Turn Your Headlights On!

Don’t Drive into Retirement Without a Plan

If you’ve ever traveled to second or third world countries, you knew you were not in Kansas anymore. Having lived a sheltered life in the Midwest and an Army Tour in Germany, I was not what you’d call a seasoned traveler. This cultural education occurred for my new wife and me on a romantic adventure together in Rio de Janeiro, Brazil.

We planned and planned the perfect getaway. We were first enticed by the travel brochures with scintillating images of one of the most beautiful places in the world. On the plane trip there, we imagined a fun place where everyone was happy. We imagined the weather, the music, the azure waters, the white sandy beaches and those warm, balmy nights.

And then we arrived.

It was very beautiful, and we had a great time, but it was impossible to not notice a lot of disorder and some mayhem. During the warm tropical evenings, it was common to see young Rio males driving without their headlights turned on. The locals told us they did it just to be breaking the law. They think it is a fun thing to do. On several evenings, we had to tell our taxi drivers to turn on their lights. I just thought it was the craziest thing they could be doing. Traffic in Rio can be intense. It often involves fender benders even in broad daylight.

And then there was the road rage. I once feared for my life when our taxi driver cut in front of someone. That offended driver came alongside us yelling obscenities and acting like he was going to sideswipe us on my door. For this Midwesterner, it all was a bit to take in. So, this driving without headlights and road rage left a lasting impression on me.

 

 Contrast this behavior to where my wife and I were stationed in the US Army just a few years earlier.

Living in Frankfurt, Germany could not have been more different than our Rio experience.  It was highly organized. Trains left on time. People followed the rules and laws. Of the hundreds of trains I’ve boarded, only one was one minute late. People in Germany didn’t jaywalk.

I was out late with my Army buddies as GIs might do, and noticed a German Couple waiting for the little green man to appear at the crosswalk. It mattered not the hour nor the fact there wasn’t a car in sight. Crossing early was just something they would not do.

The crime was low at that time and when anything resembling disorder occurred, many police officers were on the scene in what seemed like seconds.  When walking about Frankfurt, it was reassuring to see their many Polizei Officers on foot and in cars all over town. We felt safe.

Yes, there are extremes in both directions.

In my work with clients who are either approaching retirement or who have recently retired, it is not uncommon to see people driving without their headlights turned on. I have also witnessed those who would never jaywalk at 3 AM with not a car in sight.

 

OK, what do I mean by that? Before I answer that, let’s ask some questions of you…

 

Do you have a written action plan detailing how you will be able to retire?  Do you have so much wealth it would be impossible for you to run out of money during your retirement? If you have no plan and not the latter, you could be going the way of those Rio Taxi Drivers. A plan created in your head or something you scribbled down adding up income sources and rough numbers for budgeting often misses a lot of crucial items. You may have gotten it right, but just a few mistakes can derail that preferred retirement experience.

 

Are you the type who must have every possible facet of their financial life guaranteed even if it means you would have to sacrifice pleasure during your retirement? If so, you may be that German couple waiting for the little green man to appear when there’s no real danger of just crossing the street.

 

The first things to know about retirement planning is -- Will I Run Out of Money? How do I know that I will or won’t run out of money? How much money do I need? Answers to these questions should be known at least five years before one pulls that trigger to retire. For many, those last five years before retirement and the year after are the most crucial time. This is where all your dreams could become fulfilled or turn into a nightmare. This is the time you are zeroing in on that successful retirement experience.

 

That said, constructing a crucial part of our financial lives should guide us more toward that prudent German Couple and away from those young Rio Taxi Drivers. This exercise is as much a personality recognition process as it is crunching numbers. This is where you get to think about that ideal retirement lifestyle. Think about your daily activities, your travels, your family experiences and how you will spend time with friends. To do this, you must come up with your number. It’s the income needed to do all you want.

 

Rule 1: Plan for income needs first.

 

Make a list of your guaranteed income sources. For most, this will be Social Security Retirement Income and that’s it. Others may have worked for an older, larger corporation or a government agency will have a pension. We won’t get into expected income from qualified retirement assets yet. We’ll focus on your 401k, IRA, 403b and other employee-related savings plans in just a few moments.

