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How to fund a mountain of cash for retirement

Many people do not recognize that strategies that helped them while they were building wealth can actually increase risk during the distribution phase.

Baby Boomers entering the distribution phase stand to lose a significant portion of their retirement savings if they do not employ proper exit strategies.

Even at a three per cent annual inflation rate, the spending power of your money will be cut in almost half in 24 years.

This means that you will need twice as much money in your last year of retirement as in your first in order to maintain your lifestyle. That is a daunting thought.

Now you need to make the transition from savings accumulation to savings disbursement, and devise a retirement income strategy for the money you have been accumulating.

Depending on your citizenship and where you choose to relax and enjoy the rest of your days, look at a number of key issues what experts call Life Income Solutions:

Access to potential stock market gains while protecting your principle.

This income can increase with a rising stock market but not decrease when the stock market declines. A guaranteed five to eight per cent annual lifetime stream of income, based on age, with or without annuitisation.

Tax exemption for life insurance. Estate tax exemption. Hedge your retirement sav ings with currencies.

Dollar decline
Many people have not felt the recent decline in the dollar because the rest of the world, especially Asia, has either cut prices or tied their currency to the value of the dollar.

However, if you travel to Europe, you will get a real shock at how little the dollar buys these days.

What about in the future? We worry about having enough dollars to retire, but what will those hard-earned dollars be worth in the years ahead? It is enough of a concern to contemplate investments in different currencies as small portion of your funds and hedge your bets.

"Next time you pull a dollar out of your wallet, take a closer look. Yes, you'll need lots of them when you retire. And hopefully those dollars will be worth enough to pay for your retirement," says Terry Savage, a contributor at TheStreet.com.

Gold is the traditional hedge, but these days it has become easier for investors to diversify into other currencies.

There are investment alternatives for more conservative, long-term investors.

Just remember that hedging your bets does not mean going overboard. These are ideas for a small portion of your assets, depending on your risk tolerance.

Phased retirement can be a useful financial planning tool, for example, if you want to ease back gradually on work and start to replace your earnings with pension income.

It also provides more flexi ble help for your survivors if you die.

Annuities and retirement planning
You can arrange most personal pensions as a single plan, or as a cluster of many separate plans, sometimes called "segments".You can use these segments to buy a lifetime annuity at different times.

This process is called "phased retirement".

Each time you convert a segment to an annuity, you can first take part of the segment's fund as tax-free cash.

You must convert enough segments each time to buy an annuity.

Insurance firms often set a minimum fund size for annuity purchases. An annuity can often be a great addition to your retirement portfolio.

Some reasons to invest in an annuity:
Your investment earnings are tax deferred as long as they remain as part of the annuity.

You do not pay income tax on those earnings until they are paid out to you.

An annuity is free from the claims of your creditors in most states. If you die with an annuity, the accumulated value will pass to your beneficiary without having to go through probate.

Your annuity can be a reli able source of retirement income, and you have some freedom to decide how you will receive that income.

You do not have to meet income tests or other criteria to invest in an annuity.

You are not subject to an annual contribution limit.You can contribute as much or as little as you like in any given year.

You can typically postpone payments until you need the income.

Understand your annuity payout options. Keep in mind that payments are based on the claims-paying ability of the issuer. Be sure that the payments you receive will meet your income needs during retirement.

Some of the commong payput options are:
You surrender the annuity and receive a lump-sum payment of all of the money you have accumulated.

You receive payments from the annuity over a specific number of years, typically between five and 20.

If you die before this "period certain" is up, your beneficiary will receive the remaining payments.

You receive payments from the annuity for your entire lifetime.You can't outlive the payments (no matter how long you live), but there will typically be no survivor payments after you die.

You combine a lifetime annuity with a period certain annuity. This means you receive payments for the longer of your lifetime or the time period chosen.Again, if you die before the period certain is up, your beneficiary will receive the remaining payments.

You elect a joint and sur vivor annuity so that payments last for the combined life of you and another person, usu ally your spouse. When one of you dies, the survivor receives payments for the rest of his or her life.

However, before you sign on the dotted line, you must remember annuities are not for everyone.

Here are some potential drawbacks:
Once you have elected to annuitise payments, you are locked in. There is no flexibility to change your payment amount or make discretionary withdrawals over and above the payment amount.

Your annuity issuer may impose a surrender charge if you withdraw your money within a certain number of years after your original investment. You may have to pay other out of pocket costs when you invest in an annuity (for example, annual fees, investment management fees and insurance expenses, among others).

Investment gains maybe taxed at ordinary income tax rates, not at the lower capital gains rate.

Retail theraphy
Shop around for the right annuity. In fact, doing a little homework could save you hundreds of dollars a year or more. Why? Rates of return and out of pocket costs can vary widely between different annuities. Look for a reputable, financially sound annuity issuer. There are firms that make a business of rating insurance companies based on their financial strength, investment performance, and other factors. Check out these ratings.

If you have an illness or medical condition that means you do not expect to live as long as a healthy person, the insurance company might offer you a higher annuity rate. Some companies offer higher annuity rates for smokers and people with specified health problems or who have worked in certain industries. These are called "enhanced" or "impaired life" annuities.

You do not have to buy an annuity with your pension fund at retirement. An alternative to buying an annuity will be to draw an income directly from your investment fund. This is called "phased income withdrawal", and carries more risks than buying a lifetime annuity, because the whole fund remains invested and so the income it will provide is not guaranteed.

Bond loader
You may consider an alternative like a laddered bond strategy. A bond ladder is a strategy that attempts to minimize risks associated with fixed-income securities, while managing cash flows for the individual investor according to their financial situation.

A bond ladder is a multi-maturity investment strategy that diversifies bond holdings within a portfolio. It also helps manage the flow of money, ensuring a steady stream of cash flows throughout the year.

A bond ladder is the name given to a portfolio of bonds with different maturities. By taking the total dollar amount that you are planning to invest and dividing it equally by the total number of years for which you wish to have a ladder, you will arrive at the number of bonds for this portfolio, or the number of rungs on your ladder.

The greater the number of rungs, the more diversified your portfolio will be and the better protected you will be from any one company defaulting on bond payments.

Suppose you had $100,000 (Dh367,000) to invest in bonds. By using the bond ladder approach, you could buy five different bonds each with a face value of $20,000 (Dh73,400) or even 10 different bonds each a with face value of $10,000 (Dh36,700). Each bond, however, will have a different maturity. One bond might mature in one year, another in three years and the remaining bonds might mature in five-plus years each bond will represent a different rung on the ladder.

You can guarantee yourself a monthly income based on the coupon payments from the laddered bonds by picking ones with different coupon dates. This is more important for retired individuals because they depend on the cash flows from investments as a source of income. If you are not dependent on the income, by having steadily maturing bonds, you will have access to relatively liquid money. If you suddenly lose your job or unexpected expenses arise, then you will have a steady source of funds to use as required.

With the current spotlight on asset allocation and wealth preservation, laddered bond portfolios offer balance, safety and attractive yields in a comprehensive investment portfolio. In the face of interest rate changes and roller coaster market upswings and downturns, they can act like a shock-absorber to ease volatility and generate higher yields.

By Sandi Saksena

© Emirates Today 2007