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When modeling out retirement, people often apply rules of thumb for income timing. The classic one is the “4% rule,” which many people now think is a bit optimistic as a “safe” withdrawal rate.
Beyond rules of thumb, there are also plenty of sophisticated approaches to income timing. These take into account portfolio allocations, taxes, qualified-plan distribution rules, anticipated cash flows and more. The modeling process lays an important foundation for preretirees and those newly retired. It helps them sleep at night, knowing there’s a plan for delivering the income they’ll need.
Read: The 4% retirement spending rule may be too high. Could you get by on 1.9%?
But plans change. Whether the model was a rule of thumb or something more involved, real-life income needs end up lumpier than expected. A client calls an adviser and says something like, “I need $10,000 to help my son buy a house. Where can we get it?” Or the client might say, “I know we said we didn’t want expensive travel. But we’ve gotten involved in our homeowner’s association and think we want to join a group going on an African safari. Can we make it work?”
Whatever the reason for the client’s call, the adviser ends up helping to facilitate adjustments to meet clients’ needs on that day. From a planning perspective, clients are usually untroubled by deviations from a theoretically optimal plan, even when those deviations involve some trade-offs. What does trouble clients is an inability to flex as needed.
Read: Will working while receiving Social Security increase my benefit?
Flexibility—not rules of thumb or more sophisticated strategies—is the real key to retirement income timing. Nothing’s linear. Nothing’s level. Therefore, advisers who serve their clients over many years are particularly well positioned to provide spontaneous solutions.
With that in mind, one of the big ways advisers serve clients in the retirement planning process is creating conditions under which flexibility works. In my experience, that means avoiding predictable problems—the things that get people in trouble in ways that adjusting cash flows forward or backward can’t fix. Here are four examples.
Underestimating healthcare costs
In our planning models, we currently apply a 5% inflation rate—higher than the 2.5% long-term general rate—to healthcare costs. When you model out expenses for, say, 20 or 30 years, a 5% inflation rate leads to huge numbers. Assume, for example, $7,500 annually for Medicare Part B premiums plus out-of-pocket expenses (not including long-term care). Assume a client pays those costs for 20 years (e.g., age 65 to 85). At a 5% inflation rate, what starts at $7,500 becomes $19,900. Now double that figure if we’re talking about two spouses.
Read: Another casualty of inflation: People are saving less for retirement
That level of expense is hard for clients to wrap their heads around. But we have no choice. As just one example, nurses’ pay is rising fast—as only makes sense, given their increasing patient responsibility and the huge pay disparity vis-à-vis doctors.
Another way people get in trouble with healthcare expenses is assuming they can change their plans—such as to one that covers more, with a higher premium—if a need arises. That’s true…but only when re-enrolling for the next year. Sometimes huge costs are incurred before a change is possible.
Yet another common problem is retiring early and using too large a fraction of assets to pay for healthcare costs in the bridge years before Medicare. I’ve seen plenty of early retirements end in a return to work when people realize they can’t comfortably handle $10,000 per year or more from age 58 to 65. (And that’s per person.)
Planning on nursing care at home without appropriate insurance
The phrase “aging in place” holds a lot of attraction. Even people with solid long-term-care insurance coverage would rather avoid going to a facility, if at all possible. But often this is not feasible. Two elderly people living together cannot lift each other to help with bathing and other needs. Younger family members suffer total burnout. In-home professional nursing care is very expensive—to a degree it might eat up a smaller retirement plan in months, not years.
In my experience, it pays to think about long-term-care insurance as a basic healthcare cost. There are a variety of ways to satisfy long-term care needs and receive the advantage of insurance pooling. Many current insurance products permit at-home care.
Losing value to inflation
For now, we haven’t adjusted our long-term inflation assumptions of 2.5%, with an expectation that the current high rates will come down. But even a 2.5% average rate—let alone a 3% rate—can wreak havoc over the long term if too large a proportion of income is a fixed dollar amount, as is typical with pensions and annuities. Establishing a fixed dollar amount at age 70, for example, and then running into 8-9% inflation 10 years later could be a bad shock.
Inflation is especially important given that people are living longer. (Retiring earlier has the same effect of increasing the number of years that inflation can ravage a fixed income.)
The only solution is to ensure that enough of a portfolio is invested in assets that can, as I like to put it, “breathe” along with inflation. That includes stocks, given that companies have the ability, subject to competitive pressures, to adjust the prices of their goods and services.
Undervaluing survivor benefits
Let’s consider that a husband and wife worked their whole lives and, upon reaching age 67 start taking Social Security. Then, one also receives a workplace pension, and the other receives income from an annuity. Survivor benefits are relevant for all three of those income streams. In many cases, a stream will dry up completely when one of the spouses dies.
Or, there may be an option to elect lower cash payments over time but continuing spousal benefits at a 50% rate after one’s own death. That’s better—but still means half of the income is gone. If one of the spouses dies younger than hoped, that could mean 20 years or more of lower-than-hoped-for income.
The argument for delaying at least one spouse’s Social Security benefit is easier for clients to understand when advisers position it as a survivor benefit. Delaying to age 70, or as close as possible, means a larger income. When one spouse dies, the surviving spouse continues to receive the greater of the two.
Advisers generally do a good job of assuming change. They know they’ll receive those phone calls that lead to uneven cash flows. They know that some people die young. Some people get divorced in their 70s and even 80s, which can be financially devastating to the point of nearly unworkable. In my experience, it’s helpful for advisers to acknowledge to clients that flexibility is important (and more relevant than any rules of thumb) and is supported by planning that avoids all-too-common trouble scenarios.
Jesse Young is director of financial planning at Alera Group Wealth Services.
“Alera Group Wealth Services” is a brand name utilized by Alera Group, Inc. and certain subsidiaries and affiliates (collectively “Alera”).
Certain individuals associated with Alera Group Wealth Services offer investment advisory services through Alera Investment Advisors, LLC; and are registered to offer securities through Triad Advisors, LLC, Member FINRA/SIPC. Additional information about individuals registered with FINRA can be found on FINRA’s BrokerCheck. Triad Advisors LLC is separately owned and other entities and/or marketing names, products or services referenced here are independent of Triad Advisors.
