5 Top Problems and Solutions for Retirees
Retirement may not look anything like what current retirees expected it to when they began saving interest rates are a lot lower and life expectancy is longer, to name two of the biggest changes.
Financial Planning talked with Harold Evensky, President of Evensky & Katz Wealth Management, about the top challenges and some solutions to the problems.
Heres an interactive slide show that delves into five of the most common problems and some solutions facing clients who are already retired.
Dying isnt the biggest risk retirees face, Evensky says. Instead, the biggest problem is not dying, he says. In the past, people as they got older might have gotten sicker and had a tendency to spend less, but that isnt so much the case any more. Evensky, who is in his late 60s, remembers being one of the younger people on a high-end cruise he was on a couple of years ago.
Many of the other passengers were in their 80s and 90s, he says. The assumption that as people get older theyll spend less is yesterdays story.
Solution: Immediate Annuities, Longevity Insurance
These investments, which allow an investor to take a guaranteed stream of income (in the case of longevity insurance, that income stream is deferred), in exchange for lump-sum payment may not be ideal for the present, extraordinarily low interest-rate environment. But interest rates are bound to go up, and when they do, these tools will become extraordinarily important, as a means to help retirees with cash flow, Evensky says.
There isnt just the risk of living longer than expected
retirees need to make sure they have enough money to cover their current costs, as well. And theres a risk they may have underestimated those current costs.
When people retire, the big change is they now have more time, and time costs money, Evensky says. Any expectation that retirees should be able to live on 80% of their prior income is nonsense, he says. When youre retired now you have time to join the golf club and go visit those kids.
Many people are spending 120% of what they did when they were working. On top of that, theres inflation risk. Statistics may say inflation is relatively low, but the kinds of things that retirees spend money on including gas and medical expenses have inflated at a higher rate than average, Evensky says.
Solution: Standby Reverse Mortgage
A fairly new tool is a reverse mortgage, called the HECM Saver loan, thats more akin to a home equity line. Think of it as a standby reverse mortgage, Evensky says. You establish it but dont borrow on it, like a home equity line. Unlike home equity lines, however, once a Saver reverse mortgage is established, its always available to you, Evensky says, even if you actually never need to draw on it. Its a risk management strategy.
Volatility risk is clearly one of the big issues for practitioners, Evensky says. When someone is young and theyre saving, it doesnt matter if the market is up and down, up and down as long as its higher 10 or 20 years later. But for retirees, who are taking money out of their portfolios then vol makes a huge difference, he says.
Building a truly diversified portfolio is some hedge against volatility, Evensky says. As part of this portfolio, carving out around 2 years worth of cash flow to invest in money market funds and short-term bonds will provide some volatility cushion and help clients avoid having to sell at the wrong time, he says. The idea is to keep a substantial amount liquid to cover your supplemental income.
With so much focus on not running out of money, its possible to go too far and under-spend to the point of not living well, Evensky says. Clients who can afford to should think about spending the money they want to in order to enjoy themselves while they can, he says.
Solution: Scenario Planning
Making sure a clients lifestyle needs are met is part of good planning, Evensky says. Planners can do a capital needs analysis and scenario planning for retirement, and should review and update those on a regular basis.
In todays record-low interest-rate environment, the return on investment for retirees portfolios in real dollars after taxes and expenses is very low. Thats a major challenge in planning today, Evensky says.
Solution: Focus on portfolio expenses and tax costs
Assuming a reasonable expectation of real returns after subtracting taxes and expenses is around 2.5%, Evensky says, then saving even half a percentage point in expenses and taxes can increase investor returns by 20%. Thats why there needs to be an extraordinary focus on the management of expenses and taxes in portfolios, he says.
The good old days of 18% and 20% [market returns] are not likely to be the future. One strategy for keeping expenses and taxes lower is to use a so-called core and satellite approach for equities, in which the bulk (or core) of equity investments are in passive, low cost, tax efficient funds ETFs, passive mutual funds and mutual funds which are low-cost and tax efficient.
The satellite portion of the portfolio around 20%, Evensky says is in higher-risk, higher-return strategies. The expenses on this portion may be higher, but the returns should be higher, too the plan is to returns that are high enough to be more than enough to cover these costs, he says.
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