With growing lifespans, rising costs of living and the death of corporate pensions, retirement has become unprecedentedly expensive, and most recent and soon-to-be retirees haven't saved enough. In fact, a 2014 Wells Fargo study revealed that a full third of the middle class is contributing nothing to retirement savings vehicles, and the Boston College Center for Retirement Research has estimated that 53 percent of seniors won't be able to maintain their lifestyles with what they've saved.
Even for seniors who do save, however, and particularly for those playing catch-up in their 50s and 60s, a host of unpredictable expenses threaten to eat away at their nest eggs. Job losses, disabilities and sickness among elderly parents threaten workers' portfolios while they're still growing, while market downturns, long-term care and unexpected health care costs can force recent retirees to downsize long before they anticipated.
Fortunately, there are a few ways advisors can help their clients prepare for these expenses while still saving enough for comfortable retirements. Combined with well-advised saving, investment and draw-down strategies, an understanding of these expenses can go a long way in preserving those clients' hard-earned nest eggs.
Longevity and Death
“Longevity is great, but it does have its costs,” said Stein Olavsrud, FBB Capital Vice President. “An increased 'retirement life expectancy' means more risk and more years to cover in any retirement plan.” From market fluctuations to inflation to drawn-out healthcare expenses, just about every potential retirement pitfall is more likely to affect today's long-lived seniors.
Given the events of 2000 and 2008, market downturns may be the most concerning risks for recent and soon-to-be retirees. “Downturns are the biggest risks when we're talking about the whole retirement picture,” said Reno Frazzita, Secure My Funds founder. “In 2008 the market went down 40 or 50 percent, so anybody that was close to retiring and counting on that money to live off of was put in a tough spot,” he said, adding whether or not the near future brings a similar downturn, hard-to-predict fluctuations will more than likely affect Boomer retirees, especially those who overemphasize market-based assets.
Inflation is another increasingly large risk, particularly for fixed income clients already in retirement. Social Security's CPI-W-based cost of living adjustment doesn't include many of the goods and services most important to seniors, and the 401(k)s and IRAs future retirees will rely upon don't feature inflation protection. “Over time, your retirement income is going to buy less and less, and you're going to have to start withdrawing from and relying more on your retirement savings,” said Frazzita.
How should these risks change clients' retirement plans? “If anything, longevity just heightens the need to save earlier and more often and perhaps be more aggressive later in life,” said Olavsrud. “Clients playing catch-up in their 50s and 60s may have to turn to investments with more risk and more growth potential to get them through 95, since a more conservative portfolio might only take them to 80 or 85.”
Considering the risks of an equities-heavy portfolio, however, guaranteed income vehicles may make more sense for clients who plan far enough ahead. “Life insurance is a good way to pass on assets, but not everyone can qualify later in life, and annuities are the next best option,” said Frazzita. For many of his clients he recommends laddered annuities, purchased and drawn upon at different times to hedge against inflation and unexpected hits to other assets. “It's important to have an income strategy that allows for incremental increases in income over time,” he added. “Annuity ladders are great because if inflation doesn't rise, those annuities can be used for something else.” Overall, this and other guaranteed income strategies offer retirees the best of both worlds: they can rest easy knowing they'll have enough to pay their bills, but they don't have to worry about missing out on opportunities should they have the extra money, he said.
Finally, while Social Security shouldn't make up the majority of clients' portfolios, it's still a solid way to protect them from a variety of risk factors. “Social Security can be viewed as a 'triple hedge' against poor market returns, inflation and longevity,” said Olavsrud. “In fact, it's almost an insurance policy to delay the benefit as long as possible.” For healthy clients who can afford to draw upon other assets first, delaying benefits is almost always a good strategy to create a larger stream of guaranteed, inflation-protected income.
Planning for Healthcare Costs
Long lifespans and drawn-out retirements have also made medical care a greater concern for seniors, and that care isn't getting any cheaper. “When it comes to unpredictable expenses, healthcare is kind of the elephant in the room,” said Frazzita. “Medicare changes coming online in the next couple of years are going to increase out-of-pocket expenses, and costs are rising even for people who aren't yet retired.”
While Part B premiums remained the same this year, surcharges will be withdrawn from the Social Security checks of individuals earning $85,000 or more and couples with incomes of $170,000 or more, according to the SSA. The lowest surcharge is $42 on top of the monthly Part B premium, and the largest is $230.80 for couples with incomes greater than $428,000.
What makes this system unpredictable is Medicare's modified adjusted gross income calculation, which involves almost every possible source of earnings, and which takes into account income earned up to two years prior to signing up for the program. And, while the surcharges have been in place since 2007, the income brackets aren't inflation-adjusted. Without proper advisement, middle and upper middle class retirees who assumed they wouldn't fall into a “high income” bracket may be in for an unwelcome surprise. As more seniors fall into those unadjusted brackets in years to come, meticulously planned asset draw-down strategies will become crucial for minimizing surcharges and retaining Social Security benefits.
Aside from well-planned withdrawals from tax-deferred and taxable sources, however, there are still a few sources of income that don't count towards the Medicare income calculation – namely the Health Savings Account. “If a client is still working, especially if they're on a high deductible plan, they should consider contributing to an HSA,” said Marilyn Timbers, Voya Retirement Coach. “Once they're in retirement, preparing is just a matter of being aware of what the additional expenses can be and preparing for those.”
Some clients may worry that their HSA contributions will be for naught, but between gradual rises in premiums, deductibles and co-pays, surcharges that will affect more seniors each year, and the additional costs of Medicare supplements and private insurance, there are more than enough healthcare costs to cover in retirement. A 2014 Fidelity study actually found that the average couple retiring at 65 would need roughly $220,000 to cover medical expenses in retirement, and the current yearly HSA contribution limit is just $6,650 per family. Still, for clients who prefer other options, 401(h)s, Roth plans, income from cash-value life insurance policies and earnings from reverse mortgages are also exempt from the Medicare income calculation.
The Likelihood of Long-term Care
If a client needs another reason to consider an HSA, long-term care is it. “Long-term care might be the biggest of all retirement expenses,” said Olavsrud. “With medical advancements keeping people alive longer, there's a much greater likelihood of needing it.” Medicare won't pay for long-term care, but according to the IRS, long-term care insurance premiums do count as qualified medical expenses.
As for the specifics of the policy, “We highly recommend going with a credit-worthy company, since this is decision that may not pay out until decades in the future,” said Olavsrud. “A cost of living adjustment is also well worth the expense, and you need to look for features like how long the policy will pay out, what kinds of services it covers and what the daily benefit will be.” Hybrid life and long-term care policies also allow death benefits to be drawn upon for long-term care, and customers often have the option to pay up front, annually or monthly.
While seniors are often reluctant to purchase long-term care insurance , or even consider the prospect of needing it, it's a clear choice for clients who can afford it. The US Department of Health and Human Services has estimated 70 percent of people currently 65 or older will need some form of long-term care, and paying for it out-of-pocket can wipe out even sizable portfolios depending on the services required.
Sticking to a Long-Term Plan
Long-term care, medical bills and longevity-heightened market risks may be tough to predict, but clients can drastically improve their retirement prospects by sticking to well-planned budgets and investment strategies before and after they retire. “It's mathematically impossible to live on more in retirement than you earned when you're working,” said Seth Deitchman, Mercury Group Portfolio Manager. “When we're trying to plan for a successful retirement, it's actually easier to plan for someone with a smaller budget than a larger one.” When working with the well-off clients who have the most to lose, advisors must understand their expenses, establish sustainable budgets and advise flexible investments that will pay off whether or not those unpredictable expenses come to pass.