Retirement Investment Instruments
The defining feature of retirement is the end of income from full-time work. This is the one constant in retirement, unchanging from start to finish. We may associate retirement with old age, uncertain health and flagging vigor, but the fact is that age, health and vigor may vary across a wide range throughout retirement. It is the loss of full-time income that is constant.
The consequences of this status for the suitability of the various financial instruments are dramatic.
Individual stocks might be the bedrock upon which retirement wealth is built. Once retirement is reached, however, they are a dubious retirement investment instrument. Perhaps the most widespread retirement investing mistake is holding a preponderance of wealth in company stock. The greatest companies in American history have suffered precipitous declines in share price and many of them have failed outright. With no earned income to replenish portfolio losses, the retiree must keep safety of principal uppermost in mind. This precludes investment in individual stocks for most retirees.
Increasing life expectancy at age 65 has been a leading demographic phenomenon in the latter 20th century. Not only has the average life expectancy increased, the variance has also increased, meaning that more people are living into their 90s and beyond. This, together with the looming off-stage presence of inflation, has made growth a necessary preoccupation in early retirement. The way to combine growth with safety of principal is by securing the diversification and professional management offered by mutual funds. It is also feasible to take income from a mutual fund portfolio, although prudence requires withdrawing no more than would be earned in interest on a bond portfolio of equivalent size.
Mutual funds should comprise the bulk of investment assets in youth and middle age. In retirement, they should represent no more than a significant minority of a portfolio. A rule of thumb on Wall Street has long been “100 – the investor’s age” to determine the portfolio fraction devoted to equities in retirement. This represents the upper limit of aggression in the choice of retirement investment instruments.
Mutual funds and individual stocks have important advantages for tax and estate planning. Their gains can be taxed as long-term capital gains rather than ordinary income – that is, at 15% rather than the higher rate associated with the investor’s particular tax bracket. Upon death, the tax basis of the stock or fund is stepped up to the date of death, thus (probably) saving heirs a bundle in future capital-gains taxes.
Bonds are well-suited to retirement investing. As senior credit instruments, their principal is comparatively safe. Many bonds are rated; their safety can be gauged. Their periodic coupon interest payments dovetail with the income needs of retirees.
Unlike the situation with stocks, individual bonds are safer than bond funds. Individual bonds will return the principal invested at maturity, barring default. A principal investment in a bond fund will fluctuate in value with changes in interest rates. Only investment-grade corporate bonds or government bonds should be chosen.
The only big drawback of bonds in retirement investment is their vulnerability to inflation. The fixed coupon payments represent fewer and fewer dollars of effective purchasing power when all of most prices are rising. In recent years, governments have issued inflation-indexed bonds to try to remedy this shortcoming. These retirement investment instruments are not a panacea because their market prices should increase to reflect investors’ expectations about inflation. Their real value lies in protecting against unexpected inflation and even hyperinflation.
Don't Just Shop, Implement a Solid Retirement Strategy
Purchasing an annuity is a big decision. Online research is a good start, but prudent investors should discuss all their options and risks with an independent financial advisor. Request a free, no-obligation consultation today, along with a report of current rates on brand-name annuities.Speak with an advisor over the phone about annuities for FREE.
The core purpose of annuities is to provide guaranteed income for life. This makes them a perfect fit for retirement. The retiree no longer earns income and needs it; an annuity provides guaranteed lifetime income. The retiree fiercely safeguards the principal that throws off the income; a life annuity with a highly-rated insurance company is among the safest of all investments. Moreover, the tax deferral of annuity investment gains in a deferred annuity is an effective tool for the accumulation of wealth for retirement.
Annuities are tailor-made for retirement not only structurally but legally. Withdrawals prior to age 59 ½ are subject to a 10% penalty levied by the IRS. Surrender charges, usually levied on a decreasing scale for up to 10 years or even longer, penalize withdrawals beyond the minimum liquidity allowance established in the annuity contract.
The ideal time to purchase the annuity is a decade or so prior to anticipated retirement – in the case of a deferred annuity – or coincident with retirement – in the case of an immediate annuity. This allows time to outlast surrender charges and accumulate and grow savings into a sufficient capital sum. The realized rate of return on an annuity depends on how long the annuitant lives to enjoy it. Lengthening of life expectancies makes annuities a better retirement investment instrument with the passage of time.
Every ointment, no matter how curative, draws flies. Annuity gains are taxed upon withdrawal at ordinary-income rates rather than the long-term capital-gains rates applied to stocks or mutual funds. Annuities also lack the stepped-up tax basis that makes stocks and mutual funds effective estate-planning tools. Thus, individuals for whom estate planning is paramount should ponder carefully before resorting to annuities.
Certificates of deposit issued by banks meet two key criteria for retirement investment instruments. They are safe because they enjoy FDIC insurance protection up to the limits established by regulation. They throw off income because investors can arrange to take out interest payments rather than reinvesting them. There is a third criterion on which CDs come up short, however; namely, liquidity. In the vernacular of banking and finance, there is a “substantial interest penalty for early withdrawal.” Retirees usually live on a fixed (non-augmentable) income. They may have sudden and unexpected need for cash, not only for the usual reasons but also for health or travel reasons. Thus, liquid assets take on a special meaning for retirees. The last thing a retiree needs is to have to take a substantial bite out of principal in order to get access to ready cash.
There is nothing wrong with CDs as a retirement investment instrument provided that sufficient liquidity exists elsewhere in the form of a reserve cash or cash-equivalent fund. Retirees should probably shorten up maturities on CDs as a precaution against a sudden liquidity crisis. In the meantime, there is a superior alternative as a source of ready cash in emergencies.
Money Market Funds
Money-market funds are interest-bearing accounts that are fully liquid and even checkable. They are superior to CDs as a source of liquid funds to meet contingencies because they have no surrender charges and can be treated like cash. They are extremely safe and make an ideal parking place for cash, either as a reserve or in between investments.
Time-deposit savings accounts are covered by FDIC insurance but carry penalties for early withdrawal. Low- or no-fee, interest-bearing demand-deposit accounts are a superior alterative for retirees.
The range of retirement investment instruments is the same as that open to younger, employed investors. The difference in circumstances and perspective of the retiree changes the emphasis from growth to income and safety. Liquidity also ranks high among the objectives of retired investors. This preference set argues in favor of investments such as annuities, bonds and money market funds.
To find the best annuity products request a free, comprehensive quote comparision. Secure your retirement today, Get Started Now.