An overwhelming challenge many baby boomers experience is the amount and varying degrees of retirement planning information available. If you talk to 30 different financial advisors and ask them, how should I retire? You're likely to get 30 different opinions on what you should do. Retirement has been studied in depth by Ph.D.'s all over the world like Dr. David Babbel of Wharton, Moshe A. Milevsky of Schulich School of Business at York University in Toronto, Dr. Menahem Yaari of Israel, and most recently, Dr. Robert C. Merton, Nobel Prize winner in economics. I've read and studied the leading financial minds' findings with retirement, and interestingly enough: there is one optimal way to retire (not 30). That's not my opinion; it is based on mathematical, scientific, and economic facts. The steps outlined below will give you a framework of what areas to carefully plan to mitigate unforeseen risks, which could lead to an unnecessary dismal retirement experience.
A study by the National Center of Biotechnology Association followed individuals aged 50-74 over fourteen years and found a direct correlation with income and longevity. Those in the top 5% of income levels lived 2-3 years longer than those at the bottom 5% if income levels. This study has been confirmed many times over studying those who live a very long life as well. Invariably, those living a long life have been found to have sources fixed guaranteed income coming in to keep them going. These fixed income sources are most commonly found from Social Security, pensions and annuities. Research shows that annuities provide both psychic and financial benefits. Retired annuity owners feel more confident about affording their preferred retirement lifestyles—even if they live to age 90 or older—than retirees who do not own an annuity, according to a LIMRA Secure Retirement Institute study.
Think about the difference in someone’s retirement experience from those who are well prepared with adequate fixed income and those who likely know they will run out of money but don’t know when. Retirees always worried about running out of money, typically finding themselves living a “just in case” retirement. They can’t spend anything on discretionary categories (travel, lifestyle, eating out, socializing) just in case they need it. The retirement experience of living in constant fear and worry would likely be dismal and stressful. On the other hand, those who know their fixed needs are covered can essentially give themselves more permissions to have fun and do the things they’ve been looking forward to doing.
According to a Nationwide Insurance study, when a couple makes it age 65 together, there is a 45% chance –almost 50-50--one of them lives beyond age 90. The odds are 31 percent -- nearly one in three -- that one member of a 65-year-old couple will live to age 95. Making a retirement income plan to last beyond what your parents may have lived to is a crucial consideration given the advances in health care and technology over the past couple of decades.
If you’ve heard of the retirement’ 3-legged stool’ concept, this refers to each leg of the stool being a pivotal component to retirement income. One leg is your retirement savings to supplement retirement income over time. The second leg is social security, and the third leg has traditionally been pension income. The challenge is that most retirees do not have a pension, and those that do could face pension solvency issues (i.e., changes to the income stream because the pension is underfunded). A rule of thumb is to have your essential income needs come from guaranteed or fixed sources such as social security, pensions, or other guaranteed sources. For those with no assistance or fixed income above what social security will cover, adding additional sources of guaranteed income can create confidence. The remainder of liquid retirement savings should be positioned for potential growth and to offset inflation while supplementing retirement income.
When shopping for guaranteed income sources, be sure to work with an advisor who can genuinely source the market and many insurance companies to find the optimal income options for you. The challenge is the guaranteed rates on annuities, for example, change every month, so reviewing rates for extended periods can lead to going back to the drawing board. Having your actual income needs analyzed within a financial plan is recommended, so everything is taken into account for today’s needs and those expected in the future.
There are over 566 different strategies for claiming Social Security, and if you make the incorrect, irrevocable decision, it could mean leaving tens of thousands of dollars on the table. Maximizing this benefit should be of high priority when planning retirement income. There was a study done by United Income in 2019, which found that Americans lose trillions claiming Social Security at the wrong time. The study concluded that 96% of retirees are choosing the wrong year to tap Social Security. The study’s key takeaway was that by claiming Social Security at the right, more than half of retirees would see their income in their 70’s and 80’s rise by more than 25%.
Factors to considering when deciding to apply:
Even with financially savvy retirees, one mistake I commonly see is relying too much on liquid assets (such as retirement accounts) for income needs with the goal of delaying Social Security for a higher benefit. Sometimes withdrawing too heavily from retirement accounts can work against you in later years especially, if the retirement accounts are not growing to outpace withdrawals. This can leave retirees with no back-up plan for liquidity (or saving to fall back on). With thorough financial planning, there should be a set of rules created to adjust withdrawals and Social Security claiming strategies depending on how savings performs and income needs change.
I used sophisticated Social Security planning software to show people all of the claiming strategies available to them. Then I back these strategies into their overall retirement income plan to find an optimal fit. I this is something you feel you could benefit from, submit an inquiry below.