The second part of Rule 1 is creating a budget. Many financial professionals use arbitrary targets like 80% or 75% of current income. I like having a budget. The budget is realistic and something you can work on to refine it for accuracy. Don’t be fearful of getting it wrong at this point. If you’re doing this exercise a few years before retirement, you have time for adjustments. On this, it’s better to add more than you might think. I’ve found that many new retirees spend more in their first few years of retirement than when they were working. Many new retiree’s long-awaited travel dreams are fulfilled and run up costs early on in retirement. A new phenomenon is senior couples funding their youngest child’s education and their own retirement at the same time.

Now deduct your budgeted expenses from your guaranteed income sources. For most, it’s a negative number and that’s OK. If you have a positive number, it’s either congratulations to you or you’ve missed some items still needing to be budgeted. If your new budget is significantly different than your budget today, you may well have missed some things.

 

Rule 2: Get a realistic idea of how much income you can withdrawal from your retirement plans.

We’re talking about your 401k, 403b, IRA or any retirement savings plan you own. Much has been written on this safe withdrawal subject. In 1994, Financial Advisor, William Bengen created the most often used 4% safe withdrawal rate. This withdrawal rate is adjusted for inflation each year. In 2006, he revised it to 4.5% for qualified retirement funds and 4.1% for non-qualified funds and coined it, the SafeMax rate.  Fast forward to 2011 when Dr. Wade Pfau, in this Journal of Financial Planning article posited that Bergen’s rule could be overly optimistic or too conservative, based on market conditions right before the withdrawals begin. Pfau states that withdrawals beginning after a bear market can be higher than withdrawals starting right after a bull. The idea is that markets correct for volatility and investments tend to go up after a bear market and down after a bull. This withdrawal aspect can get complex and the help of an advisor may add value here. I like to think of withdrawals in retirement as an acceptance of having good and bad years. One may have to live on smaller withdrawals during an extended bear market. One should be properly diversified in their investments. This strategy will include a lower volatility pool of investments within the portfolio from which to make withdrawals. This management technique can help a retiree avoid a very real problem called Sequence of Returns risk.

 

Sequence of Returns risk, simply put, is a test of how your portfolio could fare when making withdrawals in unfavorable market conditions early on in your retirement. A 6% withdrawal from a portfolio that has just gone up in value over 20% is a very nice thing to see on one’s statement. A 6% annual withdrawal from a portfolio that has just gone down 30% in value can be catastrophic for the rest of the retirement period and result in a zero value not far down the road. Even with a market recovery in a couple more years, one could find themselves down 50% or more in just the beginning of the fourth year of retirement. It’s the timing of the withdrawals with the market gyrations that can cause this outcome.  

 

Rule 3: Ensure your insurance safety net is set up well.

Nothing is worse than working and saving for decades just to be bankrupt due to illness, injury, or death of an income earner. Health insurance for many Americans has changed starting in 2018. The Affordable Healthcare Act (ObamaCare) has eliminated mandates to own government-approved coverage. I think most retirees are wanting to have coverage that works for their situation. The questions to ask are: Do I have enough coverage? Will I be able to afford this coverage throughout my retirement? Am I trying to take on too much coverage for my budget? Let’s take on the questions regarding coverage.

Retiring before age 65 has long been, and is expected to be an expensive proposition for most. Without the coverage provided by Medicare, one will have to assume that coverage and either pay the premiums or self-insure to some extent. In many parts of the country, a couple in their early 60s might find themselves faced with health insurance premiums that are more than their mortgage payments. This aspect of an early retirement has compelled many to wait until 65 before pulling that retirement trigger.

After age 65, it’s still not a cakewalk. Medicare Part A provides comprehensive hospital coverage, short-term skilled nursing coverage and in some case limited coverage for in-home care. Part A has no monthly premiums.  When one is presently and permanently qualified for social security they get Part A. One must have paid into Social Security for 25 quarters to meet this test. At this point, one will also qualify for Part B of Medicare and pay a monthly premium starting at $134 a month per beneficiary and adjusted upward based on income. If you are collecting Social Security retirement it could be as low as $130 monthly. The Charts in this publication from the Social Security Administration will give you a better idea how much you will pay. It’s best to either visit a local Social Security office or apply online for Medicare Part A and B. This can be done at age 64 and 9 months. If you have a Health Savings Account (HSA) and/or health insurance based on employment, you may want to ask your personnel office or insurance company how signing up for Medicare will affect you. This is a great time to visit with a local Insurance Agent who specializes in Medicare Advantage Plans and Medicare Supplements. This person will be able to help you answer questions regarding your situation.

