How to recession-proof your retirement years
Posted on 25 May 2009
Permanent URL of this article: http://retirementrevised.com/column/how-to-recession-proof-your-retirement-years
I had dinner recently with my mother who’s 87 and asked her how she was doing given the financial meltdown. “I’m doing just fine, but I’m worried about what you kids will inherit, since the value of my retirement investments has dropped a lot.” I told her that “us kids” don’t worry about our inheritance and are much more interested in her well-being.
Then I explored why she’s doing so well and I realized that we can learn a lot from her situation. Let’s take a look.
–She has a lifetime pension from my father, who worked as a professor at USC until age 65. He also waited until age 65 to start Social Security income (age 65 was Social Security’s normal retirement age at the time). Her pension and Social Security income just keep coming in, in spite of the meltdown.
–She supplements her pension and Social Security income with interest and dividend income from her retirement investments. While the value of her stocks has dropped significantly, the dollar amount of her dividend income has barely changed.
–She has paid off the mortgage on her house. While the house is small by today’s standards, it meets her needs just fine.
–She keeps her living expenditures low and has no credit card debt. She drives a seven-year-old car and will most likely continue driving it for another five to 10 years.
–She’s in good health; she eats sparingly, consumes lots of fruits and vegetables, and gets good exercise by walking and gardening. She even grows some of her own food.
–She volunteers once a week in a nonprofit thrift store. She’s doing the same tasks as if she were working for wages; she could earn a small paycheck if she needed it.
–She keeps in touch with friends and relatives, and sees family members at least once per week (all of us live nearby).
The financial meltdown hasn’t changed her life very much. She still has about the same income and expenses, and she continues to do what gives her joy and meaning in life. I realized that she and my late father did a great job of recession-proofing their lives, managing to live through four downturns since my father retired in 1981.
My mother provides one example of how to protect yourself against economic challenges, but let’s dig a little deeper. While this recent recession has grabbed everybody’s attention, there are additional risks that we need to address in our retirement years. Here’s a list of important risks that need our attention.
Retirement Risks We Should Address
- Living too long and running out of money
- Recession/stock market decline that reduces the value of retirement savings
- Inflation eroding the value of fixed pensions and fixed investments
- Dropping interest rates resulting in reduced interest income
- Poor health and resulting high medical bills
- Potentially ruinous bills for long-term care expenses
- Reduction in needed wage income during retirement years (since many of us may need to work to make ends meet)
- Bad advice, fraud or theft regarding your investments
- Death of a spouse
Our November 2008 newsletter listed 10 Steps to Financial Security in Your Retirement Years, and they do a good job of addressing these nine risks. Let’s revisit those steps to see how they can disaster-proof your retirement years.
Step 1: Take Care of Your Health
By taking care of your health, you’ll help alleviate three of the risks I’ve listed above: (1) high bills for long-term care, (2) running out of money (being in good health means you’ll spend less on medical bills), and (3) the potential reduction of wage income (good health enables you to keep working if you need to). Staying healthy also helps keep you sharp, which you need to do to make informed decisions during a crisis.
Step 2: Protect Against the Risk of Catastrophic Conditions
Buying medical insurance helps protect you against the risk of running out of money and the risk of generating high bills for medical expenses. Having a strategy for long-term care expenses addresses the risk for these expenses. That strategy could include one or more of these actions:
–buying long-term care insurance,
–maintaining an investment account that is dedicated to this purpose, and/or
–keeping home equity in reserve until needed. Don’t tap it for ordinary living expenses with loans or a reverse mortgage.
Step 3: Work as Long as Possible
If you’re partially or fully meeting living expenses with wage income, there’s less pressure on financial resources during an economic downturn, which gives them a chance to recover. This also allows you to delay receiving Social Security and pension benefits until they reach their maximums (see Steps 4 and 6 below for more on this). As an employee, you may also be covered by employer-provided health insurance, thus protecting you against high medical bills.
