Let's finish May with a bang.
Here are three insights, two findings, and one action to ponder this week.
3 INSIGHTS FROM ME
I. Realistic retirement assumptions = lower retirement costs
Retirement is expensive. By most accounts, it's the single largest purchase people will make. Throw in volatile medical, and long-term care expenses, longer life expectancies, the constant threat of inflation, and a comfortable retirement can seem out of reach for all but the wealthy. Studies indicate using realistic assumptions for key retirement costs like income replacement rate, inflation, and actual retirement life expectancies can reduce cost estimates by 20 to 25 percent.
Here are the key retirement costs assumptions and a few factors to consider to bring retirement costs back within reach.
Common Retirement Assumptions
Replacement Ratio—common to estimate 80 percent
Inflation Rate—common to use the cost of living increases
Retirement Life Expectancy—common to think of 30 years
Realistic Retirement Assumptions
Replacement Ratio: 80 percent is a good starting point, but the rate needed to maintain a post-retirement lifestyle comparable to a pre-retirement lifestyle can range from 54 percent to 87 percent of final income.
Inflation Rate: Spending rates through retirement generally do not keep up with inflation, and assuming inflation-adjusted spending each year overestimates retirement costs. Real spending tends to decrease over retirement, but some increases later in retirement due to rising medical costs.
Retirement Life Expectancy: Actual life expectancies can vary widely for retirees—factor in personal health and family health history when estimating life expectancy. Also account for higher incomes, wealth levels, and more education as each correlates with longer life expectancies. And above all, focus on the probability of outliving your wealth, not just the probability your wealth will last for 30 years.
II. What does luck have to do with retirement?
1) Luck (not your choices or habits)
the randomness of market returns
order of market returns
unforeseeable world events
uncertain tax laws and public policy changes
2) Strategy (your choices)
your vision and a clear, realistic, and achievable plan of action to reach it
what do you hope to accomplish and avoid in retirement
your spending needs in retirement
how much do you have to save, and can you sustainably spend in retirement
how, when, and where to seek help if needed
3) Actions (your habits)
a commitment to your choices necessary to bring your vision of retirement to fruition
Only 2 of the three are under your control - luck is not one of them. But if you master those 2, you can improve the odds that luck will work for you rather than against you.
III. 4 strategies to create lasting retirement income
When we think about retirement, there’s this idea of longevity risks which is living a long time and not having enough assets to support a desired lifestyle. Of all the risks in retirement – return risk, inflation risk, sequence risk, health risk – longevity risk is the greatest. The only way to protect against this risk is to guarantee income for life. But the only way you can guarantee income for life is with guaranteed income. And the best sources are annuities, defined-benefit plans (pensions), reverse mortgages, and Social Security. Let's look at each to see how they support lasting retirement income.
Social Security is just about the best source of guaranteed income. For anyone who wants more guaranteed income, Social Security is the absolute first place to look. It is impossible to buy an annuity with this same rate of return. A bonus is the no-cost inflation protection provided through the cost of living increases to benefits.
Annuities should not be purchased as investments; they are risk management tools. The primary risk they address is providing income you cannot outlive. They also work well to protect against the market, cognitive decline (diminished mental ability), and inflation risks (if a cost of living feature is added). Many 401(k) plans offer a pension payout option that’s often superior to rolling the money into an IRA and purchasing an annuity outside the plan.
Defined benefit plans (pensions) are becoming less and less common, but for those who have them, they can be an important source of guaranteed income. They can provide income to bolster other guaranteed income sources by delaying their use as long as possible to increase benefits.
Reverse mortgages get a bad rap but can be beneficial under the right circumstances. For a significant percentage of Americans, the majority of their wealth is tied up in their homes. A reverse mortgage can be an effective strategy to turn housing wealth into guaranteed lifetime income. A reverse mortgage can reinforce other income sources, reduce living expenses, manage risks, and support aging in place when appropriately used.
2 FINDINGS FROM OTHERS
I. Everything You Need to Know About Medicare Overseas
Whether you are a full-time ex-pat, a roving retiree, a frequent traveler, or a homebody, your choices in Medicare are important—and powerful. This resource sheds some light on a few of the most pressing retiree Medicare questions about living overseas in retirement.
One common question is what a part-time retiree, living a portion of each year abroad, should do about Medicare. In this scenario, it’s advisable to maintain Medicare A, B, and either an Advantage Plan or Supplement Plan and to couple it with a medical transport and evacuation policy.
An equally challenging question is what to do with Medicare when someone spends the first few years traveling in retirement before returning to the U.S., at which point they might spend part of the year away and part of it stateside. Roving retirees want to maintain Parts A and B and take notice that neither Advantage nor Supplemental plans cover full-time overseas living.
Another common question is whether a U.S. address is necessary to maintain Medicare coverage. Medicare has both address and residency requirements. A residential address, including P.O. boxes, is required to enroll in all Advantage, Prescription Drug, and Supplement Plans. Medicare A and B eligibility depends on citizenship, not U.S. residency. Therefore, one may maintain both Medicare A and B while living overseas.
Maintaining Medicare coverage is advisable for just about all retirees regardless of where you plan to plant your roots in retirement. In most cases, the costs outweigh the delays for coverage and monetary penalties due to lapse coverage. Medicare rules and regulations are highly complicated, continually changing, and dependent on proper timing and execution to be compliant. It is best to think through all the angles before making these critical decisions, regardless of where retirement might be.
II. Retiring Earlier than Planned: What Matters Most?
Many workers seem to have gotten the message working longer may be necessary to boost retirement security. The share of workers reporting they expect to work past age 65 rose from 16 percent in 1991 to 48 percent in 2018. But such intentions often go awry as data indicates 37 percent of workers retire earlier than planned. Key reasons for differences in workers' planned and actual retirement ages can be attributed to four potential shocks: health, employment, family, and finances.
Studies indicate both poor initial health and health changes are the biggest drivers of early retirement. This is followed by job loss without a new job, a spouse retiring, and parents moving into the household. The big takeaway is changes in health are quite common, as are spousal retirements, marital status changes, and large swings in wealth (largely because people have little wealth, to begin with). Finally, the effect of financial shocks was statistically insignificant and relatively small.
The study reinforces that the actual retirement age is often earlier than the planned retirement age, and retirees should incorporate the possibility of early retirement in their planning to account for the risk of having to retire earlier than planned.
1 ACTION FOR YOU
I. Know what you want to accomplish and avoid in retirement.
Prudent retirement income planning begins with identifying and implementing the actions necessary to support the goals while protecting against risks that stand in the way of those goals. Undertaking the right actions consistently before and in retirement is crucial to your golden years.
Until you are clear on these two, what you hope to accomplish and avoid planning for retirement will be challenging. To start, take a sheet of paper, draw a line across the top, and another down the middle. Label one column "What I want to accomplish in retirement" and label the other "What I want to avoid in retirement." Now brainstorm ideas of what you want to accomplish and want to avoid in retirement and add them to the lists.
Examples of things you may want to accomplish in retirement:
- how will you retire
- basic living expenses
- travel expenses
- large, one-time purchases
- financially assisting others
Examples of things you may want to avoid in retirement:
- being a burden to family and friends
- running out of money
- losing money in the market
- reduced standard of living
- cuts to spending
Compiling a list of the things you want and don't want in retirement is one of the most important steps you can take to make your retirement dream a retirement reality. And best of all you don't need anyone to help you do it!
Have a Question? Want to chat about it?
Until next week,
Mark Sharp, CFP® RICP® EA