Three Retirement Topics to Plan For
Retirement. You’ve spent all your life preparing, dreaming and working towards that day when you get to trade your morning commute for a cruise to the Bahamas or grab a set of golf clubs on your way out the door instead of your briefcase. Whatever your ideal retirement looks like, they should all have a few things in common: Relaxing, fulfilling, secure, etc. But what you shouldn’t have to do is worry about money or pick up extra work out of necessity or financial hardships. To help make sure that your retirement years are some of the best of your life, take these three steps towards financial wellness.
Plan for unexpected health events.
As we get older our bodies don’t act quite like they used to. You notice an extra ache in the morning when you get up, or that it takes a little longer to get up the stairs. Health issues are a natural part of life that everyone faces to some extent at one point or another. While we don’t like to think about major healthcare events, it’s important to have a plan and contingencies in place to make sure that you can live a healthy and active life in retirement. Planning for healthcare risks and events is not only important for your physical health, but it is also vital to maintaining financial health for you, your spouse and your family.
Unexpected healthcare events are one of the biggest risks to your finances in retirement that people don’t plan for. In a study done by the CDC, it is estimated that 85% of people over the age of 65 have at least one chronic condition. While AARP estimated that 52% of people over the age of 65 would need some type of long-term care assistance, with more women needing care than men at about a 60/40 split. Based on these numbers, it’s safe to assume that you’ll be needing some type of medical care at one point during your retirement.
Now here are the big questions: how much does it cost and how do I pay for it? While costs vary based on the type of care (in-patient, prescription, long-term care, etc.), it is safe to say medical care costs are usually not cheap. A study by Genworth estimates that the annual cost for a private room in a nursing home facility could cost you up to $102,000 (national average) or up to $113,000 in Colorado. With the average length of stay being two years, you can see how a long-term care event can quickly eat away at your retirement nest egg. You may be thinking “My family doesn’t have a history of health problems so I probably won’t need chronic care services.” But it is always prudent to have a plan in place because you never know if an accident might trigger a chronic condition or healthcare need. What are some ways you can prepare for unexpected health events and fund medical expenses in retirement?
Unexpected healthcare events are one of the biggest risks to your finances in retirement that people don’t plan for.
Pay for it yourself
Many people’s first thought is that they would rather just pay for the cost of care themselves if the need were to ever arise. There are many ways you could pay for healthcare costs depending on what you are most comfortable with. The first way to self-fund would be to set up a separate savings account to take care of related expenses. Optimally, you would want to start contributing to this account before retirement, but you could also use your Social Security payments to help fund the account once you reach Social Security retirement age if you have other retirement assets to live off of (pension, 401(k), IRAs).
Another course of action could be to allocate a portion of your retirement investments as a type of rainy day fund that could be used to cover healthcare costs. You would want to allocate an appropriate amount into a lower risk investment to ensure that the funds would be available to you regardless of market volatility.* When considering this strategy, make sure to account for any possible impacts to your retirement income objectives, tax obligations and liquidity needs.
One of the best options to fund healthcare expenses in retirement is through a Health Savings Account (HSA). These accounts are usually paired with high deductible health insurance plans and have a lot of tax benefits. The contributions you make to these accounts are tax deductible, can be invested for growth and come out tax free if used for qualified medical expenses. The main thing to remember for these accounts is to start early because you can’t make any more contributions to them once you turn 65. And they have an annual contribution limit based on your age and whether it’s an individual or family plan.
When self-funding healthcare costs in retirement it is also important to think about how this may affect your spouse’s finances. If you have joint retirement savings, depleting your combined nest egg to cover costs may leave your spouse with less retirement income than planned and put a burden on them if they need care in the future. If this is a concern, then the next strategy might be a good option for you.
When it comes to long-term care (LTC), many people consider purchasing private insurance to cover costs. Stand-alone LTC policies come with a variety of options and can be customized to suit your preferences. Many plans also have the benefit of utilizing the Partnership Program which offsets the Medicaid spend-down rule (more on this later). These policies will cover different types of care such as assisted living, independent living and nursing home care. A drawback to these types of policies is that they are often “use it or lose it,” where if you don’t have LTC needs you’re paying premiums into a policy that you don’t use. A newer solution to this worry is hybrid policies that combine life insurance with LTC care benefits. These policies can be used to cover care costs, but if you don’t have an LTC event it still functions as a normal life insurance policy.
