A 60-year-old money expert friend was tapped to give a talk to his college classmates. He knew a lot about buying or selling $50 million in bonds at a time, but wasn’t that familiar with the challenges presented to the typical consumer financial planner. Here’s an outline that we developed that readers might find interesting…
Problems
1) longevity risk
2) inflation risk
3) higher costs starting at 75-80 likely (not insurable because this is a move to a $7000/month independent living place, not a nursing home)
4) insurance company default risk
Assumptions
a) $X in home equity; $Y in investments (maybe say $1MM and $2MM for concreteness)
b) Social Security entitlement
c) want to keep risk of living only on Social Security (having exhausted assets) to less than 2%
d) want to die basically broke, though maybe leave the $X in home equity to heirs
Questions
i) how much can one spend each year during Phase I of retirement and how much during Phase II (independent living) as a function of $X and $Y
ii) is it worth paying an insurance company to take on the longevity risk via an annuity? Or, given that the costs of the longevity risk don’t come until 30+ years from now, is it cheaper to handle this oneself? Are insurance companies giving away annuities cheap due to their overestimates of their investment returns?
iii) what would be the right structure of annuities if going the annuity route, to handle both inflation risk and the likely step-up in living costs?
iv) if not going the annuity route, what is the right structure of investments and withdrawals for living expenses?
Closing
Remember that we live in a world of screen addiction for most people who don’t have a full time job. So try to make sure you’ve got a project before you retire and/or that you’re going to be living in a place that keeps you stimulated and excited about learning and doing.
not insurable because this is a move to a $7000/month independent living place, not a nursing home
I know your example excludes the nursing home or assisted living facility, but when my Mom turned 60, my doc brother purchased a Long Term Care policy for her from State Farm, starting out at $600/yr and provided $250K total lifetime coverage. Seven years later the annual premium was $1000/mo at the time my Mom had a stroke and went into a wonderful ALF for the last three years of her life. The policy paid like clockwork, 80% of the monthly $4500 bill.
Fifteen years ago, upon starting a new job, I signed up for my company-sponsored (though not subsidized) LTC plan – $250/yr for $250K lifetime coverage. Just prior to leaving that job, I contacted the LTC insurer and asked if I could keep the plan, which they allowed at the same rate and coverage.
I’m surprised that none of my highly-educated, financially-savvy coworkers have LTC, nor take advantage of my company-sponsored LTD ($30/mo) or STD ($30/mo).
Simple plan: buy diverse basket of large cap Canadian stocks that pay ~4.5% dividend, live off the dividends, never sell the principal.
Pros:
– more income than typical annuity (Canadian dividends typically paid at higher rate than US)
– by never selling stocks, their value will likely grow exceeding inflation rate = possible increasing income
– by never selling stocks, leaves a large cushion for surprises
– by never selling stocks, foregoes only a small increase in income over the next 30-40yrs
Cons:
– risk of falling Canadian dollar
– fluctuations in stock market
– requires sufficient wealth to live on 4.5% as annual income
You cannot have both c) and d). Either you want a low risk withdrawal and spending rate from your assets (4% or so is considered safe) or you want to die broke so you spend too much (6-7%) and then go broke near the end.
My thoughts:
i) Classic analysis yields the ‘4%’ rule (http://www.investopedia.com/terms/f/four-percent-rule.asp) on $Y. YMMV, some studies say it’s too conservative. From that you can add Social Security.
ii) I hate annuities. But others like them. They can be extremely complex. Even thought I hate them, there are times when fixed annuities (http://www.annuityfyi.com/types-of-annuities/) can be useful, esp when the retiree(s) spend beyond their means.
iii) Good question. Since I hate them I have not studied this aspect.
iv) 30-45% stocks, 70-55% bonds, depending upon risk tolerance with re-balancing yearly. Morningstar has lots of great material (http://news.morningstar.com/articlenet/article.aspx?id=714223)
Smartest Woman on the Internet has some excellent advice and she’s clearly looked at this. Agree with Bill.
Finally there are lots of Monte Carlo simulations on the Internet around how long your money ‘might’ last, given various inputs. Here is one (and note this web site is another excellent one on money/retirement): http://www.caniretireyet.com/the-3-best-free-retirement-calculators/
You can retire safely and spend about 4% of your assets starting at 65. This can be inflation adjusted for 30 years with low risk of running out of money. If you retire younger you may reduce your risk of running out of money with a bigger nest egg or a lower spend rate. You are very unlikely to run out of money or need to buy longevity insurance or annuities at this withdrawal rate. You do need to invest 40% of your assets in low cost stock index funds (SP500 or total stock market) and 60% in high quality bonds for the whole time.
If this 4% burn rate is not adequate spending versus your budget you can buy annuities with part of your assets to reduce your risk of going broke before you pass. But then you run the risk of inflation reducing your standard of living in old age as most annuities are not inflation indexed.
Most people do not need to move into a extended care facility or nursing home before 80ish. And then only half of older people need those facilities. But when that happens the person can sell their home to pay for any needed nursing home or extended care facility costs above their normal spend rate. But if you have much lower cost home than $1M you need to look at the numbers and maybe buy some long term care insurance. But right now the cost for those polices is very high versus the return. So not many people are buying them. In the worst case you can declare yourself indigent and let the state pay your costs via Medicaid as many others do.
