Planners look at the critical zone in the five years before and after retirement.

    Patricia Barrett, a financial advisor with Lifetime Planning LLC in Houston, recently illuminated one of the mistakes that people can make when planning for their retirement-a case of water, water everywhere, and nothing to drink.

"I've got a recently retired individual going through a divorce, and his financial planner put all his liquid assets in annuities-a million and a half in variable annuities," she says. "Now, as a divorced individual, I don't know where to find him income, because his money is locked up. He will have to pay fees to get his own money out. A man with a million and a half in annuities and nothing to live on. I can't believe his financial advisors did that. We're cashing in his life insurance cash value, about $150,000, for first-year expenses."

There are other horror stories, too. Of course tales run rampant about those who had their savings wiped out by the 2001 bear market. Or had money tied up in their company's stock (an object lesson of the Enron scandal).

Prudential Financial put out a report in 2006 christening the five years before and after retirement as the "retirement red zone," a time of critical decision making when newly freed workers are free to make dramatic blunders affecting their golden years. The Society of Actuaries identified 15 risks people face in the period right after they receive their gold watch-including the financial effects of living longer, the daunting challenges of higher health-care costs, the risk of inflation (and its corollary of lost purchasing power), as well as the risk of stock market shocks.

The latter is one of the most misunderstood risks, as downturns in the first few years just after retirement can be much more devastating than those farther out. "Losing 29% in the 29th year out of 30 is not as devastating as losing it in the first year out of 30," says Michael Kitces, with Pinnacle Advisory Group Inc. in Columbia, Md.

It's an important time because their clients make decisions irrevocable in nature, ones that will dog them for another 30 years. Choices based on emotion, lack of education and procrastination.

"I think it's a critical time because of compounding," says William Garrett, president of Garrett Financial LLC in Brentwood, Tenn., who specializes in cash-flow management issues with retirees. "And if a person takes a disproportionate amount out of savings in the first few years, it can make a drastic difference in how much they have to work with, given the typical average rate of returns on assets later on. It's much better to have a larger pool in the beginning to grow out of, and take less out of it, than to do it in reverse."
Because of the importance of the money in the earliest years, Garrett thinks it's important to often supplement those savings with extra income so they don't erode at this critical time. And yet, the time right after retirement is usually the time when people want to travel and splurge.
As Garrett sees it, human longevity has been both a blessing and a curse: Retirees might be looking at a longer, more fulfilling life, but they'll also need their retirement assets to work longer and harder. And ironically, the plan is often to move into bonds-the kind of strategy meant for a shorter time horizon, not a long one. Still, if you tell retirees that they should be in equities-maybe by as much as 50% to 75%, according to some studies-it's more than they can bear.

"If you have a second-to-die expectancy of 25 years, the after-tax return on bonds is equal to inflation," says Don Mulvihill, managing director at Goldman Sachs based in Chicago and a portfolio manager of the Structured Tax-Managed Equity Fund and the U.S. Equity Dividend and Premium Fund. "If the goal is to provide something for spending while also keeping up with inflation, bonds won't do it."

Getting Emotional

It's the rash decisions that are the most important things planners say they have to manage around this time. "Clients who were dependable and did everything you asked for ten years are suddenly more emotional," says G. Joseph Votava Jr., president of Nixon Peabody Financial Advisors LLC in Washington, D.C. "You must check in with them and make sure they're doing what they said they were going to do."

However, the picture of retirement has changed, too. Many people don't want to go sit on the porch, but keep working, maybe find something that interests them more. Though many want to travel, they might get that out of their system in a year or two. This means they could be willing to earn more income and shore up the money they need to work harder in those crucial first years, because after that they face the later years and the looming shadow of higher medical bills.

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