Three Risks to Your Retirement Income - and Three Ways to Help Protect It

For years, you worked, saved, and invested in order to have a comfortable and secure retirement. Now that you've made it, your focus now turns from growing your nest egg to living off of it.

Just as you faced risks when accumulating your wealth, you now face risks when drawing from your wealth for your retirement expenses. Whether it's falling stock prices, rising inflation, or running out of money, these risks can impact your cash flow and the quality of your retirement. Here are three retirement income risks that you could face, and some strategies you can use to help protect yourself and your retirement cash flow.

RISK #1: Retiring in a down market. Individual investors have no control over the direction of the market. That's why retiring in a down market is a real risk for many retirees. A decline in the value of your retirement portfolio, whether it's a sudden drop or gradual erosion, could put a crimp in your cash flow during retirement.

To address this risk, you might consider putting some of your money in an immediate fixed annuity that can provide enough steady income to cover your essential expenses. With these annuities, payments will usually begin immediately after you have made your premium payment, and the cash payments will not fluctuate with changes in the market. The payments can also be structured to provide income over your lifetime or for a period of years. Immediate annuities are sometimes suited for single people, or for married retirees that are looking for an increased cash flow and are not concerned about leaving the unused account balance to younger family after death.

RISK #2: Outliving your savings. As individuals live longer and spend more time in retirement, the odds of outliving your savings increase. Retirees face a real risk of drawing down their savings too quickly and leaving their retirement savings depleted later in life.

In response, you might consider a deferred annuity (either variable or fixed) with a portion of your savings. This can help to provide you with a source of income to cover your daily living expenses during retirement.

Fixed deferred annuities can provide the annuity owner with a predictable stream of cash flow to meet daily living expenses. These payments can last for a period of years or can be paid out over a lifetime or even the joint-lifetimes of a husband and wife. Most companies offer interest rate guarantees, which vary from company to company. The initial guaranteed rate could range anywhere from 3-5%, and the rate will typically vary according to company involved and the duration of the contract. (AnnuityFYI.com June 20, 2005). Some companies also offer increases in the interest rate for premium payments above a certain amount. Earnings in a fixed annuity can also accumulate on a tax-deferred basis, which means that you do not pay an income tax on the earnings during the accumulation period. For this reason, the earnings of your annuity will also not affect your social security income during the accumulation period.

Variable annuities are different from fixed annuities that are invested primarily in government securities and high-grade corporate bonds. Variable annuities enable you to invest in a selection of investment accounts, known as sub-accounts. Available investment choices inside these accounts include money market accounts, US treasury bonds, stocks, and mutual funds to name just a few. The equity investments inside the sub-accounts can provide a possible hedge against the inflationary risks discussed below.

Similar to the other annuities we just talked about, any earnings that are made from variable annuities can potentially accumulate on a tax-deferred basis. Unlike fixed annuities, however, variable annuities are subject to market risk and your account balance will increase or decrease in value, depending upon the market performance of the sub-account investments.

It is important to recognize that fixed and variable annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts from each of these annuity types are subject to income tax and, if taken prior to age 59 1/2, a 10% federal tax penalty may apply. Early withdrawals from both of these annuities may be subject to withdrawal charges. Variable annuities are sold by prospectus only, and investors should read the prospectus carefully before investing. Annuity guarantees are also subject to the claims-paying ability of the issuer.

RISK #3: Falling behind inflation. The rising cost of living can hit some retirees particularly hard. To keep pace with inflation, your income must continue to grow, even during retirement. In addition, health care costs can be expected to rise at a faster rate than inflation.

In response, you might consider keeping a portion of your retirement savings invested in equity market investments, such as publicly traded stocks, seeking long-term growth of capital. In many cases, stocks have good potential to keep pace with inflation over the long term.

Research conducted by Ibbotson Associates (Ibbotson yearbook 2005) found that between 1925 and 2004 stocks outpaced inflation by a wider margin than any other asset class (Of course past performance is not a guarantee of future results). Of course, stock are subject to market risks, and your investment may increase or decrease in value.

Note: Mutual funds are investments involving risk and are offered by prospectus only. Investment return and principal value will fluctuate so that upon redemption an investor's shares may be worth more or less than original value. An investor should carefully consider the investment objectives, risks, charges and expenses of a fund before investing. The fund prospectus contains this and other information about the investment company. For a copy of a fund prospectus, please contact your financial advisor. Please also read the fund prospectus carefully prior to investing.