By age 65, most tax paying Americans will qualify for Medicare. Part A, which covers hospital services, has been paid for through years of payroll taxes, so 99% of retirees don’t come with an additional monthly premium (although a deductible and coinsurance can apply). Part B covers physician services, outpatient services, some durable medical equipment, and certain home health care services. Part B comes with a monthly premium based on earned income before retirement. For most retirees, the standard premium cost is $144.60/month (for 2020) but can go as high as $491.60/month. Medicare Part D is prescription drug coverage based on the geographic area through a private insurance company. A good exercise to consider is going to Medicare.gov and entering your formulary (list of prescriptions) and regularly shopping for part D coverage to ensure you’re in a highly rated plan that may have much less out of pocket expenses than others. Shopping part D costs should be done before enrollment or for future planning if a potentially expensive prescription drug is prescribed. Medicare Part A and Part B are known as original Medicare offered by the federal government.
Medicare Part C (or Medicare Advantage) is separate from original Medicare and is a type of private insurance offered by health care companies contracted through Medicare. These are typically HMOs or managed health care plans under providers such a Providence Health Care or Kaiser Permanente. With managed health care, some people love them, and others hate them. One benefit HMOs offer is to combine Part A, Part B, and Part D in one comprehensive plan. A disadvantage is that most major managed care providers require a referral is you want to see a specialist of any kind. Your doctor in a Medicare Advantage Plan could be a gatekeeper whose job is to care for you and control costs for the HMO (which obviously can have some conflicts of interest).
On the other hand, original Medicare is widely accepted anywhere where it’s accepted and typically does not require a referral to see a specialist but can have deductibles or coinsurance to pay to see one. Medicare Advantage plans also have geographic areas where they provide service. So those who move out of the coverage area or travel south in the winter need to be aware that health care costs (excluding necessary emergency services) could come with a hefty bill if your Medicare Advantage plan is not services where you travel.
What catches people off guard:
I personally don't put in place Medicare advantage plan for clients but keep a short list of professionals to refer who have access to just about everything a retiree could consider (in Washington and Oregon) and do a great job determine what is the best fit for a particular person or couples needs.
Unfortunately, Medicare and other health insurance plans do not cover long-term care costs. An estimated 70% of those living beyond age 65 will need some form of long-term care (home health care, adult daycare, assisted living, nursing home, or God forbid memory care). The median current annual cost of Home Care Services in the pacific northwest is $68,640, and a semi-private nursing home room is $109,343. These costs are expected to double by 2040. Experts agree that the middle class is at the most significant risk likely saved for retirement but not for the cost of long-term care.
As people age, they need help, and that help costs money. Many family members can’t afford to drop everything and be a caregiver. Having a financial tool such as long-term care insurance can pay out tax-free benefits to allow people to age in place and live the retirement they want, on their terms. It’s heartbreaking to see a couple who didn’t plan for this and one spouse having a long-term care health event in a financial planning sense. Sometimes assets are spent down (or have to be spent down to qualify for state-sponsored Medicaid to cover the costs), leaving a healthy spouse impoverished for the rest of their life.
For some retiree’s these policies are too expensive. The rule of thumb is if the cost is more than 5-7% of gross income. If an individual or couple has less than $400,000 saved for retirement, depending on other factors such as their fixed income and income needs, they may need those assets, so purchasing a long-term care policy could be a wrong financial move. There’s also a small percentage of retirees who don’t have significant goals to pass their assets onto heirs or charities and have enough liquid wealth, $2,000,000+, for example, that they could likely self-pay for this type of event.
Although insurance companies have dramatically dropped off from offering this type of coverage over the past ten years, there is some good news. Many insurance companies have created hybrid policies to tailor coverage or care benefits while having more flexibility.
Qualifying and purchasing a long-term care policy can have one or more unique benefits:
Given that people typically don’t get healthier as they age (or get any younger) and to qualify for your own policy, you would have to prove you are at least in average health for your age; it makes sense to apply as soon as you can.
There is no upfront cost to apply or going through the underwriting process (having a simple medical questionnaire by phone, which is sometimes followed by a health exam from a nurse). It can take 3-5 weeks to get approval from a selected long-term care insurance company.
Ever hear of the story about Rip Van Winkle? It’s a story about a Dutch-American villager who falls asleep in the Catskills Mountains for 20 years, missing the American Revolution. The story was originally written in 1819, and regardless of when he fell asleep or when he awoke in history, over every 20 years, things we need to buy to live on will cost more. If we use the average inflation rate (or the rising cost of goods) from 1920, which is 3.25%, it will take 22 years until prices double. So, if Rip had a $100 bill in his pocket (which would have been equivalent to roughly $913 in 1819) and woke up 20 years later, it would only buy a little over $50 of goods. The value or spending power would have been eroded although the principal stayed intact.
