Over the years, there are two mistakes I’ve found that people consistently make when preparing for retirement. Making one or both mistakes can leave you in a “what if” retirement, afraid to spend your savings as you ask yourself:
- What if one of us has an extended chronic health care need?
- What if our retirement savings suffer losses and we are unable to pull out enough income to continue our lifestyle?
- What if we outlive our money completely?
The first mistake is failing to plan for a long-term chronic condition. A person could benefit from long-term care (LTC) if they need assistance with at least two out of six daily living activities (bathing, dressing, etc.) and/or if they are unable to stay alone due to a severe cognitive impairment.1 My classic answer to someone who tells me he or she doesn’t anticipate needing LTC is: “It happened to Superman and the President of the United States. Why are you special?” If devastatingly handsome Christopher Reeve (those blue eyes–don’t get me started) can become a quadriplegic at 44, and a fine intellect like Ronald Reagan can develop Alzheimer’s, it can happen to any of us.
Many people never require living in a nursing home, but the need for care at home or in an assisted living facility is increasing rapidly, along with the cost. In 2018, families paid an average of $2,517 a month for in-home care. Some LTC workers charge a monthly rate of up to $3,968.91.2
The “sequence of returns” can derail the best-laid plans. Someone with a million dollars, who is counting on withdrawals from assets, can run out of money with a few bad years at the start, even without a need for long-term care.
Don’t let anyone tell you there aren’t any good options left to insure long-term care. Traditional LTC insurance products have become more stabilized by providing pricing for today’s economy. Life insurance and annuities with LTC riders offer a guaranteed premium and could pay an increase in the death benefit if care is not needed.
The second mistake people make in retirement planning is failing to plan for a guaranteed lifetime income. When people retire, it’s normal to miss friends, mental stimulation, or contributing to a cause. But the most common thing they miss is a paycheck.
Last century, people often received a gold watch when they retired after years of faithful employment. The watch was nice, but even better was the employer-funded pension that provided them guaranteed income for the rest of their life. Between pensions and Social Security, the focus for a successful retirement was on guaranteed lifetime income. As the economy worsened, many companies froze or eliminated their pension plans.3
Today, employers set up retirement accounts, like 401(k)s or 403(b)s, that employees use to fund retirement with pre-tax dollars automatically deducted from their paycheck, many with an employer match. A lot of financial planners advise contributing enough to the account to get the employer’s full match, so as not to throw away free money. The self-employed can fund retirement with a solo 401(k), SEP, Keogh, SIMPLE IRA, or a traditional IRA.4 Those who want tax-deferred distributions have options including an index universal life insurance policy or a Roth IRA. In other words, retirement planning has changed its focus from guaranteed income to return on investment.
Retirement is based on assets, not income, and there is a lot of talk about a “safe withdrawal rate” to avoid spending your retirement savings too fast. What hasn’t changed is the primary concern of the saver, which is whether they will have enough income in retirement to live comfortably. Nobody wants to outlive their life savings!
Some traditional avenues are no longer viable. Robert Merton points out that the U.S. Treasury bill is nearly as volatile as the stock market in terms of converting to an income stream.5 Bonds are also producing yields near historic lows, and the prospect of capital losses, as the Federal Reserve inches up interest rates.6 Roger Ibbotson, of Ibbotson-Morningstar, released a report in 2018 revealing that uncapped FIAs have outperformed bonds on an annualized basisfor almost the past 90 years. Based on his research, which backtested to 1927, he further stated that uncapped FIAs are a viable option in accumulation portfolios leading up to retirement, as well as in retirement. The best allocation for today’s economy, he concluded, is 60% stock, 40% FIA and no bonds.7
What is a fixed index annuity (FIA)?
An FIA is a contract between the policyholder and insurance company to promote the growth of the policyholder’s money while avoiding much of the downside of the market. It gets better. There’s no fee if the account is for accumulation only. Insurance companies typically add an annual fee of about 1% to provide guaranteed lifetime income. The money is not in the market. Instead, the insurance company tracks at least one stock index and credits interest based on the performance of that index. My favorite FIA is one that is uncapped so there is more upside potential. At the end of the surrender period, you have the option to move the money if you find a better deal elsewhere. The policyholder usually has access to 7-10% each year penalty-free, except withdrawals by a policyholder who is less than 59½ years of age. These policyholders are generally subject to a 10% penalty when pre-tax dollars fund the annuity.
Here’s an example: One of my clients, let’s call her Mary, is a 60-year-old single female in Minnesota. She is planning to work until 70, at which time her Social Security will be $2,700 a month. She also has a pension of $500 a month which beginsin four years. She switched jobs a couple of years ago and is still saving for retirement. Mary has an eight-month emergency fund and regularly contributes to a fund she calls “periodic expenses.” She knows she needs LTC insurance, but discretionary income is low. However, she has a 403(b) from her old job with $230K, which she can choose to roll into an FIA. She will allow that plan to pay the LTC premium of about $4,800 annually, until her $500 monthly pension kicks in. At age 70, Mary can turn on the lifetime income of around $2,500 a month, giving her a total monthly income of $5,700. She will have to pay the LTC premium without extra income the first year, but she can manage by using some of her other savings. Mary can have added peace of mind knowing:
- She has the choice to protect her old 401(k) money from market downturns.A long-term care event no longer threatens her life savings.
- She can never outlive her monthly income from the FIA with the added income rider.
Ask your financial professional how long-term care insurance and fixed index annuities can help prevent you from making these two big mistakes.
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