This is not new advice. I am sure your friend knows these ratios and numbers.
http://news.morningstar.com/articlenet/article.aspx?id=564139
@Bill: In the worst case you can declare yourself indigent and let the state pay your costs via Medicaid as many others do.
Yes, some people try to game the system, but many states have strict rules regarding this, and the ALFs and SNFs that freely accept Medicaid may not be as comfortable as one would like. When I was looking for an ALF for my Mom, the monthly rates varied from $2500 for a basic shared room in an understaffed single-family home to $4500 in a quality well-staffed facility w/ many activities. The high-dollar place had about 50 individual rooms and held exactly one room for a Medicaid resident. On my first call, they advised no rooms available, until I told them we were well-insured. (Oh, and from #1 above, Mom’s LTC rate increased from $600/yr to $1000/yr.)
@Bill: You can retire safely and spend about 4% of your assets starting at 65.
If a retiree had, say, $1MM to invest, then couldn’t she just put that into a ten-year (or longer) CD at (assume) 4% and not worry about it? That being, if $40K + SS was sufficient too live on. And assume inflation wouldn’t matter as her costs are largely fixed. Or is that too big of an assumption? And is the reinvestment risk after ten years too big?
Smartest Woman: I think that you’ve hit on the issue! I was just at a lecture last night by a Nobel-winning economist (will blog about it later). He mentioned that Social Security was set up to be “overindexed” in 1972 by Congress. Everyone involved was aware of this, but they thought it was okay because the U.S. was never going to have high inflation. By 1977 the system was in crisis.
But certainly your plan to spend interest rather than principal is at least a pretty good one.
4 percent plus inflations is a big deal in retirement. So you need 6% returns which is 3% plus inflation returns. So you need some stock to get that return. In my case my real inflation in 18 years of retirement is double cost of living.
If you need the state to take care of you it will not be a deluxe. ALF. If you want deluxe you need to work harder or save more so you have more $$$ in old age.
Regarding the 4% Withdrawal Rate Rule – doesn’t Required Minimum Distributions at age 70.5 from retirement accounts likely force greater than a 4% withdrawal? If so, then does one just reinvest the excess over 4% into a 60/40 stock/bond diversification.
And, regarding the 60/40 diversification – there are plenty of mutual funds that diversify exactly like this, so then would selecting just one of these funds, at low cost and high quality, like one of the reputable Vanguard fund for one’s entire portfolio be sufficient, simple, and optimum?
A lot of people retire with outstanding mortgage, if so, that could kill your retirement plans and will limit your options. Having zero depth at retirement need to be a priority.
Smartest Woman: Good point on MRDs. And yes that is what I would do (after paying taxes). Also, I’d probably try to get 2 Vanguard funds as you suggest, one international, one US.
As Anonymous says, Inflation *could* be a big deal. Try one of those Monte Carlo simulations, and just vary Inflation. It’s shocking how much impact it could have..
The first three years of MRDs are less than 4%. The gotcha with IRAs is the gov’t wants their tax cut and they really own about 25% of that money. Most retirees have taxable accounts as well as IRA accounts. So when MRDs start they just move money or stocks (you can do in kind transfers) to their taxable account and continue spending as normal from that account. I rebalance annually and keep enough cash in my taxable account for 2 years spending. That way if the market crashes or I need extra I do not have to sell in a down market.
I use multiple Vanguard funds in different accounts to keep taxes lower and make rebalancing easier. But others use single funds.
Go to Bogleheads.org for lots of great information about investing.
When you retire with extra $1 million it is time to play derivatives market!
Concerning children, remember that $10K/year per child, $20K/year for married child with spouse, can be given away tax free. This can add up and avoid probate issues later.
Further, personal property, including jewelry, is not included in certain calculations, especially if dealing with Medicare etc. Thus I have known of cases where an older person bought a $300K piece of jewelry, bringing their total assets ex personal property under the limit needed for Medicare to start paying their $6K/month long term care.
LTC facilities are wise to a lot of this – the way they are trying to get money from you has changed as a consequence. In some cases a $250K buy-in is needed in order to even get a spot – they assume that you will deplete your cash and end up getting reimbursed by the Feds after some time.
So they front load the profitable part, making you pay more than the govt pays, assuming that for the last 6 months of your stay they will get shafted by the lower reimbursement of the Feds…
The Deep Hidden Meaning of Life is we accumulate all we can for 75 +-years, then turn it over to the healthcare system. It would be nice to skip that last part. The last few months, or however long it is no longer really living, is no value for self or family.
assisted suicide?
It is actually easier in many cases to hire regular outside help to watch and help an older person so they can age in place and stay in their home. The cost is not too high at $40Kish per year for full time help 50 weeks a year. It is lower if the help is only part time. I know a lady who does this for extra money while her husband works. She likes the job and it sure helps the older people. She takes them shopping and cleans their house and so forth. The only issue the older people have is climbing stairs in their existing houses.
My wife’s uncle also had a day helper that watched him during the day. Then his daughter or her husband stayed every night with him for about three years. That was hard on them but he was happy staying in his home. I could go on but staying in your own home with some help is the best LTC solution.