(This article appeared previously on Marketwatch.com.)
Financial planners love rules of thumb when it comes to saving for and spending in retirement, and guidelines can help clients conceptualize a daunting subject. But the best advisers acknowledge that reality is much less predictable than the rules imply, and that financial plans need to accommodate a good deal of uncertainty — including question marks about your own longevity and the amount you might need for long-term care.
“When you’re doing retirement planning, you really have to look at the individual circumstances and you have to realize that the spending and the assets are not that predictable and that they change over time,” said Dirk Cotton, a financial planner in Chapel Hill, N.C. at a recent Retirement Adviser panel discussion in New York City moderated by MarketWatch senior columnist Robert Powell.
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Retirement Rules and Retirement Reality
Some investors have undoubtedly heard of the 4 percent rule, which says retirees can safely withdraw 4 percent of their nest eggs annually without running out of money. And some might be familiar with the advice that savers need to sock away 25 or 30 times their projected annual spending in retirement.
These rules generally rest on assumptions of spending stability — that is, a retiree will spend a fixed amount annually, indexed for inflation over a period that could last 30 years or even longer. And yet, retirement spending
is usually much choppier in reality, due to all sorts of risks and uncertainties.
Most investors are well versed in market risk. After all, the financial crisis showed how much damage a stock market crash can do to a 401(k) balance. But they’re less familiar with the other risks that can derail a retirement plan. These include everything from the likelihood of needing long-term care, to the death of a spouse
, to falling victim to bad advice or even fraud
. There’s also the risk that a person can’t retire on his own timetable and must stop work early
due to an illness or layoff.
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Planning for Long-term Care
is one of the most vexing risks to factor into a financial plan, advisers say. People reaching age 65 have a seven-in-10 likelihood of eventually needing help with basic tasks of daily living, such as bathing and eating. And yet, advisers and their clients too often avoid planning for that likelihood, said Joe Tomlinson, an actuary and financial planner in Greenville, Maine. Even if you assume you’ll need help, it’s impossible to predict how much you’ll need.
doesn’t cover this type of custodial care, as it’s known, and it can be enormously expensive. The median national cost of a private nursing home room nationally is $87,600 a year, in today’s dollars, according to Genworth, and in some parts of the country it’s already much higher. Provided in the home, custodial care costs around $20 per hour.
A long-term care expense would cause a spike in spending that the traditional planning models don’t account for. An adviser will typically program the model with a housing budget based on a pre-retiree’s current mortgage payment. But that payment may be much lower than the cost of nursing care or assisted living
. And that amount also doesn’t reflect the additional expenses a couple incurs when one of them enters a facility and the other continues living at home and paying the mortgage, utilities and property taxes.
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Choosing the ‘Best Bad Solution’
So how should planners incorporate this risk into their clients’ portfolios? “Unfortunately, I would say there’s no good solution, so it kind of comes down to, how do I choose the best bad solution for long-term care?” Tomlinson said.
Tomlinson recommends that clients take a serious look at long-term care insurance, even though the industry has had its share of problems. Carriers have exited the business in recent years as the product has proved unprofitable, and the carriers that have remained have trimmed benefits and raised premiums.
And yet, “if you went without insurance, then you’d be facing more expense than you thought,” Tomlinson said. People shouldn’t wait until they’re about to retire to consider a long-term care insurance purchase, since they may not be healthy enough at that point to pass the policy’s medical underwriting.
Given all the unknowns, Cotton advocates reassessing a retiree’s spending needs, account balances and risk tolerance annually, and then tweaking the portfolio’s asset mix accordingly. “I can’t tell anyone, ‘This is what you ought to do over your retirement career, that you should have more stocks when you’re 80,’” he said. “I’m going to have to wait until you’re 80 to let you know.”
In addition to unpredictable expenses, retirees face an uncertain lifespan. An income annuity
is a good tool to address this so-called longevity risk, since it provides a guaranteed income stream for life, said Wade Pfau, a professor of retirement income at the American College in Bryn Mawr, Pa.
However, it’s important not to put all of a retiree’s assets into an annuity, Pfau said: “You also need liquid reserves that are just available to deal with unexpected spending.”
Elizabeth O'Brien is a retirement healthcare reporter for MarketWatch. Contact her at Elizabeth.O'Brien@dowjones.com
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