Our most recent generational research report examines the financial strengths and weaknesses of each generation and the opportunities and threats they face. The greatest vulnerability of each generation is not saving enough for retirement, with the most immediate threat to Baby Boomers age 55-64, who are approaching retirement. While a majority of them have never even run a retirement estimator to see if they’re on track to retire, we know what can happen to even the best laid plans when L.I.F.E gets in the way:
L is for longevity. The main challenge in retirement planning is making sure that our money lasts at least as long as we do. The first problem is that we don’t know how long that will be. According to a recent report by the Society of Actuaries, a majority of Americans underestimate their life expectancy. But even using an accurate life expectancy for retirement planning is problematic for a couple of reasons. First, by definition, about half of people will live longer than average. If you’re in good health, your odds are greater. Second, advances in biomedical technology could mean rising life expectancies. In fact, some experts even recommend planning to live to 120 or older.
I is for inflation. The second challenge is that the cost of almost everything we buy will likely be increasing over time, reducing the real value of our wealth and income. With the Federal Reserve pumping so much money into the economy with QE and the possibility of further money printing to pay for the national debt and accelerating costs of our entitlement programs, many financial experts are predicting rising inflation rates.
F is for fluctuation. Market volatility can not only keep you up at night, it can devastate your portfolio in retirement, especially negative returns in the early years. That’s because withdrawals can force you to sell more of your investments while they’re down in value, leaving less in your portfolio when the market eventually recovers. Take this example from Deena Katz writing in the Wall Street Journal:
“two investors — both with the same $1 million portfolio — each withdrew $62,000 per year adjusted for inflation and each earned, over the ensuing 30 years, 7.6 percent per year. The only substantive difference was their first year return. Unfortunate “Investor A” retired in a bad year and his portfolio was off 10 percent while lucky “Investor B” received 29 percent the year he retired. For the next 28 years each received 7.6 percent and the last year A earned 29 percent and B lost 10 percent, bringing them back to even. Unfortunately, A would have run out of money in 22 years while B, in 30 years, would have a nest egg in excess of $1,500,000. The point is, in retirement, timing is everything and careful planning must take this into account.”
E is for events. The biggest being health and long term care costs. Fidelity’s most recent study estimated that a 65-yr old couple will need about $220k to cover out-of-pocket health care costs in retirement while almost half of pre-retirees (age 55-64) estimate they’ll need only about $50k. That’s not even including any future cuts in Medicare needed to keep the program afloat, greater than expected increases in health care costs, and long term care costs. The latter is particularly dangerous since about 70% of people are expected to need long term care at a median cost of almost $84k a year for a private room in a nursing home. Keep in mind that Medicare doesn’t cover long term care costs and Medicaid requires you to spend down your assets to a poverty level to qualify.
So what to do? Here are some steps to consider taking if you’re within a few years of retirement:
1) Make sure your portfolio is properly diversified. The last thing you want is to see your nest egg get scrambled just before you retire. At the same time, being too conservative may not give you enough growth to reach your goals. The key is to have a balanced portfolio that protects you from a severe downturn while also maintaining enough growth to at least keep pace with inflation. The simplest way to do that is with a target date retirement fund that serves as a fully-diversified one-stop shop, which gradually becomes more conservative as you get closer to your retirement date. If you’re looking for more customized advice that can coordinate your retirement accounts and taxable accounts, consider an online investment advisor like FutureAdvisor or Jemstep. The former provides specific recommendations at no cost and both provide ongoing investment management using low cost vehicles for a relatively low fee.
2) Purchase long term care insurance. A lifetime of smart saving and investing can be wiped out with a few years in a nursing home. Even if you’re relatively young and in perfect health, you’ll want to make this a priority. First, you never know when an accident or injury can happen. Second, a future health condition can make long term care insurance much more expensive or even impossible to qualify for. Finally, you’ll want to know the premium costs so you can factor it into your retirement budget.
3) Pay off your debt. While it can make financial sense to maintain a mortgage and contribute savings to tax-sheltered retirement accounts while you’re working, paying off your mortgage in retirement can improve your cash flow. That’s because you’re unlikely to generate enough income to make the mortgage payments from what it would cost to pay off the balance. Just be sure to keep enough savings set aside for emergencies and be careful to avoid making large retirement plan withdrawals that can force you into a higher tax bracket.
4) Estimate your pension and Social Security income. Get projections of any pensions you’re fortunate enough to be eligible for and Social Security benefits. (This calculator can help you figure out how to maximize your Social Security benefits.) Finally, you can calculate how much of your Social Security will be taxable and reduce your Social Security and pension payments by your effective federal and state income tax rates.
5) Estimate your expenses. Start by looking at your actual bank and credit card transactions to see your current expenses and record them on a worksheet like this. Then think about how your expenses could change. For example, your mortgage and other debts may be paid off and you may spend less on clothing, eating out, and transportation but more on health care, travel, and entertainment. You may also want to consider ways of reducing your expenses.
6) Run a retirement estimator. Once you have your numbers above, enter them into a retirement calculator like this to see what the odd are of running out of money during different historical time periods. Be sure to use a long time horizon to hedge against a long life span.
7) Determine your income strategy. You’ve spent your whole life accumulating assets but retirement is about how to safely draw them down. If you face a significant chance of running out of money, you may want to purchase an immediate annuity, which provides a guaranteed payment for the life of you and possibly your survivor. Some even include inflation protection. You can also get inflation-protected income by investing in high-dividend stocks, real estate, and TIPS (treasury inflation protected securities). The income will be lower than with an annuity but you maintain control over your assets, can benefit from future growth, and can pass the remainder to your heirs. Finally, you’ll want to take steps to minimize the taxes you pay on that income.
Sound like a lot? Fortunately, if you need help, there are lots of resources available to you. See if your employer offers unbiased retirement advice or education or consider hiring your own financial advisor. Life happens but you don’t have to let it get in the way of your retirement.
Erik Carter, JD, CFP® is a senior resident financial planner at Financial Finesse, the leading provider of unbiased financial education for employers nationwide, delivered by on-staff CERTIFIED FINANCIAL PLANNER™ professionals.