Expect the unexpected
August 25, 2000: 7:29 a.m. ET
Serious illness, living longer than planned can be tough to finance
By Staff Writer Shelly K. Schwartz
NEW YORK (CNNfn) - Retirement planning: It all comes down to basic math, right?|
You project your life expectancy, estimate annual expenses, factoring in a lower tax bracket later in life, and crunch the numbers.
Trouble is, calculations like that - which fail to account for variables - cause thousands of otherwise carefully crafted financial plans to self-destruct each year. From inflation, to health problems, to the financial burden of adult kids returning home to roost, life, as they say, has a knack for butting in.
"You should definitely consider that you'll probably live longer than you expect and you'll need more than you think," said Phil Cook, a certified financial planner and head of Cook & Associates in Torrance, Calif. "It's like remodeling your house. It always costs more than you project it will."
Luckily, there are lots of ways to insulate your portfolio from the onslaught of unexpected events. And just as many ways to ensure your nest egg lasts as long as you do.
The X factor
Medical advances have extended life expectancies, causing many retirees to fall short of their savings goals, Cook said.
Many Americans who began padding their nest eggs in the 1950s, expecting to live into their low 70s, have outlived that projection by a decade or more. Short on cash, many older Americans have had to move in with their children.
Serious illness is the other financial obstacle for retirees. And it's exacerbated by today's extended life spans, which up the odds of suffering heart attacks, cancer and debilitating strokes, not to mention mental illnesses including Alzheimer's disease.
A case of pneumonia or a broken hip alone can eat through a lifetime of savings in a matter of months, as home health care and nursing home costs surge into the $40,000 to $60,000 a year range.
"Basically, the uglies are what keep people from reaching their dreams," said Kim Dignum, a certified financial planner in Ft. Worth, Texas. "More times than not, that includes long-term care costs and major medical expenses."
Medicare, the government-sponsored health insurance program for those 65 and older, picks up the tab for most medical needs. But there are some things, including prescription drugs and hospital stays over 60 days, the program doesn't cover.
Click here for CNNfn.com's special report, The Road to Riches.
"Most retirees should be looking at long-term care insurance, which is often called nursing home or home health care coverage now," said Kenn Beam Tacchino, an associate professor of taxation at Widener University in Chester, Pa. and author of numerous personal finance books including, "Financial Decision Making at Retirement." "If you need it, the options are there and this will enable you to preserve your assets."
He noted you can still get a good deal on premiums well into your 50s.
Click here for a sample of yearly premiums, based on age, provided by the Long Term Care Insurance National Advisory Council.
Tacchino, along with many other financial planners, adds most retirees also should consider Medigap coverage, a type of insurance that picks up where the federal government leaves off.
"Medigap insurance will help you stretch your assets and preserve them, too, by providing gaps in the Medicare system," he said. "Otherwise, you can lose all your estate and everything you worked for your entire life if you're not properly insured."
The Health Care Financing Administration, which administers Medicare, offers this helpful tool to help seniors learn more about Medigap insurance and compare policies offered by providers in their state.
Another common, but often overlooked, expense that can throw a retirement budget into a tailspin involves the kids.
"More often than not it's because you've got children, who left the home and now are back because of a divorce, legal problems or financial issues," Cook said. "And whether they are the good child or the bad child, the parent wants to help."
Cook said he continually warn clients about being too generous, because it's "so much easier to go to the bank of Mom and Dad than the Bank of America."
"If they want to buy a house and they need a down payment, the parents want to help," he said. "That's not to say it will ruin the parent's financial (horizon). It's doable, but you have to consider the long-term effect of making that loan."
One way to safeguard your nest egg when disaster strikes is to annuitize.
By definition, an annuity is a contract sold by an insurance company that pays a monthly income benefit for the life of a person or persons, according to Barron's. Basically, you invest a chunk of cash into an account and the insurer promises to send you a monthly check, based on those dollars plus a portion of the interest earned.
"You can't outlive your income when you have an annuity," Tacchino said. "I think you're better off having some type of annuity in your retirement account since it transfers some of the risk."