One of the greatest threats to a retiree’s wealth is having too much focus on protecting principal because, by doing so, inflation risk takes over. Think about a CD (Certificate of Deposit) at a bank. The average, and taxable, return is always below inflation. If you were investing in the average six-month CD in 1990, you got an interest rate of 8.17%. On the surface, that seems amazing, especially compared to today’s average rates (as of May 2020) of 0.95%. However, if you were earning $100,000 filing married-filing joint at the time, your federal tax bracket (not even including state and local taxes) was 33%. When you subtract the tax and the inflation that year (based on Consumer Price Index or CPI) of 6.1%, the real return of that CD was -0.63%. You may have slightly more money than when you started investing in CDs, but you will not have more wealth because of inflation.
There are many strategies to overcome this risk, but they can be individually depending on risk tolerance, income needs, portfolio size, tax bracket, and other considerations. Working with a CFP® professional can help you determine how much risk and return you should be targeting while being able to help back you into the proper asset allocation to consider.
When looking back at historical tax rates, those in the highest marginal rate are paying the least percentage of Federal Income tax compared to any other decade since 1920 (as of the year 2020). This fact isn’t a tell-tale sign of rising taxes in the future, but I lean on other professionals I respect who have a track record of prudent forecasting. One of those people is Greg Vallerie, the Chief Strategist for IESB and author of Morning Bullet. He wrote in his Jun. 3, 2020 political summary that “The question that we get more than any other from clients is how we’ll pay for all of this; the deficit in this fiscal year, which ends on Sept. 30, could exceed $4 trillion, and it will far exceed $2 trillion next year.” He goes on to comment, “There’s No Easy Answer: Interest rates probably will stay remarkably low, which will help with debt servicing costs. But major belt-tightening is coming later this decade, as spending cuts, entitlement reform, and significant tax hikes loom regardless of who’s unlucky enough to win the 2024 presidential election.”
What Greg and many other economists are predicting is that taxes will have to change and likely not for the better to pay for the current COVID-19 Lockdown stimulus. As a pre-retiree or retiree, this should be a serious planning concern as a simple tax change could mean a majority of your savings could cover fewer expenses because more tax must be paid. Predicting exactly how taxes will change is not possible but having planning flexibility and options when tax laws do change can put those well poised in a position to keep more of their savings than those who fail to plan.
The concept of tax-diversification, having savings held in different accounts, each taxed differently, is import to consider. This way, if taxes negatively change for a type of account (i.e., IRA, 401(k), 403(b)), another type can be drawn from, which may result in more income after little to no tax. There are three different types of tax treatments for investments. These three types make up the ‘Tax Triangle’. One corner of the tax triangle is the taxable bucket, which may include assets taxed at preferred capital gains rates such as stocks, mutual funds, and ETFs. Then there is the potentially tax-free bucket or corner of the triangle, which may include Roth IRA, municipal bond holdings, cash value life insurance, and 529 plans. Finally, there is the tax-deferred bucket, which has qualified plans, such as your 401(k), 403(b), tax-sheltered annuity, IRA, or SEP accounts. You get a tax deduction on your contribution, the money isn’t taxed while it grows, but as soon as you take it out, it is taxed as ordinary income. A typical retirement income planning challenging I see is having everything saved in the tax-deferred corner of the triangle. A $20,000 new roof in retirement can become a $32,000+ expense when all liquid savings are coming from a source that is likely subject to Federal and sometimes state income taxes (such as an IRA).
The idea of the tax triangle or having your savings arranged in different buckets is so you have options and flexibility in your retirement income plan. When tax rates are high, you may want to consider taking distributions from the tax-free bucket. When tax rates are low, consider taking a distribution from the fully taxable bucket. When running taxable, partially taxable, and tax-free withdrawal strategies through financial planning software for clients (measured by Monte Carlo Analysis), I’ve seen clients able to stretch their savings by a decade or more. This is accomplished by withdrawing the right percentage for various savings sources, which can reduce overall tax exposure.
Investing in a financial plan to run tax-efficient income scenarios for you; could pay for itself many times over and avoid unnecessarily giving up too much of your income to taxes.
Finally, it's essential to have a plan and each critical area to diligently plan for in retirement is unique to each person's situation. If you hire a financial advisor to guide you through the process, you have to spend some money upfront, but all the work will be done for you, and you'll be setting yourself up for long-term financial success (and hopefully peace of mind). I've found there's a cost to doing something, and there's a cost to doing nothing. Quite often, the cost of doing nothing ends up being a lot more.
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 2015 Medicare & You, Centers for Medicare and Medicaid Services
 2019 U.S. Department of Health and Human Services (longtermcare.acl.gov ), site accessed 08/28/19. Genworth Cost of Care Survey 2019, conducted by CareScout®, June 2019
 (FederalReserve.gov, 1985-2013) (FederalReserve.gov, 1985-2013)
 (https://www.fdic.gov/regulations/resources/rates/)(FDIC.gov, Weekly National Rates)
This is meant for educational purposes only. It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions. Waddell & Reed and its representatives do not offer tax advice. The hypothetical examples are for illustration purposes only and not intended to be representative of actual results or any specific investment and do not include all fees or expenses associate with investing. Please keep in mind that it is possible to lose money by investing and actual results will vary.
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