The Great Recession and lingering global pressures have forced many Americans to rethink, reschedule and restructure their retirement plans. This year, more than one-third of respondents to Gallup's retirement survey said that they were planning on postponing retirement until after age 65, compared with 12% in 1995. Fewer than half of respondents said they expected to have sufficient funds to retire comfortably.1
If there is a silver lining, it may be that a new era of conservative financial awareness has been ushered in. According to the World Wealth Report, a proprietary survey of high-net-worth investors by Merrill Lynch Wealth Management and Capgemini, 90% of the respondents now consider "effective risk" management an important part of their investment strategy.2 Forewarned is forearmed, as the saying goes, and those with a solid strategy will be better prepared when cold winds blow again. To support this new, more activist approach, Merrill Lynch's retirement specialists have identified five of the most common areas of vulnerability for retirement plans today, along with some ways to save, allocate assets and withdraw income that can help you shore up your defenses and prevent these pitfalls from derailing your dreams.
No. 1: Health care costs
One of the biggest retirement traps is failing to adequately provide for the expense of health care, which since 1970 has risen, on yearly average, 2.4 percentage points faster than the gross domestic product.3 While the recent sweeping reform may make health care more affordable for some, costs are expected to continue to rise overall, according to a report from the Department of Health and Human Services.4 "If you're not accounting for the variability in inflation and factoring in the higher expenses you'll face later in retirement, that's a danger," says Katherine Roy, Director of Personal Retirement, Innovation and Planning for Merrill Lynch.
Long-term care can be particularly expensive: The tab for full-time nursing home care currently averages between $69,000 and $78,000 annually.5 Given that trend, Roy advises exploring your options early — consider purchasing a long-term care policy to help save on premiums, for example — so that you're not forced into costly, inefficient financing when and if the time comes.
No. 2: Unexpected outlays
Whether it's a daughter seeking investors for her business or a son who's lost his job and returned home, surprise demands on your cash can cut into reserves. That's why it's important to have an emergency stash even after you retire, says Roy. "Most people think about having a contingency fund when they're still working," she says. "But it's equally important in retirement."
This reserve fund should likely be allocated to cash or other highly liquid investments (such as short-term bonds and CDs) and should be considered within the overall framework of your retirement holdings. Clients at Merrill Lynch are encouraged to think of their retirement portfolio as consisting of three sub-portfolios — a short-term one earmarked for special outlays and ongoing liquidity needs, another designed to optimize investment opportunities over a longer period, and a third that marshals excess savings to help maximize the value of legacies. Approaching your allocations this way can help you stay disciplined and avoid "borrowing" from your reserves to pursue other opportunities. And if you haven't retired yet, make sure you have other liquidity options to tap in a crisis, such as savings you can withdraw from taxable accounts without penalty, leaving retirement funds untouched.
No. 3: Market freefalls
As you get closer to retirement, shifting your allocation toward more conservative assets, such as corporate and tax-free municipal bonds, can provide greater security in a bear market. Since a portion of your portfolio may still be invested for growth, you'll also need to consider a good income-withdrawal strategy to help minimize the need to harvest investments at the wrong time, says Roy.
This strategy may also prevent you from reacting emotionally to a volatile market — for example, by selling stocks and overweighting fixed income, which won't likely help you keep pace with inflation. "It's important to maintain a disciplined asset allocation approach that you can stick to, no matter how hard it may seem when the markets are in flux," Roy says.
It's also good to maintain your income in retirement. You can help to do that by seeking a mix of low-volatility, income-producing assets, such as high-quality bonds, Treasury inflation-protected securities (TIPS) and certificates of deposit.
No. 4: The dreaded 'D's
No one wants to plan for divorce or the death of a spouse, but either could threaten your financial security. First, make sure you both have up-to-date wills and beneficiary information on your accounts. Next, consider consolidating your IRAs and other savings and investment accounts so the surviving spouse, already coping with a devastating blow, isn't also burdened with the task of locating accounts and chasing down income.
Divorce can be equally disruptive from a financial perspective, if not more so. The couple's assets must now be divided to support two households instead of one. And there are tax considerations to keep in mind. For example, married couples who sell jointly owned property enjoy capital gains of as much as $500,000 free of taxes, while for single individuals the exemption is half that. So a divorcing couple would either have to sell the property prior to dissolving the marriage or have language written into the divorce decree that would allow the moving spouse to get the favorable tax treatment. Qualified retirement plans like 401(k)s and IRAs are typically split up using a qualified domestic relations order (QDRO), but if that document is not drafted correctly, one of the spouses could be taxed immediately on deferred income. The most appropriate protection is for both spouses to stay up to speed about family assets and involved in discussions with their Financial Advisor and tax professional long before any need arises. "That way, if your financial strategy has to be unwound, either for reasons of death or divorce, both individuals are educated," says Roy.
No. 5: Fear of poverty
The flip side of couples living too large and outspending their assets is that some are so worried about having enough that they fail to enjoy the years they spent a lifetime preparing for. "For individuals so used to saving, shifting into a distribution mode can be really difficult," says Roy. To help give you the confidence to spend, ask your Financial Advisor to run a sensitivity analysis that will show you how some catastrophic financial event, such as a market meltdown or a family illness, would affect your portfolio. You may be surprised at how solid your strategy really is.
To help with your comfort level as you shift your saving/spending behavior, you may want to consider an annuity that can provide a guaranteed income stream. Your Financial Advisor can walk you through the various options, from annuities that include a death benefit for your beneficiaries to others designed to maximize your payments while you're alive.
Whatever the financial tools you ultimately choose, with enough careful planning, you can help protect your future from financial pitfalls and make your retirement dream a reality.
Consider asking your Financial Advisor these questions about how to avoid some of the most common retirement planning pitfalls: - How can I position my retirement plan to help prepare for the rising cost of health care?
- What's an appropriate way to allocate my rainy-day fund?
- What kind of investment strategies can help protect my assets from a market downturn?
- Are my accounts as consolidated as they should be?
- What's a "sensitivity analysis"? And should we run one?
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