Financial Management.
Overview
Managing our finances during retirement is a challenge, especially after the “Great Recession” of 2008. Losses, low interest rates and low returns can be catastrophic to our lifestyle and the legacy that we leave for our families. You have a great deal at risk. Out living your money is a major financial disaster for you and your loved ones.
In the past, many retirees relied on defined benefit pension plans to provide sustainable, lifetime income. Over the past few years, we have been seeing a dramatic reduction in the number of companies offering pension plans and even a reduction in pension benefits. Managing income for a lifetime is an extremely complex task. And the responsibility for managing retirement income has been shifting from our employers to us as individuals.
Remember that lifetime, sustainable income is a cash flow issue. We need consistent, predictable income. Whether we are already in retirement or planning for retirement, we are managing a lifetime, cash flow need.
The three major risks that you face in planning for a lifetime of income are:
Mortality and Longevity Risk
Inflation and Spending Risk
Investment Risk
MORTALITY and LONGEVITY RISK
We typically think of longevity as a blessing. In the financial world, longevity is a risk. That is, longevity increases our risk of out living our money. With improvements in diet and health care, life expectancy has been steadily increasing.
There are online tools that can help us estimate life expectancy. Here is a link to one such tool: http://www.nmfn.com/tn/learnctr--lifeevents--longevity_game
Remember that statistics and tools provide us with a view of what we might expect on the average. We always need to consider the possibility that we may not be average. We want to be able to sustain our income even if we live 5, 10 or more years beyond what is average. Today, it is reasonable to plan for life expectancies into the 90s and beyond.
In this video, Dr. Moshe Milevsky introduces the three major risks that you face in planning for a lifetime of income and then talks about the decline of defined benefit pension plans and longevity risk.
http://www.youtube.com/watch?v=8zcGMtvYvuk
INFLATION RISK
As inflation increases, your purchasing power decreases. The cost of living has increased an average of 3% (as measured by the Consumer Price Index) over the last 20 years. This is considered a moderate rate of inflation. However, at a 3% rate of inflation for 25 years, your expenses could be more than double what they are today.
This Nightly Business Report video addresses the impact of inflation.
http://www.youtube.com/watch?v=U_lGB5lzL1w
INVESTMENT or SEQUENCE OF RETURNS RISK
While you can control how your investments are allocated and how much you withdraw each year, you cannot control the ups and downs of the stock market. The timing of these highs and lows can be a critical factor in determining whether your assets can provide you with income for life. The decline in the stock market performance after the Internet bubble of 2000 and the Great Recession of 2008 are recent examples of difficult “sequence of returns”. If you entered retirement any time since 1990, you have experienced a difficult “sequence of returns” at the worst possible time. If you were not protected against “sequence of returns” risk, it may impact you for years to come.
In this video, Dr. Milevsky addresses how the sequence of returns can impact our income during retirement.
http://manulifegifselect.ca/incomeplus/retirement_challenges/retirement_risk_zone_video
CREATING GUARANTEED INCOME FOR LIFE
Addressing the major risks to retirement income requires integrating investments into your portfolio designed to protect you against the risks of longevity, inflation and an unfortunate sequence of returns. This Prudential video describes an example of how guarantees can protect you against longevity with lifetime income and volatility (that is sequence of returns risk). This video also addresses “asset allocation” which is a key element in addressing inflation.
No single investment product will address all of your financial needs. As this video mentions, working with your financial professional, you should evaluate your retirement savings and determine what percentage of your assets would be appropriate in a variable annuity.
http://www.youtube.com/watch?v=xeCaZVFnbjs
ASSET ALLOCATION AND WITHDRAWAL RATES
Asset allocation is the framework an investor uses to distribute his/her investments among various classes of investments (i.e. stocks vs. bonds). In the traditional financial planning process, finding an asset allocation that is “appropriate” for the individual’s appetite for and ability to shoulder market risk is the key goal. Although this may be acceptable during the accumulation phase, it is the wrong approach to planning for a lifetime of income and may cause an individual to increase the chance of running out of money during their lifetime. An retiree who is too conservative (i.e. too large a percentage in cash, bonds, CDs) is exposed to the risks of inflation. A retiree who is too aggressive (i.e. too large a percentage in stocks including mutual funds that invest in stocks) is exposed to excess “sequence of returns” risk.
To increase the likelihood of meeting your life time income needs, adjust your asset allocation and manage your withdrawal rate. The chance of a portfolio falling to zero is less likely if the withdrawal rate is low and the ratio of stocks to bond is optimized for the withdrawal rate.
The basic rule of thumb is to allocate 50% of your portfolio stocks and 50% to bonds with a 4% withdrawal rate. And you should consider implementing your stock allocation in investment products with guarantees like the Prudential variable annuity with HD Lifetime 6.
OTHER CONSIDERATIONS: Long Term Care
Chances are your medical expenses will increase with age. Medical insurance and Medicare are a critical foundation for your financial plans.
Long Term Care expenses are not normally covered by medical insurance or Medicare. According to the U.S Department of Health and Human Services (www.longtermcare.gov, March 26, 2008), 70% of individuals, age 65 or older will require some type of Long Term Care support and the national average costs were:
o Nursing home, semiprivate room: $181 per day, $66,065 per year
o Nursing home, private room: $205 per day, $74,825 per year
o Home health aide: $25 per hour
The costs for Long Term Care vary by geography. The costs in Louisiana and New York City can be very different. This report will give you an idea of what the costs might be in your local area.
http://www.metlife.com/assets/cao/mmi/publications/studies/mmi-market-survey-nursing-home-assisted-living.pdf
Also note that Long Term Care costs have been increasing faster than the typically reported inflation. You should plan for these costs to continue to increase faster than the inflation rate reported on the evening news.
If you are married, consider the impact on your total expenses if one partner requires Long Term Care. For a couple, when one person requires Long Term Care, the expenses may be in addition to all of the couple’s other current living expenses. That is, the mortgage does not go down when one spouse moves to a nursing facility. A single individual may sell the house when moving to an assisted living facility.
This video will provide you with an overview of the issued related to Long Term Care:
http://www.youtube.com/watch?v=8gcs96dg0Z4
ADDITONAL RESOURCES
Designing and managing your portfolio for a lifetime of income is a complex task. It requires special knowledge and access to a variety of investment options. You should learn as much as you can about the risks and solutions available for managing your retirement portfolio and work with an expert. A Certified Financial PlannerTM may be able to assist you with this effort.
This link will provide you with access to the Certified Financial PlannerTM Search page: http://www.cfp.com/search/
Below is an example of the type of information that it can provide you.
