But what if things you never anticipated happen? Retirement Test Drive lets you make those adjustments, and repeat your test drive. With the revised analysis, you can reconsider your retirement plans and make the necessary adjustments.

Retirement Test Drive: Case Study 1

Dr. Rusty Scalpel and his wife had just been working with their advisor on their retirement and estate planning. Much of the planning dealt with estate planning manners, as their retirements seem to be well funded. In fact, he had worked closely with the advisor to consider exactly when to retire. PlanLab’s Estate Tax Analysis was used to formulate an estate plan. Then Retirement Test Drive was used to see how it would work and the advantages and disadvantages of various retirement dates. The whole process was being finalized. Then the economic crisis of 2008 occurred.

Rusty and his wife became very concerned—would their plans still work? Should they take their losses and convert everything to cash? Did their plans allow time for the market to recover? Should they start over? It was time to take another Retirement Test Drive.

Their advisor modified their plan to reflect the current values of their investments and retirement plans. The results were favorable; the program showed that even after adjusting the values for the current market losses of almost 40% in the past year, their plan could still provide for the lifestyle spending they desired.

But October 2008 was a very scary time. Had the economy reach bottom? What would the new president and new Congress do? At what point would their plans not work?

The advisor, using alternative scenarios with their Retirement Test Drive analysis, made additional changes. The cost of living assumptions were adjusted upward in the event of increased inflation in the future. Values of investments and retirement plans were set to twenty-five percent (25%) of their 2007 values. Retirement Test Drive showed that their plans still could support their desired retirement lifestyle through year 2040, although their net worth would be significantly decreased and the net to heirs would be somewhat decreased. Rusty and his wife now felt confident that their plans did not need to be changed at this time.

Retirement Test Drive, with its scenario “what-if” planning features, can reassure clients when things change. Its graphics (Illustration 1) makes it simple to see the effects of changes. The second illustration (Illustration 2), using Monte Carlo Simulations, showed that the probability of success for the first ten years was about the same in both scenarios, but that continued success after that were less. The advisor was able to put some of their fears to rest—they did not need to make any immediate changes.

Retirement Test Drive: Case Study 2

Take the case of Robert and Andrea. Their planning had required considerably more adjustments in the initial planning. Using Retirement Test Drive last year, they were able to make a number of adjustments so that their retirement lifestyle could be met. They had not prepared for retirement to the degree of the Scalpels in the prior sample. However, they were able to make the adjustments that could meet expenditures for many years. Of course, in October 2008 their advisor received their panic phone call, “What should we do?”

By adjusting the values for the current market conditions, and using the revised scenario, they were able to retake their Retirement Test Drive. The results showed that for the next eight years (8), their plans would continue to work. However, unless the market recovered some of its recent losses, adjustments would have to be made. Again, a simple graph (Illustration 3) was used to show Robert and Andrea the effects of the current conditions on their plan. It showed when the shortfalls were likely to occur. By retaking their Retirement Test Drive from time to time, they would know when changes would be necessary.

Retirement Test Drive is not just a great tool for analyzing retirement plans, but it is a great tool for restoring a clients’ confidence in their retirement plans.  Retirement Test Drive can be used with any plan developed with one of PlanLab’s analysis tools. Retaking a Retirement Test Drive lets you see how your plans work in a world of changing conditions.

The answers must consider individual situations, but a few basic concepts should always be considered before making decisions to each question.

Should I take my money out of my 401K Plan?

If you take your money out of your plan, it is subject to income taxes. Paying taxes on the decreased values will increase your losses. If you are under 59 ½ you may pay an additional 10% penalty tax. You can avoid the taxation by rolling over to an IRA, but that generally provides no advantage to leaving it in the 401K. Unless the money is immediately needed for another reason, you should not take it out of the plan.

Should I change investments in my 401K?