Another type of coverage that you may want to consider even if you don’t anticipate an LTC event is called critical illness (CI). CI can cover acute events such as the diagnosis of cancer, heart attack, stroke, dementia and other conditions. These plans can either give you lump sums of money or reimburse you for care-related expenses. They especially come in handy to help cover deductibles and copays for covered conditions.
Have the government pay for it
The final way to fund retirement healthcare expenses that we are going to discuss is to rely on a government program such as Medicare and Medicaid. Medicare covers inpatient and outpatient care and prescription medication costs. It will pay for the first 90 days of hospital care following a triggering event; however, it does not cover LTC costs after the first 100 days.
If you want a government program to pay for LTC expenses, you would need to qualify for Medicaid. To qualify for Medicaid, you need to have a combination of income and assets valued at less than a specified level (this may include your residence, depending on which state you’re in). If you have more assets than the specified level, you would need to spend down those assets before being able to qualify. If you try to give away or gift those assets to family members, Medicaid may penalize you and/or make you ineligible for benefits. If you have a qualified LTC Partnership Program policy, you can exclude assets from the spend-down limit equal to the amount of LTC benefit you received from the policy. For example, if you received $100,000 in benefits from a qualified LTC policy, you could keep an extra $100,000 (you wouldn’t have to spend it) and still reach the Medicaid asset limit.
So when should you start thinking about incorporating a healthcare plan into your finances? Many experts would agree that the earlier you can start planning the better, but preferably before you enter retirement (up to 10 years before). There are two main reasons for this: to give you time to build up savings if you want to self-fund, or to increase your chances of insurability if you plan to insure yourself. Whether you plan to self-fund by saving, investing, or using other financial tools like reverse mortgages or other financial products, they all have one common necessity: time. It’ll take time for those accounts or lines of credit to build to a point where they can be relied upon to cover larger medical expenses. If you plan to purchase some type of private insurance to cover expenses, you usually must go through a medical (and sometimes cognitive) underwriting process. The longer you wait to apply, the more of a risk you become to an insurance company, which could increase the amount of your premium or make you un-insurable altogether. When planning for medical events and expenses in retirement, do your research, start planning early and utilize expert advice to find a solution that aligns with what makes you most comfortable.
Start learning about government programs.
As you approach your 60's, two topics come up repeatedly: Social Security and Medicare. You’ve probably received countless emails and mailers that have different information and programs, all while hearing varying pieces of advice from friends and family. It can all be very overwhelming when thinking about what you need to do and where to start researching. However, these programs are a great asset to you in retirement and enrolling doesn’t have to give you a migraine. This guide is intended to give you a brief overview of the two programs and a few points to watch out for.
Medicare is a healthcare program that is intended to provide health coverage for retirees age 65 and over. Many are inundated with information and advertisements for various Medicare programs as they approach their 65th birthday. There is a lot of confusion surrounding the programs, their coverage, enrollment dates and costs. To help you wrap your brain around the complexities of the various parts of the program, just remember your ABCs.
Okay, so more accurately you want to think of Medicare in parts A-E. Each part has different costs and rules, but you can think of them in these simplified terms.
Part A – this part of Medicare covers inpatient/hospital care, skilled nursing care up to 100 days, and hospital care. If you worked for 40 quarters or qualify for full Social Security benefits (more on this in the next section) you will not have to pay a premium for Part A and can enroll up to 3 months before your 65th birthday. You must meet the annual deductible of $1,364 (2020) before coverage begins and then pay coinsurance for certain services.
Part B – this portion can be compared to more general medical insurance, and covers outpatient care, doctor’s services and other preventative services and testing. Part B has an annual deductible of $198 and a monthly premium that is based on your income. Your monthly premiums can be deducted directly from your Social Security payments. Normally, people enroll in Part A & B at the same time. However, if you choose to delay the enrollment of Part B past your 65th birthday, you may have to pay a late enrollment penalty. Generally, these penalties do not apply if you’re coming off of other eligible coverage such as employer plans or TRICARE. To see if any of these special circumstances apply to you, use the resource guide at Medicare.gov.