Step 4: Maximize Social Security Income - Delay the Start Date
Since Social Security provides lifetime retirement income, it helps protect you against the risk of running out of money. Benefits are indexed for inflation, so you’re protected against high inflation. And since Social Security benefits are unaffected by stock market or interest rate fluctuations, it protects against those risks as well.
Step 5: Be Prudent When Withdrawing Retirement Savings
Being cautious protects against the risks of running out of money and stock market declines. If you live on just the interest and dividends from your savings, you’re partially insulated from capital market fluctuations, as the dollar amount of this income is much less volatile than the fluctuations in the underlying investments. If the interest and dividend income isn’t sufficient for your needs, then you should limit annual withdrawals to 4% to 5% of the portfolio. These strategies give your assets a chance to recover when the market comes back.
If you don’t have a significant income from a pension plan, consider buying an immediate annuity from a highly rated insurance company with a good portion–from one-third to one-half–of your retirement investments. Consider this to be longevity insurance and protection against market declines. As with other sources of lifetime income, such as Social Security and pensions, waiting as long as possible to buy the annuity will increase your monthly income.
Step 6: Maximize Income From Traditional Pension Plans
Working longer and delaying commencement of benefits accomplishes this goal. Since a pension provides lifetime retirement income, you’re protected against the risk of running out of money. And because pension income is unaffected by stock market or interest rate fluctuations, it protects against those risks as well. Benefits aren’t usually indexed for inflation, so you’ll need to address that risk by taking the other action steps described here.
Step 7: Use a Simple Investment Strategy
Diversify your retirement savings among stocks, bonds, real estate and cash investments. This helps mitigate the impact of either a significant stock market decline or high inflation. For many people, the simplest course of action is to own their own home and invest in some combination of (1) highly rated balanced or target date mutual funds with low expenses, (2) federally insured bank accounts, and/or (3) U.S. Treasury bonds such as Treasury inflation protected securities (TIPs).
Step 8: Adjust Living Expenses to Match Your Income
Minimizing your living expenses protects against most economic risks. If you don’t have to buy very much, you’re partially insulated against inflation or a stock market downturn. You might say “Duh! It doesn’t take a genius to figure that out.” But let’s take a closer look.
Surveys by the U.S. Bureau of Labor Statistics show that the five biggest sources of consumer expenditures are, in order, housing, transportation, food, health and entertainment. Together, these consume about 75% of the typical American’s budget. Strategies to manage expenses include paying off your mortgage, downsizing your house and/or cars, taking care of your health, buying healthy food (which often costs less than unhealthy food), and buying only what truly makes you happy.
Budget your money so that your living expenses for the next one to three years are completely covered by your Social Security, pension, annuity, and interest and dividend income; cover any shortfalls with cash investments such as bank accounts and money market funds. This eliminates the need to liquidate stock and other longer-term investments during a market downturn.
Steps 9 and 10: Become a Student of Retirement, and Build Your Professional Team
These steps protect against all retirement risks, including bad advice, fraud and theft, which are serious problems for retirees. You can best protect yourself by making informed decisions, assisted by the appropriate professionals.
So far, I haven’t addressed one important risk: protecting your surviving spouse. All of the above steps accomplish that goal, but here are a few more suggestions:
–If you have annuity or pension income, continue income to your spouse after your death with a joint and survivor option.
–Include your spouse in steps 9 and 10, so he or she is informed as well.
–Keep your wills and trust documents up-to-date.
You should be patient but diligent about achieving these goals over the next several years; although you can’t implement them all at once, you should begin implementing them as time allows. Take the time to investigate the alternatives and details, which I’ll cover in future newsletters. One valuable resource that addresses retirement risks in more detail is a report prepared by the Society of Actuaries, titled Managing Post-Retirement Risks: A Guide to Retirement Planning [pdf file].
My parents took many years to get all their ducks lined up. But given that my mother has been in retirement for 27 years with hopefully many more good years to come, her story illustrates that it’s time and money that’s been well spent.
