In speaking with clients, connections, family and friends it is inevitable that many people will share the same questions and concerns about their finances. This week, I want to take a moment to cover a few of the questions that I have received lately and hopefully provide some valuable answers. If someone has asked it, there are probably others who want to know the answer as well! Let me know what you think and send me any questions that you would like to see in a future FAQ style blog post.
Q: What is Long Term Care Insurance (LTC)?
A: LTC coverage can take a variety of forms but at its most basic it helps to defray costs associated with things like, nursing home care, skilled nursing care, and other types of assisted living expenses and in home care. As to why you should get it, one need only to look at the skyrocketing cost of care. We recently had a discussion with a client that has suddenly found themselves needing to pay substantially more for her mother's nursing home care. It is not uncommon for someone in that situation to be paying over $9,000/month and that may not even be a private room! Now, with costs of care rising, so has the cost of LTC insurance. So much so that some of the largest insurers stopped selling it because they couldn't make any money off of it without charging outrageous premiums! In its place are a few carriers that will sell traditional LTC and many carriers that will sell a LTC/life insurance hybrid product that tends to be less expensive. These types of policies usually give you the option to pay the premium as a lump sum and may also allow you to roll over an IRA to fund the policy. This can help boost the monthly benefit but it is certainly not the option for everyone. This topic can get quite complicated and really should be discussed with your financial advisor.
Q: How do I determine my withdrawal rate in retirement?
A: The idea behind saving money for retirement in an IRA, 401k or other investment vehicle is that you will be able to take an income off of those accounts in order to replace your income in retirement. Seems pretty simple right? Well, there are actually a couple of ways to think about it:
1) You could spend your accounts to zero and leave nothing behind. In theory, there is nothing wrong with this approach as long as you are not interested in leaving an inheritance. However, this is also the riskier of the two options as it means that you are taking the chance that you may run out of money sooner than you expect. This could happen for any number of reasons not the least of which is the topic I just talked about, LTC.
2) The second approach is where the 4-6% withdrawal rate comes from. The idea is that a well-diversified portfolio should be able to earn a modest 4-6% return without taking undue risk and volatility. Obviously, we can never guarantee this, but it is reasonable to expect that long term this would not be a difficult hurdle to clear. Hypothetically, you would be able to maintain the value of your portfolio and not drive it to zero if you only withdraw 4-6% a year.
In practice, these are not two options so much as they are two different realities. The reality is that if you consistently withdraw more than 6% a year in retirement your likelihood of being able to take an income from your accounts for the remainder of your life comes into question. If you keep your spending to between 4 and 6%, you will have a much better chance of success without taking undue risk.
Q: How much should I save for retirement?
A: There is no “magic number” that you should have in retirement. Every single person and family is different and thus need to plan differently. We have clients that will retire well on $500,000 and others who will be able to make do with $100,000. Some suggest that you should save 10x your income, but I don’t ascribe to that philosophy because it says nothing to the client’s rate of spending. Case in point, the client with $500,000 has made a consistently much lower salary over the course of his life than the client who only has $100,000. That said, our approach to determining how much a client needs in retirement is personalized based not just on their current income but rather on a holistic view of their financial picture including income, debt, monthly spending, retirement contributions, social security, pensions, annuity payments, vacations, gifting, etc.
I know that this is not exactly a straight answer to the question but the fact is that those questions are intensely personal and vary widely from person to person. For some, 10x their income will be more than enough. For others, they won’t be able to live the way they want to on 10x their income. The assumptions made on how much of your income you should replace are also somewhat silly. The idea is that once you enter retirement your expenses should steadily go down. This may be the case for some but in the case of my client with $500,000, they will need to make a pretty large purchase upon retirement and we have had to account and plan for that. My point is that you should really take some time with your financial advisor discussing what you want your life to look like in retirement. They should be able to help you determine what your rate of investing should be and how much you will need to draw off of your accounts to support your income in retirement. And of course, I am always willing to answer questions!
I don’t remember if I have recommended this week’s song of the week in the past but here it is again! Lucy, Kendra and I are headed out to Arizona with her family this weekend to soak up some rays and do some hiking so this song is perfect! (I would also be remiss if I didn’t include the original version by Dwight Yoakam here)