INCOME PLANNING FOR THE NEW RETIREMENT

By Michael Falcon of Merrill Lynch

Americans—and baby boomers in particular—are completely redefining traditional views of retirement. Not only are people living longer lives than ever before, they now have the potential for many more years of healthy living in which they can choose to extend or re-invigorate their career. This trend is creating a whole new life stage that previous generations have not had – one that includes a balance of work and active living.

In fact, life expectancy for all Americans increased from 70.8 years in 1970 to 76.9 years in 2000. Americans who reach 65 years of age today can expect to live another 18 years; those who reach 75 should live to see 86. For a married couple at age 65, there is a 72 percent chance that one spouse will live to 90 or beyond.

With more time available during their traditional retirement years, boomers are offered more choices on how to spend their active senior lives, from continuing their current employment, to seeking a new career, to pursuing an entrepreneurial venture. The majority of these boomers are planning to remain active in the work force or plan to continue working in some fashion.

According to 2006 findings from The Merrill Lynch New Retirement Study, 71 percent of Americans between ages 25 and 70 envision working into retirement—and 45 percent of this group say they never plan to stop working. Of those who do plan to quit completely at some point, the average age they plan to cease working is 70.

What age to cease working and what shape their career may take during traditional retirement years is just the first step in the new view of retirement. As part of this paradigm shift, boomers must also rethink certain traditional financial strategies to ensure they have sufficient income to support their lifestyle goals during this newly defined life stage.

Making Retirement Goals More Attainable

At first blush, the ability and willingness to remain in (or return to) the work force for additional years might seem like a boon to individual savings and retirement planning.

The income provided by additional years of work reduces the need to draw down assets, allowing funds in tax advantaged IRAs and 401(k)s to continue compounding, tax deferred. However, longer life spans and varying stages of retirement still require careful planning and the financial resources to navigate these changing patterns of income and expenses without outliving their income. Boomers may be more in tune with these issues than might be expected as concerns about money under lie survey respondents’ anxieties about retirement preparedness.

Traditionally, funds for retirement have been represented by a “three legged stool” of Social Security, pensions and individual savings. According to the survey, possible Social Security cuts are the top retirement concern (cited by 69 percent of respondents), regardless of age. That factor, coupled with the collapse of many companies’ defined benefit plans and uncertainty about future health care costs, helps to explain why 41 percent of all survey respondents do not feel at all prepared financially for retirement.

Inflation is an important factor to consider when evaluating a retirement savings strategy. Even at a relatively benign 3 percent annual rate, inflation can cut purchasing power in half over the next 30 years. At 4 percent, it would only take 18 years to lose half of your purchasing power. In addition, when factoring in healthcare costs—which are apt to continue increasing—a portfolio that is invested primarily in fixed income investments will not likely be enough to sustain someone through retirement because the returns generated are unlikely to provide the growth necessary to outpace inflation.

Setting Income Expectations

In terms of preparing for your next life phase, you shouldn’t focus just on when you plan to retire, but how you plan to retire since your retirement is likely to be unique to you and to have multiple phases.

As a starting point, consider your answers to the following questions:

• How long do you plan to continue working and what kind of compensation do you expect?
  
  
• What activities and hobbies do you plan to pursue?
  
  
• Realistically, what income level will you need to support your lifestyle in these different phases of retirement?
  
  
• How do you plan to provide for health insurance and other health care costs?

A good exercise for this analysis is to estimate your expenses over the next 30 years and how these patterns may change as you transition through different phases of retirement. Keep in mind that this does not need to be an exact calculation, but it should include a realistic estimate of your regular monthly bills and include a reasonable allotment for travel, entertainment and emergencies.

Next, write down all of your expected sources of lifetime income—any pensions or annuities and Social Security, and of course a realistic estimate of any employment or business income. As you project these amounts out across different phases of retirement any shortfall between income and expenses will need to be made up from your savings and investments. You’ll need a strategic asset allocation plan that not only meets any gaps today, but also potentially outpaces inflation down the road.

Tailoring Your Financial Strategy

The following strategies can be a good foundation for helping you sustain a lifetime income stream and achieve your optimum retirement lifestyle:

1. Develop a sound asset allocation strategy. Aside from establishing a reasonable rate of withdrawal from your savings and investments, particularly in the early years of retirement, how you allocate your investments across stocks, bonds and cash, can have a significant impact both on the volatility of your investments and on your chances for a successful retirement strategy.
   
   
2. As “The Importance of Portfolio Growth” (below) demonstrates, maintaining some exposure to equities is critical to giving your strategy a good chance to succeed. Investing some portion of your portfolio in equities, although more volatile than bonds and cash, can help provide the growth needed to decrease the risk of you outliving your assets in retirement.
   
   
3. Sell smart. Making decisions about which securities to liquidate—
   and when—is also key. As a general rule of thumb, you should sell securities in taxable accounts first and allow those in tax deferred accounts, such as IRAs or 401(k)s, to continue compounding as long as possible.
   
   
4. Consider an annuity. Purchasing fixed or variable annuities with optional living benefits to guarantee some amount of monthly income for the rest of your life can help provide peace of mind that, regardless of what happens or how long you live, you have a guaranteed floor of income. While you probably shouldn’t rely completely on annuities for retirement income they can be effective tools helping ensure that your basic non-discretionary expense needs are covered.
   
   
5. Time Social Security payments. Another important factor is when you will begin collecting Social Security. If you elect to do so at age 62, your monthly benefit will be considerably smaller than if you wait longer. Remember, too, that if you plan to work while collecting Social Security, your benefits may be reduced. Waiting to full benefit age or even until age 70 will result in a greater benefit which may be an important source of income later in retirement since it lasts as long as you are alive and is indexed to increases in cost of living.

For example, the Merrill Lynch Retirement Income Service simplifies four critical steps of successful retirement income management:

• creating a comprehensive approach,
  
  
• developing a supportive investment strategy,
  
  
• automating and simplifying cash- low management and monitoring results regularly to stay on track.

Armed with this service and the experience of your Financial Advisor you can transition smoothly into this exciting new phase of your life.

The 2006 Merrill Lynch New Retirement Study: A Perspective from Individuals and Employers was released in May 2006. For more information on the study, visit:
www.totalmerrill.com/retirement.

Michael Falcon is Managing Director and Head of the Retirement Group at Merrill Lynch.

Merrill Lynch and its representatives do not provide tax, accounting or legal advice.  Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein. 

Variable annuities are offered by prospectus only. Your Merrill Lynch Financial Advisor can provide you with more information, including a current prospectus that contains more details on the underlying investment options, investment objectives, risks, fees, charges and expenses, and other information on the investments, which you should consider carefully. Please read the prospectus carefully before you invest or send money. All guarantees are based on the claims paying ability of the issuing insurance company. Asset Allocation does not assure a profit or protect against a loss in declining markets.

U.S. Census Bureau, Current Population Reports, p.35, 65+ in the United States: 2005, U.S. Government Printing Office, Washington, DC, 2005.

Kiplinger's Retirement Report, Volume 11, Issue 2, February 2004.

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