Well-Respected Advice To Stay Away From

Try something radical in your old age.

Make no mistake: Retirement is extraordinarily expensive. How will you generate the income you need? Forget the standard advice you've heard from friends and family.

Much of this advice isn't merely wrong. Rather, it's downright dangerous. Here are three pieces of conventional thinking -- and why it is time to trash them.

1) Life is Short

Retirees may not live like there's no tomorrow. But they often make financial decisions that way. Folks in their 60s are typically way too concerned about dying early in retirement, and that drives them to make foolish choices.

Possibly the most foolish choice is taking Social Security retirement benefits early. You can start Social Security at any age from 62 to 70. The earlier you claim benefits, the smaller your monthly check. Nonetheless, in 2004, 54% of women claiming Social Security were age 62, as were 49% of men.

Sure, if your health is poor, taking benefits early could be the right decision. Even then, however, you need to consider your spouse's life expectancy. Why? If you were the family's main breadwinner, your spouse will likely get your benefit as a survivor's benefit -- and thus it may make sense to delay and get the larger check.

But let's suppose you aren't married and you aren't sure how long you will live. Should you delay benefits or should you claim early? It's no contest: You ought to delay.

True, if you postpone benefits and you die early in retirement, you may get precious little out of Social Security and, as a result, your estate will be a tad smaller. But the risk of dying a little poorer is nothing compared to the risk of being poor and still very much alive.

That, unfortunately, might happen if you live a surprisingly long time and you deplete your savings. At that point, your only income could be your monthly Social Security check -- and the earlier you claimed benefits, the smaller it will be.

2) Preserve Principal

How many times have you heard "never dip into principal" and "never touch your capital"? In truth, dipping into principal may be the best way to ensure you don't run out of retirement savings.

That brings me to some advice I have often doled out in this column: When you retire, consider sinking 25% to 50% of your nest egg into an immediate fixed annuity that pays lifetime income. To give yourself some inflation protection, buy an annuity with payments that are linked to inflation or that are stepped up by, say, 3% a year.

Yet many folks balk at the idea of purchasing income annuities. In part, this reflects the same sort of thinking that spurs retirees to claim Social Security early.

Seniors hate the idea that they will buy an annuity and die soon after, getting scant income in return for their huge investment. You can reduce this risk somewhat by making smaller annuity purchases over the first 10 years of retirement, rather than stashing a big sum in an annuity all at once.

Retirees, however, have another objection to annuities. When you sink cash into a lifetime-income annuity, the money is gone, which violates the rule about "dipping into principal." But dipping into principal and buying the annuity could, in the long run, help to preserve your portfolio.

The fact is, in retirement, your spending will likely exceed your portfolio's after-inflation investment return. In the early years of retirement, this will mean a slow shrinking of your portfolio's "real" value.

But as the years go by, this shrinking will pick up speed, as your need for income climbs along with inflation and as your dwindling portfolio kicks off less investment gains. By your 80s, you may be on the verge of exhausting your savings.

You are less likely to face this sort of financial Armageddon if you purchase an annuity. Not only will your annuity kick off income for life, but also that income means you won't have to draw so heavily on your remaining portfolio. Result: There's a good chance you will die with a decent chunk of your portfolio still intact.

If you opt for the immediate annuity, toss out another piece of conventional wisdom. You might have heard that you shouldn't buy an annuity inside an individual retirement account.

Yes, you wouldn't want to purchase a tax-deferred fixed or variable annuity inside an IRA. The IRA is already giving you tax deferral, so there's not much point in using this money to buy investments that also give tax-deferred growth.

But purchasing an immediate annuity with IRA money can be a smart move. For starters, there won't be any immediate tax bill. By contrast, if you buy an immediate annuity with taxable-account money, you may have to sell stocks to fund the purchase, triggering a capital-gains tax bill.

Moreover, annuity income is taxed as ordinary income, just like your IRA withdrawals. Thus, you won't be generating unnecessarily large ongoing tax bills by purchasing an immediate annuity with IRA money.

3) Buy Bonds

Conventional wisdom says that, as you approach retirement, you should dump stocks and buy bonds. And a little selling may be in order.

Don't, however, sell all your stocks. I believe retirees ought to keep 40% to 60% of their portfolio in a globally diversified mix of stock funds. What about the conventional wisdom? It's built on a faulty assumption -- and it overlooks a major risk.

There is an assumption that retirees are highly risk averse. But, in fact, retirees are often less unnerved by bear markets than younger investors, because they have a lifetime of investing under their belts.

Admittedly, a stock-market crash is a far bigger financial problem if you're living off your portfolio, rather than merely saving for retirement. But plunging stock prices aren't the only risk that retirees face.

Over the course of a 25- or 30-year retirement, inflation could wreak havoc with your cost of living. To combat that risk, you need an investment that will generate healthy, inflation-beating gains -- and that's why you need to own stocks.

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