Is Your Retirement Plan More Trick Than Treat

Not knowing if your retirement plan and investment strategy is adequate could be scarier than Halloween. While ignoring deficiencies or just guessing that you’ll be okay might sound easier than asking tough questions, uncovering the skeletons in your retirement closet is a must. We’ve found that many retirees find themselves behind simply because they don’t know what they don’ know. It’s tough to plan properly when you overlook pitfalls.

Today we have a list of 5 Frightening Facts to consider in your planning.

 

Long Term Care Needs Could be Lurking Around the Corner

Someone who turns 65 has about a 70% chance of needing long term care at some point in their lives, and 20% will need it for longer than 5 years. A semi-private room in a nursing home averages $6,844 per month. Medicare and regular health insurance will not cover any of this cost. Failing to proactively address your health needs throughout retirement can be devastating to your financial position.

Proper planning using long-term care insurance and trusts can help reduce your exposure to increasing medical costs in retirement. It’s important to plan well ahead of time, however, as trusts have a 5 year lookback that can prevent their effectiveness.

 

The Monster That is Inflation

There is a 25% chance that a 65-year-old man will live to 93 as well as a 25% chance that a woman of the same age will live to 96. For this reason, most financial planners recommend using a life expectancy of 95 when starting the financial planning process, and updating the plan accordingly through time. Assuming a retirement age of 65, this results in about 30 years of retirement. From 1960-2021, the average inflation rate in the United States was 3.8%/year. Using this inflation rate for 30 years means an increase in cost of living of 300% over retirement.

Does your financial plan consider an increase in cost of living of 300% over your retirement? While inflation may not repeat itself at 3.8%, it has been 8.2% for the 12 months ended September 2022. It’s important to run projections of your required income stream throughout retirement to review if your nest egg can keep pace with inflation.

 

The Social Security Shortfall is Spooky

 The average social security check is $1,614/month. For someone who worked all of their adult life at average earnings and retires at age 65 in 2022, Social Security benefits will replace about 37% of past earnings. This leaves a considerable gap to fill from your own savings.

For most, it’s important to ensure you have adequate, separate sources of income aside from Social Security to cover your retirement needs.

 

Sequence of Return Risk can be Scary

 Sequence of return risk involves the ordering of market returns/declines during the distribution period of your retirement. Two portfolios could average the same return over a ten-year period, but with one portfolio experiencing gains in early years followed by losses in later year while the other portfolio does the opposite. Assuming the same annual distribution from each portfolio, the portfolio producing gains up front will have a noticeably higher balance than the other portfolio after the ten-year period. Assuming a constant growth rate in your retirement can be a big mistake.

Modeling potential sequence of returns in your retirement can stress test your plan and assets to see what impact poor return years in your retirement could have, and allow you to better understand if you are well positioned to ride out a storm. Ensuring you are diversified can help, too. It may be advantageous to borrow from a permanent life insurance policy during times of market decline. Perhaps carving out some of your assets to put into an annuity which can provide for a guaranteed income stream that is no longer susceptible to market performance and sequence of return risk is right for you. Reviewing these options and what might work well for you and your unique circumstances is important.

 

Taxes are Terrifying

 Taxes are often someone’s largest annual expense. This is no different during retirement. Did you know that Social Security is up to 85% taxable? What about that most people’s retirement nest egg is in qualified or tax advantaged accounts that require distributions (RMDs) and are taxed at ordinary income rates? These RMDs can put drag on your portfolio. It’s common to believe that your tax bracket will be lower in retirement than it is in your income earning years, but this could prove to be a major oversight. The highest federal tax bracket is currently 37%. This is historically LOW compared to multiple periods in United States history. In 1944 the highest rate was 94%. In the 50s, 60s, and 70s the highest bracket never dipped below 70%. In the early 80s it was reduced to 50%. Are you confident you’ve properly planned tax expense into your income needs and its effect on your savings? Do you think it’s more likely that tax rates will go up or down considering the past?

It is wise to review your current investments and ensure they are in vehicles that make the most tax sense for you today while balancing the possible trade offs for tomorrow. If tax rates are to rise, implementing a ROTH conversion strategy  now may reduce future tax burden significantly and leave you ahead of the game.

 

What can you Do?

If you haven’t addressed these concerns in your retirement planning, now is the time to do so. If you’re not sure how to start, we can help. Proper financial planning involves much more than just investment management, and includes constructing a plan that addresses these topics as well as others. If you’d like to see where you stand and if there is room for improvement, we welcome a meeting.

 

 

 

Sources:

https://acl.gov/ltc

https://www.worlddata.info/america/usa/inflation-rates.php

https://www.cbpp.org/research/social-security/top-ten-facts-about-social-security

https://bradfordtaxinstitute.com/