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Spending retirement cash can be fraught with tricky calculations

For some, having adequate income in retirement may mean working longer.

Associated Press/File 2013

For some, having adequate income in retirement may mean working longer.

Even if you’ve socked money away in your 401(k) plan and invested it carefully, some of your toughest decisions lie ahead. And don’t expect much help. Strategies for drawing down lump-sum accounts in retirement — more important than ever in the 401(k) era — get little attention from the government and employers. Yet for retirees, choices about how to spend a life’s worth of savings are fraught with tricky calculations about financial risk, taxes, and death.

Jim and Sue Cleary, both 69, are living through that now. They have a home in Florida and a second one in Michigan that keeps them close to five of their nine grandchildren. But Jim Cleary says he knows they won’t be able to maintain this lifestyle indefinitely.

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The Clearys have cut out vacation cruises, but they’re spending down their savings, aware they may eventually have to sell one of the homes. Sue Cleary is confident in their T. Rowe Price Group plan; it has 60 percent of their assets in stocks and mutual funds. Still, she recognizes they are spending a bit too much. ‘‘That’s kind of the main concern I have — are you going to outlive what you have?’’ said her husband.

It’s a worry echoing across the baby boom generation. Its first retirees, who lean heavily on 401(k)-style defined-contribution plans, are learning on the fly to do what pension managers did for their parents.

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Yet the standard formula, squirreling retirement savings into bonds or certificates of deposit, doesn’t necessarily work in an era of increased longevity and depressed interest rates. Men who reach 65 will live another 17.9 years on average, while women will live 20.5 years, according to 2012 data from the Centers for Disease Control and Prevention.

The Clearys are more fortunate than millions of Americans who are reaching retirement without enough savings. They have a clear financial plan, two years of cash available, long-term care insurance, and Social Security and pension income. At the same time, they’re not wealthy enough to focus solely on estate planning. They’re now steering their way through a challenge that requires morbid thoughts.

Spend now to enjoy healthy years and risk running out of money? Or scrimp for a tomorrow that may never come — or come only when they’re too infirm to savor it?

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The drawdown phase is a retirement topic that’s attracted little notice. Young workers get clear, simple advice: Save as much as you can. Create a diverse investment portfolio and hold on. That should yield a pile of assets. But when it’s time to take from that pile, retirees are often overwhelmed by choices and tax consequences.

The government helps workers save money in tax-deferred accounts, but offers little guidance on when it should be spent. The requirement for annual distributions from tax-advantaged accounts simply depletes the money.

‘‘There’s sort of a money illusion when you have a big lump sum of money sitting in your 401(k) account,’’ said Jonathan Forman, a law professor at the University of Oklahoma. ‘‘You think you’re rich.’’

For a 65-year-old man, $100,000 buys an annuity that pays $572 a month for life, according to Hueler Investment Services. That’s often not what people see, however, and sometimes they don’t think about the income taxes they’ll owe.

‘‘We see situations where people at retirement look at this monster lump sum compared to, say, their annual income and they figure: There’s no way I can ever spend all this money,’’ said David John, a policy adviser at AARP. ‘‘I may as well do something that’s a luxury.’’

The government has taken limited steps to ease the spending-down phase of retirement. Still, John said, a ‘‘clear direction’’ is lacking.

Minimum-distribution rules, which make retirees take taxable payouts starting at age 70½, can cause problems for people who live longer than average. For some, the rule acts like an income stream, because it’s designed to mimic life expectancy. Without a policy to ensure the tax break is recouped, the tax deferral would turn into an exemption and retirement accounts would become an estate-planning technique for wealthy households.

This year, the Treasury Department created a partial waiver to the required minimum distribution rules for people who purchase longevity annuities, those that don’t start paying out until age 80 or 85.

The Labor Department has been looking at requiring 401(k) providers to show people how long their money will last, which many providers already do. It said in 2013 that it would propose formal rules; it hasn’t done so yet.

President Obama has proposed eliminating the required distribution for people with account balances of less than $100,000, to simplify the system and save taxpayers $484 million over the next decade. That proposal has stalled.

Another issue: The minimum distribution tables haven’t been updated since 2002. Since then, average life expectancy at age 65 has increased by 10 percent for men and 7 percent for women.

For an individual, however, the right decision on how much to withdraw depends on lifestyle, risk tolerance, and life expectancy.

The hottest debate is over the role annuities should play, with the Government Accountability Office and Treasury Department nudging some Americans toward that kind of insurance.

The key question: Should retirees continue the do-it-yourself approach by switching to more conservative investments and making routine withdrawals? Or should they turn over some money to an insurer that will create an income stream that will last as long as they do?

‘‘People are living longer and obviously . . . they’re going to need that money spread out, and they’re not necessarily planning for that,’’ said Jim Poolman, executive director of the Indexed Annuity Leadership Council.

Annuities often carry high fees, and today’s historically low interest rates depress payout rates. Also, Social Security already creates a steady income stream for many people.

Annuity providers have responded to the criticism in part by adding features to their products. They aren’t as simple as before, with a lump sum up front and a monthly payment until death. Some offer continued exposure to equity markets. For a price, others allow retirees to ensure their heirs get a partial return of the premium as a way to hedge against the risk of early death.

Annuities are also available in some 401(k) plans, though that’s still rare.

Beyond annuities, retirees face a much different set of challenges than they did while working. Their lifestyles can be damaged for decades by a few bad years of investments just before or after they stop working — with little chance to recover.

And retirees, especially those who can’t go back to work, have to think about inflation, what they want to leave to their children, and how much they will have to spend on health care.

Those retiring at 65 will pay an average of $220,000 for health care, excluding nursing home and long-term care costs, according to a Fidelity Investments survey.

Things are complicated by older workers’ tendency toward caution when investing and a lack of preparation on retirement spending, said Janice Scherwitz, a Florida benefits specialist. ‘‘They are probably going to have to end up being in the workforce a lot longer than they would like.’’

And then there’s the touchiest, most important issue of all: ‘‘People are undercalculating the level of risks and longevity they need to save for,’’ said Sri Reddy, at Prudential Financial. ‘‘The age-old question that people are often asked and they seldom have the answer to is: When are you going to die?’’

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