Pre-retirees looking for return of principal — not return on principal

The 2008 global financial crisis provided a financial wake-up call to investors. The vast majority of pre-retirees now say they are more cautious in their approach to investing and are far more likely to seek financial peace of mind rather than pursuing potentially higher — but riskier — returns, according to the AIG Retirement Re-Set Study released Monday.

An online survey of more than 3,400 adults age 55 and older found that 80% are seeking a safer and more predictable road to retirement than before the financial crisis.

“While the stock market and economy have somewhat rebounded, the confidence that many Americans once had has diminished,” said Jay Wintrob, president and CEO of AIG Life and Retirement, one of the largest issuers of annuities and life insurance in the U.S. “People are now looking for stable, lower-risk strategies that will provide the income and security they need in retirement.”

The survey respondents were asked to rank “ideal” retirement investments or insurance. The results: Guaranteed not to lose value snagged the top spot at 67%, followed by products or investments that protect income from market loss and guarantee income for life (62%); provide guaranteed rising income (58%); provide income to my family if I died or become disabled (50%); and have potential to provide higher returns, but has a higher risk (19%).

Pyschological fallout

“While there has been a great deal of discussion about the economic impact of the past few years, this survey revealed that the psychological impact was also substantial,” said Ken Dychtwald, CEO of AgeWave, a market research firm that focuses on the impact of aging on a variety of industries. “Many people are adapting a new retirement mindset and are choosing to work a bit longer, thereby helping to make retirement more affordable,” said Dychtwald, who has collaborated with AIG on the retirement surveys since 2001. “They are re-setting their sights on a revised, more achievable path to retirement.”

While more than half of the respondents said they feel less financially secure than they did just a year ago, the 30% of pre-retirees in the survey who work with a financial adviser said they feel better prepared for retirement than they did last year. They listed the two greatest benefits of working with an adviser as having a greater understanding of their long-term financial goals and peace of mind.

New Mantra Needed

But Rick Rodgers, founder of Rodgers & Associates wealth planning firm in Lancaster, Pa., says many pre-retirees may be asking themselves the wrong question when evaluating their retirement readiness.

Rather than trying to determine if they have saved enough, they should focus on whether they have saved appropriately. “Saving everything in tax-deferred accounts is one of the biggest problems I see in retirement planning,” said Rodgers, author of The New Three-Legged Stool. “Maybe it’s going to take something like the fiscal cliff and fear of higher taxes next year to get people to focus,” Rodgers added.

Just as investors need to diversify across a variety of asset classes, they should also diversify the tax treatment of their future retirement income by contributing to Roth IRAs and non-qualified investment accounts in addition to traditional tax-deferred retirement accounts so they have more flexibility when it comes to tapping those savings in retirement.

The original concept of stashing as much money as possible in tax-deferred retirement accounts was based on the assumption that most Americans would be in a lower tax-bracket once they stopped working. But that may not be the case. “Taxes probably won’t be coming down in the future,” Rodgers said. “Defer, defer, defer should not be the mantra going forward.”

One of the best things individuals can do is convert some of their traditional retirement savings to a Roth IRA before the end of this year to take advantage of current tax rates. If Congress doesn’t raise income tax rates, or if investors change their mind about the wisdom of the move, they have until October 2013 to undo their Roth conversions without tax consequences.