“I’ve just followed the financial advice of my father, your grandfather,” my mother reminded me. “He was a stock broker who supported our family during the Depression, and he learned lessons the hard way.” Her life experience provides good examples to follow in these trying times.
There really is a lot we can do on our own to protect ourselves against retirement risks, and that’s probably the best way to deal with the natural fear and anxiety we all feel right now.
Steve Vernon is President of Rest-of-Life Communications, and a member of the Executive Faculty and Research Fellow with the California Institute for Finance at California Lutheran University, where he conducts research on behavioral finance. He recently retired as Vice President and Consulting Actuary with the human resources consulting firm Watson Wyatt Worldwide. For over 30 years, he helped large employers design and manage their retirement programs.
May 26th, 2009 at 7:21 am
Your Mom is living proof that if you have your health much else can be addressed with proper living adjustments. My father had a history of coronary and circulatory problems. He eventually had a serious stroke. Long Term Care Insurance had a profoundly positive impact on my family. My father was a proud, conservative & head strong WWII vet. When the stroke hit the entire family was devastated. Soon we realized that he and my mother had the foresight to purchase Long Term Care Insurance. It was called home health care insurance at that time. There was NO WAY my father was going to some facility, that was one of the biggest factors for them both when buying. My father’s rehabilitation efforts and care took place at my parent’s home. He maintained his dignity as neither my sister nor I had to take care of issues that “his” hired caregiver provided. Albeit a devastating event, to the end he managed to smile for the most part and was generally happy. My mother today is living comfortably in a facility, her choice. It has a built in social network and she feels very secure. She did not want to move in with her children, pride again I’m sure. The ONLY reason our family can afford this is due to both my parents having coverage in place. If they had not purchased LTC my father’s stroke would have wiped out my parents assets, taken freedom of choice away from my mother and eventually started to become her children’s financial responsibility. This is what they both wanted to avoid, mission accomplished! The gesture and wisdom have not been lost on their children. I am such a believer I went out an got licensed to actively educate and promote my community on this important product.
May 26th, 2009 at 7:43 am
I appreciate this piece as long term care insurance is a very important topic for seniors as well as their families. This insurance can be a life saver in many situations. However, long term care insurance is not for everyone as it can be really expensive and might not make sense in some cases. You must evaluate your net worth, annual income, family situation, and many other issues. You can obtain at a more detailed explanation and comparison on my site at: http://www.dollarstep.com/ltc.html
May 28th, 2009 at 5:41 am
Very interesting story and article. I am a long way from retirement - 2030s, but never too early to start planning setting the correct habits.
May 28th, 2009 at 8:14 am
My parents are in good physical health and my step-father planned well for retirement. They did not, and could not, plan for him to have Alzheimers and my mother to have dementia. They need someone to handle their finances, make important decisions, do their shopping, pay their bills, and protect them from two con artists who have been praying on them. Because they can feed themselves, dress themselves and toilet themselves, long-term care will not compensate them for the care they need. They cannot shop or cook but as long as they can put food in their mouths, they are ineligible for LTC. We went to court and had them declared incompetent and found a professional guardian. He costs $85/hour but is worth his weight in gold. Now the family (all distant) does not have to intrude and they have excellent group of people who care for them. It is expensive but they can remain in their home and because they are in such good health, they will likely live this way for many years. There is no insurance that covers dementia, although LTC’s claim they do. One in twenty elders will have this problem and it needs to be addressed. We were lucky that our lawyers knew that professional guardians existed. This company includes a housekeeper whose job is also to make friends with my folks, is journaling their stories, building trust with them, and warning when the con artists come around. A nurse monitors their meds, another nurse/social worker takes them to doctor’s appointments, keeps the family informed, advises us on ways to communicate with them, and explains their diseases to us. The guardian works with lawyers and probation officers to keep the con artists at bay, is trying to get some of their stolen resources back and to straighten out the mess their finances were in. We get to go back to being the family. We feel we are very, very lucky but it’s a side of retirement you never hear about.