Annuities come in many shapes and sizes. And many contracts now offer an "enhanced death benefit," which ensures that you and your beneficiaries will receive the full amount of money you invested into the account, plus interest.
(Click here, on the National Association of Variable Annuities guidebook for more on annuities.)
One other good way to preempt portfolio problems is to carefully consider your investment strategy. Many Americans, especially as they get older, flock to the safety of fixed-income securities, like bonds and certificates of deposit.
That's not always wise, Cook said.
"We haven't seen a recession in a while, when interest rates decline, but that can certainly be a factor because if you're like some retirees and you keep everything in the bank, you'd be earning less (in interest on your savings)," he said. "It's not a huge threat, but it's there and it's something you have to think about, especially when you're planning long-term."
At the same time, he said, falling interest rates would force you to reinvest that money at a lower rate, when your bonds and CDs mature.
For that reason alone, Cook said most investors would be "foolish to fall below" an allocation of 60 percent equities and 40 percent bonds, or other fixed-income products. You can - and should - still keep your stock picks conservative, opting for stable blue chip stocks and low-risk mutual funds that generate long-term growth with little volatility.
That will help protect your premium as you approach retirement day.
T. Rowe Price, in fact, has a new product that creates for seniors a model portfolio based on their answers to a questionnaire. The service, called "Retirement Investment Manager" is free in some cases.
And don't ignore the merits of positioning yourself in good financial stead to begin with. Save enough to support your lifestyle.
It's often suggested you'll need roughly 75 percent of present-day income to live on when you retire. That money that would come from savings, Social Security, IRAs, 401(k)s and from investment-generated income such as rental properties, bond yields and dividend-producing stocks.
The reduced cost of living reflects the fact that most retirees have paid off their mortgage, enjoy a dramatically lowered tax bracket and are able to eliminate expenses normally associated with work - business clothes, lunches out and commuting costs. But some financial planners contend that can lead to too limiting a lifestyle.
"I don't buy that because, look at the logic of using 75 percent," said Kim Dignum, a certified financial planner in Ft. Worth, Texas. "You have more time on your hands after you retire so you pursue more hobbies and travel more. You're spending more."
A better way to plan ahead, and to avoid a savings account shortfall later on, she insists, is to sit down with a planner before you retire (or go it alone if you feel comfortable) and carefully review your current monthly cash flow, or income.
Factor in any costs you expect to incur down the road. That might include a new car, beach house or boat, if those are among your Golden Year goals. Next, subtract any contributions you're making now to your retirement accounts and Social Security, since you'll no longer be paying into the system upon retirement, but rather withdrawing from it.
Contrary to the advice of her peers, Dignum said most retirees should avoid subtracting their mortgage payments from expenses, since the cost of that mortgage never really goes away. She explains: "Your house may be paid off after you retire, but with the effects of inflation, your homeowner's insurance and property taxes will probably still be equal to your original mortgage payment. You never really get rid of that expense."
Finally, do the math. Multiply your newly estimated cash flow by the number of years you expect to live.
(Click here for a story that helps to define life expectancy.)
And be sure to set up a safety net, which should consist of three to six months worth of living expenses that you can draw from in case of emergency.
What if you're too late
But what if you planned ahead, adhered to a sound investment strategy and still have trouble financing an expected event?
Kacy Gott, a CFP in San Francisco, said that's the time for some serious strategizing.
"When that happens you really need to revise your plan and start over again," he said. "You've had a major change in the amount of resources you have available because it's no longer what you thought it was going to be."
He notes one way to get back on track is to invest in stocks and mutual funds with higher expected rates of return.
"It's not necessarily that you should just spend less immediately," Gott said. "You may be able to do it by shuffling your investments."
You can also always take a larger monthly distribution from your IRA - the distribution rules are only there to make sure you withdraw the bare minimum. And you could consider the reverse mortgage, which allows you to borrow from the equity built up in your home.
(Click here for a story that fully explains the concept of reverse mortgages.)
If you have no other choice, you can always sell your home.
"That's something that a lot of client's decide on because it's just more convenient," Gott said. "You'd rent a smaller apartment, which is probably all you'd need, and reinvest (the money from the sale of the home) elsewhere."