Part C – Medicare Part C is also known as Medicare Advantage. This program is provided by a private insurance company and will cover at least the same services as Medicare Parts A & B. Private insurers for Medicare Advantage often add extra benefits and services to these plans such as prescription drug coverage, wellness, hearing, dental and vision programs. With Part C Advantage plans, you still have to pay a Part B premium and copays/coinsurance, but there are little to no other costs associated depending on the level of coverage you select. You must choose to enroll in either Medicare Parts A & B or Part C Advantage plans: you cannot be enrolled in both.
Part D – this plan covers your prescription drugs, biologics and insulin. You can enroll in Part D prescription drug plan (PDP) if you are enrolled in the original Medicare (A & B). If you have a Medicare Advantage plan it may already cover prescription drugs, and if not, you can purchase a stand-alone PDP. Pricing is based on your income (the higher income the more it will cost). Don’t just think about the present when deciding if you’re going to enroll in Part D coverage. Remember that if you decide to enroll in a PDP 63 days after your Initial Enrollment Period (IEP) (3 months before and after your birth month on your 65th birthday) your premiums will increase by 1% for every month you wait.
Don’t just think about the present when deciding if you’re going to enroll in Part D coverage… It’s better to have it and not need it, than need it and not have it.
Part E – Known as either Medicare Supplement or Medigap, these plans are designed to pay for deductibles, copays, and coinsurances that are not covered under the original Medicare plans. These plans are provided by private insurance companies and have guaranteed enrollment regardless of pre-existing conditions if you enroll within 6 months of enrolling in Part B. If you wait until later to enroll, you will have to go through medical underwriting and may not qualify for coverage under these plans. If you think you might want this type of coverage, you may want to err on the side of caution because it’s better to have it and not need it, than need it and not have it. Prices for these plans can change from year to year and are based on your age and zip code.
Optimize your retirement income.
Retirement income planning is one of the most important pieces to plan for if you want to have a rewarding retirement. In general, retirement income planning is the process of creating income from various financial tools (401(k)s, IRAs, Annuities, Cash Savings, Social Security, etc.) in a way that is most suitable for your goals and needs in retirement. While many variables go into this type of planning, you can break it down into the 4 Ls, a term popularized by Wade Pfau Ph.D. Each of these factors encompasses an aspect of retirement income planning that should be considered when making financial decisions. As you approach retirement, you should also have asked yourself, “what are my goals for each of these factors?” By doing so, you can be more confident that you are having the best retirement you can have and that your money is working for you and not the other way around.
While many variables that go into this type of planning, you can break it down into the 4 Ls: Lifestyle, Longevity, Liquidity and Legacy.
When you think about lifestyle, think about the standard of living. What do you want to do in retirement? Do you plan to live a more modest lifestyle, or do you have a lot of events, excursions, or trips planned? To accomplish this, you need to ensure that your purchasing power is at the very least keeping up with inflation. A common piece of advice you hear as you approach retirement is that you should move towards more conservative investments. You might have heard that you should have a larger portion of your money in less risky investments such as bonds, CD’s, or cash. While this is prudent advice because you can generally afford to take less investment risk during retirement, you should make sure that you are balancing your lifestyle needs with investments that will give you the necessary growth and/or cash flow.
If you plan to spend more in retirement, you’ll need to have a sufficient portion of your retirement funds in an investment that will have greater returns and therefore greater risk. If your investment returns are not large enough to keep up with your lifestyle, you run the risk of depleting your savings too quickly. This isn’t to say you should look for more risky investments, but rather investments that have a risk-vs-reward profile that is suited for your lifestyle goals. Retirement should be a time when you can spend your hard-earned money, just be sure to plan for it so that your retirement funds can keep up.
Outliving one’s money is one of the greatest fears that retirees face. In a study done by the Employee Benefit Research Institute, it is estimated that 40% of US households will run short of money in retirement. This could be caused by a multitude of factors including not saving enough, improvements to healthcare causing people to live longer, changes to Social Security benefits and a host of other things. When creating your retirement income plan, you should take precautions to make sure you never run out of money in retirement. There are a few strategies you could use to plan and prepare for this.
