Seven Steps to a Sound Retirement

There are seven keys to a lot of things in life. There
are seven steps to heaven and seven types of
intelligence and seven habits of effective leaders.
Now we have seven steps to retirement planning
courtesy of the Society of Actuaries, which just
released a
64-page report with the not-so-consumer
friendly title "Segmenting the Middle Market:
Retirement Risks and Solutions Phase II Report."
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"Retirement financial planning requires a methodical
approach that identifies and quantifies each
important component that affects the asset
accumulation, income management and product
selection/investment decision processes," according
to the report, which was sponsored by the society's
committee on post-retirement needs and risk and
written by Noel Abkemeier of Milliman.
Not surprisingly Abkemeier says this approach is
especially important for middle income Americans
who likely have less than $100,000 set aside for
retirement. So what are those steps?
1. Quantify assets and net worth
The first order of business is taking a tally of all that
you own — your financial and non-financial assets,
including your home and a self-owned business, and
all that you owe. Your home, given that it might be
your largest asset, could play an especially important
part in your retirement, according to Abkemeier.
And at minimum, you should evaluate the many ways
you can create income from your home, such as
selling and renting; selling and moving in with family;
taking out a home-equity loan; renting out a room or
rooms; taking a reverse mortgage; and paying off
your mortgage.
Another point that sometimes gets lost in the fray is
that assets have to be converted into income and
income streams need to be converted into assets.
"When we think of assets and income, we need to
remember that assets can be converted to a monthly
income and that retirement savings are important as
a generator of monthly income or spending power,"
according to SOA's report. "Likewise, income streams
like pensions have a value comparable to an asset."
One reason retirement planning is so difficult,
according to SOA, is that many people are not able to
readily think about assets and income with equivalent
values and how to make a translation between the
two. Assets often seem like a lot of money,
particularly when people forget that they will be
using them to meet regular expenses.
Consider, for instance, the notion that $100,000 in
retirement savings might translate into just $4,000
per year in retirement income.
2. Quantify risk coverage
Take stock of all the insurance that you might already
have or need — health, disability, life, auto and
homeowners. In addition, consider whether you
might need long-term-care insurance, especially in
light of the cost associated with long-term care and
the very real possibility that you might need some
assistance at some point in your life.
According to the report, those households with
limited assets, say less than $200,000 in financial
assets, may need to spend down their assets and rely
on Medicaid, while those with more than $2 million
in financial assets can cover long-term-care costs out
of pocket. But those households with assets in
between $200,000 and $2 million should include long-
term care insurance in their plan, according to the
SOA. And the best time to buy such insurance is in
the late preretirement years.
The SOA also notes in its report the possible need for
life insurance, the death benefit of which can be used
for bequests or to provide income to a surviving
spouse. Life insurance premiums can be expensive if
you're getting on in years. That's why the SOA report
suggests that you continue "existing preretirement
coverages during the retirement period."
Of note, there will soon be many policies that
combine long-term-care insurance with life insurance
and annuities.
3. Compare expenditure needs against anticipated
income
The thing about retirement is that it's filled with
expenses, which according to the SOA report "can be
thought of as the minimum needed to sustain a
standard of living, plus extra for nonrecurring needs
and amounts to help meet dreams." What's more,
those expenses are likely to change over time.
So, to make your retirement plan work in reality you
first have to make it work on paper. You need to
compare whether you'll have enough guaranteed
income to cover your essential living expenses,
including food, housing and health-insurance
premiums, at the point of retirement and then
compare what amount of income you'll need to cover
your discretionary expenses, such as travel and the
like (if those are indeed what you might consider
discretionary expenses).
Your guaranteed sources of income include Social
Security, and possibly a pension and annuity. Your
not-so-guaranteed sources of income include
earnings from work, income from assets such as
capital gains, dividends, interest, and rental property.
No doubt, as you go about the process of matching
income to expenses, you might find yourself having
to revise your discretionary expenses, especially if
there aren't enough guaranteed sources of income to
meet essential expenses.
4. Compare amounts needed in retirement against
total assets
So here's where your math skills (or your Google
search skills) might come into play. Besides
calculating your income and expenses at the point of
retirement, you need to figure out whether your
funds will last throughout retirement. In other words,
you need to calculate the net present value of your
expenses throughout retirement.
Now truth be told finding the present value of your
expenses is a bit tricky, especially since there are
many factors that can affect how much is really
needed, including the date of your retirement,
inflation rates, gross and after-tax investment returns
and your life expectancy.
But the bottom line is this: If, after crunching the
numbers, the present value of your expenses is
greater than the present value of your assets you've
got some adjustments to make. And the good news is
that there are plenty of adjustments that you can
make.
You could, for instance, delay the date of your
retirement or return to work or work part-time.
Those actions might be enough to offset the
difference. In addition, you might consider trimming
your expenses or consider a more tax-efficient
income drawdown plan.
5. Categorize assets
The SOA also recommends that assets be grouped to
fund early, mid and late phases of retirement. Thus,
assets for early retirement should be liquid, while
mid-retirement assets should include intermediate-
term investments such as laddered five-to-10-year
Treasury bonds, TIPS, laddered fixed-interest
deferred annuities, balanced investment portfolios,
income-oriented equities, variable annuities, and the
like. And late retirement assets include longevity
insurance, TIPS, balanced portfolios, growth and
income portfolios, laddered income annuities,
deferred variable annuities and life insurance.
6. Relate investments to investing capabilities and
portfolio size
This should come as no surprise; the SOA
recommends that you invest only in things that are
suitable, relative to your risk tolerance, investment
knowledge and the capacity of the portfolio to
accommodate volatility. "In short, a retiree should
not invest beyond his investment skills, including
those of his adviser," the SOA report stated.
7. Keep the plan current
This too might be a bit obvious, but retirement-
income plans must not be built and set on a shelf.
The plan is a point-in-time analysis that must be
reviewed on a regular basis.
Consider, for instance, just some of the things that
could change in one year, according to the SOA.
Health status or health-care costs could change; your
life expectancy might change; your investment
returns and inflation might be quite different than
your assumptions; and your employment status and
expected retirement date might change.
What's more, you might suffer the loss of a spouse
through death or divorce, or perhaps you might not
be able to live independently any longer, or perhaps
you might need to sell your house or unexpectedly
care for dependents, or change your inheritance
plans.
Said Abkemeier: "You want to keep your plan current.
You need to tie everything together and go back to
the start of the process each year. You want to enjoy
retirement, but you don't want to be at rest."