If you are close to retirement, say within five years, you definitely want to reexamine your asset allocation to be sure you are not too heavily invested in stocks. If you are already retired, you want to be sure that the portion, from which you are taking your retirement income, is in very conservative investments. In most cases, if your investments are diversified, you should consider leaving them as they are. If you move them to a low risk investment now, they will not be able to recover. The more time you have between now and retirement, the longer you can wait for the values to recover.

Should I continue to make contributions to my 401K?

Yes. First, you always want to take advantage of any employer match—it is free money. For example, if the employer matches $.50 for each dollar you contribute, that’s like earning 50% after taxes for each matched dollar. Regardless of economic conditions, you should always contribute up to the amount that the employer will match.

The other reason that you want to contribute is called dollar-cost-averaging. This principle always works to your advantage, but it is especially advantageous when the market is down— like it is now! Here’s how dollar-cost-averaging works. My making monthly contributions, you purchase shares based on their value each month. If the price per share goes up, you get a few less shares that month. If the price goes down, you get a few more shares. Proportionately, you get more additional shares when the price goes down than you give up when the price goes up. Consider the example in the chart below.

$100 is contributed each month. The first month the price per share is $5, so 20 shares are purchased. The price goes up the next month to $6 per share. The $100 buys 16.667 shares. The third month, the price is back to $5 and 20 shares are purchased. The next month the price drops to $4 per share, so you receive 25 shares. If the price returns to $5 the next month, 20 more shares are purchased. You now have a total of 101.667 shares worth $5 per share for a total of $508.33. It is easy to see that the average price paid per share was $5. Had all $500 invested been invested at the average price, you would only have had 100 shares worth $500. Systematic purchasing with varying prices allows you to do better than the average.

Let’s continue the prior example, but this time let the prices go really low. This time, the price continues to decline to $1 per share. It would be easy to get discouraged when the price has fallen so low and values so low, but continuing to contribute each month until the market has reversed, provides substantial gains. In this example, dollar-cost-averaging has produced 30% more value than would have been earned buying the stock each month at the average price.

If we had lost our nerve when the price reached $1 and quit making monthly purchases, we would have only had $1,325 when the market had recovered.

For someone who is a number of years from retirement and has time to let the market recover, dollar-cost-averaging can make this economic crisis a “blessing in disguise.”

Photo credit: m kasahara

Companies and advisors, who used Retirement Road Map from Impact’s PlanLab®, last year, can reassure their clients that their retirement plans are fine. Retirement Road Map recommends time horizon investments by retirement phases. The two images are pages from Retirement Road Map that explain investing by phases and time horizons (click to see full size).

Investing by Phases

Investment Time Horizons

Consider the case of Sam and Sara. They retired October 2007 when they were both age 65. They wanted to know how much should be invested, and how it should be invested to provide their desired retirement income.

Retirement Road Map Assumptions:

On the first anniversary of their retirement in October 2008, the country was in for a big shock. Sam and Sara found that there very conservative investments, from which they were withdrawing their retirement income was just about what was expected. But, the conservative investments had lost 10% of their value, their moderate investments had lost 20% of their values, and the aggressive investments had lost 30% of their values.

You can tell Sam and Sara that they should continue to make their regularly scheduled withdrawals. A plan that invests by phases and time horizons is design to allow market recovery over an entire phase. Even after what were larger first years loses than ever anticipated, they don’t have to make any immediate changes. With a few simple calculations, you determine that if the very conservative investments continue to earn 2%, and each of the other classes of investments average earning an extra 1 ¼ %, then their plan will continue to support their planned income through age 100. Their retirement plan allows for slow recovery, so there is no need for drastic adjustments.

Retirement Road Map uses conservative assumptions that are about half of the twenty year averages. Assuming slight increases in the assumptions are reasonable. Combining conservative assumptions with investing by phases and time horizons makes retirement plans secured. Plans don’t require major adjustments while in retirement – even when the completely unexpected happens.

Don’t your retirement clients deserve to have a retirement plan that takes advantage of the market and higher returns, but in a way that minimizes frequent adjustments and retirement income worries? They deserve a retirement plan made with Retirement Road Map.