Thoughts on Investment Strategies for Seniors

Vanguard is definitely my favorite investment company – low fees, no sales pitch, good advice, solid research. Every now and then, Vanguard broadcasts an online webinar. I thought I would let you know what I got out of Thursday’s webinar entitled “What You Need to Know about Social Security, Annuities, and Pensions.”

This is just my take, not an actual summary. At some point, Vanguard will publish a link to the transcript, and when that happens, I’ll post it.

People head into retirement in two basic situations – some have Social Security, plus a pension, plus a portfolio of savings and investments. Others, and this is increasingly the case, have just Social Security and a portfolio. Some are lucky enough to find that their Social Security and their pension meet their monthly income needs. They can afford to be more aggressive in investing their portfolio. But if there is a gap between income and needs, or no pension at all, then it’s necessary to be more cautious in dealing with the portfolio.

The great thing about Social Security and pensions is that they pay for the rest of your life, no matter how long you live. This doesn’t mean that you should take excessive risks with your portfolio, however. Perhaps you would want to put just 10 percent more in stocks than you would have otherwise.

Young people who say that Social Security is not going to be there for them when they retire are being naïve. In the worst case, if Congress takes no measures to solve the system’s problems, Social Security will still pay seventy to eighty percent of promised benefits. But if young people are worried that the worst case might occur, they should save more – which is usually a good idea.

Some investors are drawing down four percent per year from their portfolios because they have heard that this is the rule and what they should be doing. But many, particularly those with Social Security and a pension, may not need to do this. They can afford to preserve their portfolio. They might need it later. Those without a pension, however, may have to start drawing down their portfolio at retirement. They need to plan carefully and work with a financial advisor.

It’s generally a good idea to defer taking Social Security benefits for as long as possible. The benefits you will receive increase about seven percent a year to age 70 if you do this. Of course, if you have knowledge that you’re not likely to live a long life, you might decide to take your benefits sooner. Moreover, there are people age 62 and over who simply need income. If they didn’t take Social Security, they would have to start taking a lot from their portfolio, which is not a good idea. Still, if you can hold out and delay taking Social Security for at least two or three years, that’s a good thing. If you can continue to work for a time, your savings will be larger and so will your Social Security benefit.

Should Social Security be means tested? That’s a policy question, of course, but it’s important to realize that ,in a sense, benefits are already means tested because the wealthy who receive Social Security are paying higher taxes. To some degree, their benefit is taxed back. (A comment from Ray – maybe this suggests that progressives shouldn’t waste time on the means-testing issue. It might be better to focus on other reforms, such as raising the amount of income subject to the Social Security tax.)

On another topic, one good reason to purchase an annuity is to assure that you have guaranteed income for as long as you live. Think of an income annuity as a hedge against longevity. This might be of interest to someone who has just Social Security and a portfolio. Purchasing an income annuity will assure that even if you exhaust your portfolio, you will still have income beyond your Social Security benefits. If you have a pension as well as Social Security, you might not need an annuity. Annuities aren’t for everyone.

If you purchase an income annuity, you are giving up control over a portion of your money. An annuity isn’t an investment, but rather a form of insurance that you buy. Purchasing a $100,000 immediate annuity might give you $7000 in annual income – although the amount will vary slightly from company to company. You should shop around. There is a slight risk that the insurer may turn out to be unsound, although the insurance industry is closely regulated.

Immediate annuities are easy to understand and can be readily purchased from well-known companies. Deferred annuities that only start to pay if you reach a certain age, such as 80 or 85, can also be purchased. Look for qualified longevity annuity contracts (QLACS). The amount you put into a QLAC is not counted when determining the Required Minimum Distribution (RMD) from your IRA or 401(k) after age 70 and a half. In other words, there are tax advantages to a QLAC.

An insurer that sells you an annuity pays you each month out of the amount you put in, the amount the insurer earns on investments, and the amount people who die early have put in. This is known as the “mortality credit.” When interest rates are high, the monthly amounts offered by insurers may be somewhat higher since they are earning more on their investments. But since this is only one component of the payout, it may not be worth waiting for higher interest rates before buying an annuity. This is particularly true if you are holding savings to make the purchase in the money market, where yields are extremely low.

Variable annuities are a different sort of animal. They allow you to keep control over your money, subject to various qualifications, and give you some play in the stock market. But they are likely to come with a strong sales pitch, and to be complicated and difficult to understand. Surrender fees and penalties can be quite high.

You can purchase all sorts of bells and whistles with annuities, such as provisions allowing them to be passed on to a spouse or inherited at your death. But the more such bells and whistles, the less the monthly benefit.

Investing for retirement is not an easy matter. What have been your experiences? Is there something you would advise others to be wary of?

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