Annuities and the Other Side of the Retirement Savings Coin

Help your clients achieve their financial goals for their golden years.

January 2009
by Richard Marcus and Glen Janken/Journal of Accountancy

Like many of their clients, CPAs tend to consider the problem of retirement planning solved once they develop a plan for accumulating savings during the client’s working years. But as recent events have shown, panics and bear markets can add another dimension to the equation. Moreover, there is another side to the retirement savings coin, the post-retirement side, when clients must figure out how to make their nest eggs last as long as they do. The planning necessary to solve this problem differs from the planning that creates the nest egg.

Indeed, when retirement begins, people face entirely new financial problems, most of them stemming from the fact that, given better health and ongoing improvements in longevity, they are likely to live longer than retirees in the past and, hence, will need their assets to last longer, too. What’s more, the ordinary market corrections that, depending on your client’s exposure and risk, might cause relatively minor setbacks during the accumulation stage can wreak havoc in retirement, when the individual is least able to recover.

Consider, for example, what might befall the individual who retires with a $1 million nest egg at the beginning of a “down” year, as has been the case recently, during which the assets in his or her investment portfolio fall in value by 20 percent. Take away an additional $40,000 for living expenses and this individual has $760,000 left at the end of the first year — that is, a nest egg worth 76 percent of what it was when retirement day dawned. A gain of seven percent in the second year, less $40,000 in withdrawals, brings the nest egg up to $773,000. But if values fall by five percent in the third year, assuming the same $40,000 in living expenses, this individual now has only $694,000.

It is an axiom of financial planning that systematic investing, compounding and dollar-cost averaging can work wonders during the accumulation phase. But the lesson here is clear. Once retirement begins, the vagaries of the markets, coupled with the retiree’s need to withdraw money from an investment portfolio to pay for living expenses, can have an effect exactly the reverse of dollar-cost averaging, with unhappy results. This makes it imperative that financial planners not close their files and exit the scene when clients reach retirement. Instead, they must help their clients figure out how to manage their savings so that they need not fear running out of money before they die.

This article has been excerpted from the Journal of Accountancy. Read the full article here.