The first thing you should do is evaluate your yearly distribution amount. If you have retirement savings, a 401(k), IRAs, or other investments you plan to use, you can make a distribution plan to minimize your chances of running out of money. One way to do this is to divide the amount of money you have by your life expectancy to determine what a safe amount to withdraw every year. Another way to plan for this is to only withdraw the growth from your retirement savings account. For example, if you have $500,000 saved for retirement and it’s producing a 5% annual return (interest or dividends) you know you can safely take at least $25,000 (5% of $500,000) per year without your principal amount ($500,000) decreasing. You can also work with a financial planner to get more detailed projections and estimates of how long your money will last based on how much you want to take out per year. A downside to this method is that it can’t reliably account for stock market crashes or downturns which will alter any projections you’ve made.
One way to combat this is to use financial products that are meant to produce lifetime income such as annuities. Annuities are contractual products that have built-in features to help guard your money against taking losses as a result of a stock market crash. They also can provide lifetime income that could be used to help ease the worry of running out of money. They do have other restrictions that may prohibit you from using your money for a certain period and may have higher fees for extra features. One rule of thumb is to fund an annuity to a point where the lifetime income it will produce will cover your basic monthly expenses and no more. This way you know that you have your basic needs met at the very least. If you’re considering an annuity, make sure that you’re not allocating too much money into it that will take away from your other goals (lifestyle, liquidity, legacy).
Liquidity refers to the ability to access funds in the event of an unforeseen expense such as support family members through emergencies, major home repairs, and renovations, or unexpected illnesses. People can run into liquidity problems in retirement if they have a large portion of their income coming from pension-like sources such as lifetime annuities, government pensions, or Social Security. If more than 70% of your retirement income/assets are coming from pension-like sources, it may be necessary for you to have a separate plan to combat unforeseen major expenses and liquidity risk.
The easiest way to do this is to set up a separate pool of money to use for emergencies or unexpected events. You can think of this as a general emergency fund that you don’t touch unless you need to. If you’re living off a fixed income like Social Security, it is even more important to have a fund like this to weather financial emergencies. Use our emergency fund calculator for an estimate of how much you may need to save per month to get to a comfortable level of savings. You can base how much you need to save in an emergency fund off of things like monthly living expenses, or deductibles of your health, auto, and homeowner’s insurance.
When making financial decisions in retirement to improve your lifestyle, longevity, and liquidity, you should also factor in what type of legacy you want to leave. Legacy planning refers to leaving behind a financial gift to family members or charitable causes. Different financial tools or products you use will have differing effects on the legacy you’re able to leave behind.
For example, if you have a lot of your retirement savings in an annuity as mentioned in the previous section, your spouse or children may not get anything after you pass away depending on how you set it up or if you included a death benefit feature in the policy.
If you have a lot of wealth in an IRA (individual retirement account) that you want to pass down to your children, pay attention to the rules regarding inherited IRAs. If a child inherits an IRA from their parents, they are now required (per the SECURE Act passed in December 2019) to spend down the balance of that IRA within 10 years. To illustrate, imagine that your child inherits a $1 million IRA from you. Your child would be required to withdraw $100,000 from it every year, for the next 10 years. This could cause their reported income for each year to increase dramatically which would likely impact how much they have to pay in taxes. To combat this potential tax burden, some people choose to use a portion of their IRA to fund a life insurance policy because its proceeds are tax-free for beneficiaries.
In another scenario, you may not want to use a reverse mortgage if you planned to pass down your residence to your children. Alternatively, if your children don’t want to inherit your house, a reverse mortgage could be a great tool to supplement your retirement income.
When it comes to retirement income planning, it’s important to consider the 4 Ls to make sure that your overall goals are met. No single factor is more important than the other and you want to balance out each category to best suit your situation and preferences. Taking the 4 Ls of retirement income planning into account can also help you with questions on Social Security timing to get the most out of your benefits. Be sure to remember the ABCs of Medicare as you approach your 65th birthday and pay attention to required enrollment dates. And finally, make sure you plan for the unexpected and have adequately prepared to cover healthcare costs. If you follow these three steps, you’ll have less to worry about and be able to live the retirement lifestyle that you’ve always dreamed about.