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How To Tap Your Nest Egg -- And Not Go Broke


After years of cajoling baby boomers to invest for retirement, the financial-services industry is gearing up to advise people on how to spend their nest eggs without going broke. Along the way, the firms hope to attract some of the estimated $300 billion the boomers are expected to transfer annually from employer-sponsored retirement plans as they leave their jobs -- plus whatever other savings and investments they've accumulated.

At the core of the new offerings is investment guidance designed to maximize the chances your money will last as long as you do. The programs also estimate how much you can afford to spend in retirement and counsel you on how to tap your accounts to minimize tax bills.

Some of the new services come with sophisticated cash-management tools. For example, Fidelity Investments' Income Management Account and Merrill Lynch's (MER) Retirement Paycheck Service, slated for launch in early 2006, can track your income and spending. They'll also monitor the value of your investments and issue warnings when your portfolio falls short of your financial plan. The products offer other conveniences as well, such as automatic bill payments.

With some retirement services on the market and many more in the works, BusinessWeek decided to test-drive three: the programs from Fidelity and Merrill Lynch and a six-year-old competitor from T. Rowe Price (TROW) called Retirement Income Manager. Since our staff is still too far from retirement to use these tools -- the ideal T. Rowe Price candidate, for example, is within two years of retiring -- we asked the firms' financial planners to crunch numbers for a fictional New Jersey couple, the Smiths, who currently earn a combined $200,000 a year and are both about to retire. Because the Smiths are fairly well-off, we figured they could afford to retire early -- she's just shy of 60 and he's a bit over -- without doing any part-time work. At first, they won't be eligible to collect Social Security. But they will receive an annual company pension of close to $30,000.

We gained insight into the difficulties of balancing a budget in retirement. With an annual income of $200,000, the Smiths, we figured, were used to a comfortable lifestyle. So we gave them a yearly budget of $10,000 for travel, more than $2,000 for clubs and hobbies, and $6,000 for entertainment and restaurants. Combined with daily living expenses -- including mortgage payments, property taxes, home and auto insurance, maintenance, groceries, and health-care costs -- the grand total came to about $9,000 a month. We also gave the Smiths a $2 million portfolio. We put more than 70% of it into stocks, with the rest divided between bonds, cash, and other ultra-conservative investments.

Unfortunately, we learned that the Smiths' $2 million retirement nest egg wouldn't support that lifestyle -- never mind the $500,000 we had hoped they could leave their heirs -- even when supplemented by Social Security and a pension that together are worth almost $60,000 a year. In fact, Fidelity, Merrill Lynch, and T. Rowe Price all warned us that at this level of spending, the Smiths would run a substantial risk of depleting their assets. All three services project to at least age 90. Why? Because if both members of a couple make it to 65, there's a 50% chance at least one of them will live to 92, according to Fidelity.

WORKING PAST 65

The financial planners offered various trade-offs to improve the Smiths' odds of achieving financial security in old age. Working longer is one option. Merrill, for example, gave the Smiths a greater-than-90% chance of having enough money to last on our proposed spending plan (adjusted for inflation) provided the husband -- the bigger breadwinner -- postpones retirement until age 65.

The firms' investment recommendations had substantial differences (table). Merrill Lynch advised the Smiths to put 50% of their money into equities -- nearly the same as T. Rowe Price's 54% target. But Fidelity's stock allocation was 70%. "Based on their time frame and risk tolerance, we felt that was the more optimal portfolio," says David Olsen, our Fidelity adviser. While all three counseled the Smiths to cut spending, Merrill gave them the green light to withdraw $8,961 a month from their investments in the first year of retirement while Fidelity held the line at $4,822 a month and T. Rowe came in at $5,802. (Each forecast assumes the Smiths will retire early and is designed to give the couple at least a 90% chance of having enough money to last their entire lives.)

Why the differences? For one thing, Fidelity assumes health-care expenses will rise 7% annually, with most other expenses increasing by 2.16%. But T. Rowe Price and Merrill use a single inflation rate -- 3% and 2.5%, respectively. The plans also cover different time periods. Merrill projects five years beyond average life expectancy -- to age 90 in this case. To provide some extra insurance, T. Rowe Price targets age 95. Fidelity plans to age 92 for men and age 94 for women. T. Rowe Price's projections assume you'll shift to a more conservative asset allocation over time, while Fidelity's and Merrill's don't. (You can ask them to change their default assumptions.)