Having Medicare and a Supplement or Advantage Plan will not get you out of the woods for Long-Term Care or LTC. LTC can be care received in a Nursing Home, a Senior Daycare Facility or in your own home. Medicare Part A only provides Nursing Home coverage in a Medicare Approved Facility. Additionally, you must primarily need skilled care to qualify. If you meet these strict criteria to qualify for benefits, Medicare has full coverage only for the first twenty days in a benefit period and partial coverage for the next 80 days. The balance of 100 days is often covered by a Medicare Advantage plan or Supplemental Coverage. Long-Term Care and care that is primarily custodial in nature is not covered. Long-Term Care is the biggest hole in most financial plans.

Long-Term Care can be covered in a few different ways. One could self-pay for all or part of their LTC needs. Nursing Home costs vary widely around the country. Genworth, a leading provider of Long Term Care Insurance, has provided this calculator to give you an idea of what costs may average in your area. Yes, the costs are staggering for all but the very well-heeled.

One could buy Long Term Care Insurance. It could help pay the part you cannot afford. For this to work, you must be very healthy when applying for the policy and pay the premiums. Benefits are paid when you cannot perform 2 or more basic Activities of Daily Living. Coverage is provided for a nursing home, adult day care and in-home care costs.  It sounds straightforward but premiums often start out high and can be raised periodically on a class basis. One could pay tens of thousands in premiums and never get any benefit from the policy if they never need covered care.

Another option that has been gaining traction are single premium or structured premium life insurance policies with long-term care benefits built into the policy. Here, one applies for the policy and sets up either a one-time premium payment or a limited term of payments with a start and specified end to the payment period. Here one knows exactly what they are going to put into the policy. They also know they will get back more in benefits than what they put into premiums. One accepts a relatively low return on these premiums in exchange for the coverage.

Many people, for a long time now have sought out Medicaid Planning from Elder Law Attorneys. The client pays the Attorney a fixed, upfront fee. The attorney helps their clients move assets from Medicaid Countable Assets to Medicaid Non-Countable Assets to qualify for Medicaid Benefits. This is usually done by liquidating investments, retirements plans and annuities to employ whatever strategy they may have at the current time. Medicaid planning can create a significant tax bill. Medicaid occasionally changes the rules to make qualification more difficult through planning. The attorneys analyze the new rules and change their strategies accordingly. This Cat and Mouse Game has gone on for decades. Medicaid planning is often done at the last minute when a family member is just now needing Long Term Care.

 

Rule 4: Set up an Estate Plan with an Estate Planning Attorney

Estate Planning, simply put, is having what you want to have happen when you are unable to do it yourself. This may occur at your death. It could also be at your incapacity to make decisions while alive. Everyone becomes incapacitated before dying. This incapacity could happen one second before dying or thirty years prior to our death. We have no choice in the matter. All we can do is proper planning for these eventualities.

For most, a Simple Will and a Durable Power of Attorney for HealthCare is all that is needed. If your assets are largely in accounts titled in a way that passes to your heirs without a probate delay and costs, this may be true. If your situation is more complicated, further planning work with your attorney may be needed.

Finding a competent attorney is best done with a referral from another professional. Knowing your situation well, your financial advisor or accountant should have a good recommendation for you.

 

Putting it All Together

So now you have your retirement infrastructure set up. Your insurances are planned to work well into the horizon. Your wishes in your estate plan are backed up with the legal documents you and your attorney worked out. You have an income plan you and your financial advisor created. But something’s missing… Yes, it’s your investment strategy. This was purposely left to last on the list. For most, this is the first thing to do. But you, with your headlights on, and seeing far down that retirement road know exactly how much risk you can take with your investments. It’s easy for you to see now that doing investments first without a plan is driving your retirement just like those Rio Taxi Drivers would.

This is where working with a competent advisor can help. It can make life easier and remove unwanted surprises out of your life. An Advisor will be able to show you different scenarios that can work for you and let you choose what feels best. The Advisor will be able to communicate the pluses and minuses of your options. You will also know the probability of success in hard numbers for each option. Your situation will be monitored.

Driving with your headlights turned on is a good thing.