YOU Are the Biggest Threat to Your Retirement Plan

People planning to retire often tell me their greatest fear is running out of money after they stop working. They have a valid concern, but the risk is not really about living too long.

Instead, the issue that could bring calamity is the risk of failing to consistently follow a reasonable retirement plan.

Keep on Track

After people create their retirement plans, the tough part for many is staying the course. That's true particularly when investment returns are volatile and negative. The natural reaction to that kind of market environment is to cut and run. But studies show that investors lose 1% or more on their returns when they are not in the market. This could mean five or more years in lost income.

However, unlike the risk of market returns, which no amount of diversification can fully allay, you can control the “stay the course” risk. All it takes is a little adjustment in your retirement planning, based on a simple premise: Reduce the amount of your income that is subject to the market — or what we call "income volatility."

With preparation, you can reduce your income volatility during retirement by 50% or more. And, with the proper investment, you can get a 20% increase in income that lasts a lifetime.

You can achieve these results with an income allocation plan.

How Income Allocation Works

As I have written previously, income allocation's twin goals are to increase the amount of after-tax (spendable) income and to reduce income volatility (for more dependability).

Here’s an example for two new retirees age 70, and how income allocation compares with a traditional asset allocation plan in which all income comes from withdrawals from savings:

Investor A follows an asset allocation withdrawal strategy and invests 50% in the stock market and 50% in bonds. Her withdrawals are set to last for 25 years, assuming a blended long-term market return of 4.5%.

Investor B follows an income allocation strategy, using both withdrawals from savings and guaranteed lifetime income from income annuities. Some of her savings are used to purchase an immediate annuity with income starting at 70. She also uses a portion to buy deferred income starting at age 85. The balance is invested in a managed portfolio of stocks, bonds and cash, with withdrawals set to last for 15 years.

Unfortunately, soon after the start of the plan, a market meltdown occurs, just like in 2008-09. Investor A, with all her savings in an investment account with no guaranteed income, loses $180,000 in account value. Investor B loses $90,000, but still receives guaranteed income from her immediate annuity. She also has the peace of mind of knowing that income after age 85 is guaranteed for life. Further, Investor B has a managed withdrawal program that takes some of current year’s withdrawals from the cash account. (I am preparing a study on managed withdrawal strategies and will post it soon.)

Who is more likely to stay the course?

Investor B is not happy with the market machinations, but her income allocation plan reduced her income risk, so she sticks with her plan. Investor A is more likely to change course. She might sell during the downturn in hopes of stanching the losses, or she might reduce withdrawals — and her lifestyle — going forward.

Even the most expert adviser can’t protect against volatile markets. But when you consider all possible outcomes and create an income allocation plan as you prepare for retirement, you will be able to weather troubled times in the markets with confidence.