Fees vary. Investment plans are free at Fidelity and Merrill. T. Rowe Price charges $500, although that fee is waived for those with $1 million or more at the firm. Those with $250,000 or more of assets at T. Rowe Price get free annual reviews.

The plans we tested have different strengths and weaknesses. Here are some factors to consider:

Handholding. Nearly all of these products require you to work with a financial adviser. What that means varies. At Merrill, you can sit down with someone face-to-face. At Fidelity and T. Rowe Price, you can do so at an investor center. (Fidelity has 103 nationwide, while T. Rowe Price has 11.) Otherwise, advisers and clients communicate by phone and e-mail. And at T. Rowe Price, one adviser will craft your plan, while another adviser may handle the periodic reviews.

If you want to draft your own investment and spending plan and are a Fidelity client, you can log on to Fidelity's Web-based Retirement Income Planner. It took us about two hours to input all the requested information, including the Smiths' projected income and expenses. In general, the program is user-friendly. But we relied on our financial adviser for help in navigating some of the more sophisticated features, including an expense tool that permits you to vary estimates from year to year.

Thoroughness. Each program we tested starts with a questionnaire that asks you to estimate retirement income and expenses. You'll also have to disclose the contents of your brokerage, bank, tax-deferred, and other accounts. Fidelity's questionnaire was by far the most detailed and time-consuming. Its budget worksheet alone asks for 43 entries, covering everything from mortgage payments to Internet access fees. (For those who lack the time or already have a budget worked out, there's also an abbreviated version.) In contrast, T. Rowe Price's questionnaire simply asks the "amount of desired monthly pretax income" the Smiths will want to withdraw from their portfolio. Our T. Rowe Price counselor, Robert Matricardi, says advisers typically work with their clients on budget projections.

Portfolio Customization. You may think you're getting individualized investment advice. But the services we tested fit clients into one of a preset menu of "model" portfolios. At Fidelity, there are six, while T. Rowe Price has 13. Merrill offers five, each with two versions -- one with alternative investments, such as real estate investment trusts and hedge funds, and one without. Which portfolio you land in depends in part on how you answer questions about your risk tolerance. Fidelity asks just two questions, while Merrill lists nine.

Recommended Funds. Both Fidelity and Merrill build portfolios from their own funds and those of rivals. Fidelity picks from among 4,500 funds, while Merrill's universe encompasses more than 3,000. Fidelity advised that we dump the Smiths' current portfolio, including Fidelity Growth & Income (FGRIX) and Fidelity Select Technology (FSPTX) funds. Instead, the firm selected nine funds that passed its screens for above-average performance and below-average fees. Among them are three Fidelity funds: Fidelity Export & Multinational (FEXPX), Fidelity Short-Term Bond (FSHBX), and Fidelity Mortgage Securities (FMSFX). (If you prefer to hold on to an investment, the services will plan around that.)

T. Rowe Price sticks mainly to its own funds. All three firms recommend you consult a tax adviser to assess the tax impact of a sale.

Plan Monitoring. Fidelity's Income Management Account and Merrill's Retirement Paycheck Service can track your income and spending, while frequently updating your portfolio's value. They'll also warn you if any of these deviate from your financial plan. They work by routing all your income -- Social Security and pension checks, as well as interest and dividend income -- into a single account held at the firm. Any money you spend should also be withdrawn from this single account.

These two services have shortcomings. They can track the value of accounts held at other companies. But they can only look inside those accounts to see the actual holding if the firm where the assets are housed permits it, Fidelity says.

The services have a lot of frills, too. Fidelity will notify you if your Social Security check is late, your taxes are due, or you're up against a deadline to take a distribution from a tax-deferred account. Merrill has a version of Paycheck that can estimate your quarterly tax payments. Ask about fees. For example, Fidelity charges $6.95 a month for bill payment, although the fee is waived under certain circumstances. While the overall cost of the service is $50 a year at Fidelity and $125 at Merrill, it's easy to satisfy requirements that'll get those fees waived.

At T. Rowe Price, there's less monitoring. Clients transfer the amount the service calculates they can afford to withdraw from their investments for the coming year to a money market account. While the firm will update your financial plan annually to assess how you're doing, it will do so only for the portion of your assets held at T. Rowe Price.

These services can help retirees generate a stream of income for life -- no simple task -- in an era in which finances depend more on investment savvy than on a predictable pension check. But they're only as good as the assumptions they make. So before signing on, make sure you're comfortable with your plan's assumptions regarding longevity, future expenses, inflation, and the like. You don't want to risk running out of money because of faulty estimates.

By Anne Tergesen


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