.
• After you die, all distributions are fully taxable to your beneficiaries at their highest tax bracket.
Does that sound like a good thing to have during retirement?
Any one of these lies can easily lead you down the road of financial hardship if you don’t know the truth and how to plan around it.
Please be sure to check back next week for the rest of the “seven biggest retirement lies.”