I spent a lot of time traveling in October, which was good for my tan, but bad for my writing schedule. There’s quite a bit on the editorial calendar for November though, so stay tuned. In the meantime, below is a list of articles published at Intentional Retirement during October.
Thanks for reading!
Joe
October 17-23 is officially National Estate Planning Awareness Week. As in years past, my procrastination got the better of me and I didn’t get you a gift, so I’m sending out this handy little estate planning primer instead. Enjoy.
What is estate planning?
It’s pretty simple really. Someday we’re all going to die. Our estate plan spells out things like how we want our property distributed, who we want to take care of our minor children, and who we want to handle our affairs. It also spells out who we want to make medical and financial decisions for us if we become incapacitated.
Who needs an estate plan?
Short answer: You. Regardless of how much or little you have, you should have a plan for both death and incapacity.
How do I go about setting up a plan?
Estate planning laws are complex, always changing, and often very rigid. As unpleasant as it can sometimes be, you need to work within that complex framework if you want to accomplish your goals. Working with your financial adviser and a competent estate planning attorney will ensure that you have a plan that not only accomplishes your wishes, but saves you time, frustration, and a lot of money.
What should a good estate plan accomplish?
A good estate plan should accomplish three things: It should pass your property to the correct people, designate the correct people to take charge, and minimizes expense, hassle and taxes.
What are the key estate planning documents?
Most estate plans have a will, living trust, durable power of attorney for finance, durable power of attorney for health care, advanced medical directives, and a letter of instruction.
What is a will?
A will is simply a legal document with formal signing requirements which spells out your intentions for the division and distribution of your property to heirs at death. If you die without a will (also known as intestacy), the laws of your state of residence, or the laws of the states in which you own real estate, may control who inherits your property. You need a will even if your assets are owned in joint tenancy, a revocable living trust, or in a manner where you designated a beneficiary (e.g. life insurance) to guard against intestacy for property titled in your own name or in the event your joint tenant or beneficiary dies before you do.
What is a revocable living trust?
A living trust is a legal entity that owns your assets. You typically act as trustee of those assets during your life and then name someone to take over for you after you die. Your trust document gives instructions for how you want your property handled and distributed after death. A living trust is often used as a will substitute because it avoids the costly and time consuming process of probate. You will typically title your assets in the name of your trust while alive and also have a “pour over will” that will transfer any assets not properly titled into the trust after you die.
What is a durable power of attorney for finance?
A durable power of attorney for finance is a simple and inexpensive legal document that authorizes a person you have chosen to step in and manage your day-to-day financial decisions if you become incapacitated. Everyone needs this document to provide for the ongoing management of their financial affairs if they cannot make decisions for themselves.
What is a durable power of attorney for health care?
Similar to the power of attorney for finance, the health care power of attorney is a legal document that authorizes a person you have chosen to step in and make health care decisions for you if you become incapacitated and can no longer speak for yourself.
What is an advanced medical directive?
An advanced medical directive (sometimes called a living will) provides written instructions to your agent that communicate your wishes regarding the withholding or withdrawal of certain life support equipment or medical procedures. Without these instructions, medical providers are typically required to use artificial means like life support to prolong your life.
What is a letter of instruction?
A letter of instruction is a non-legal document that you can choose to include with your planning to give any personal thoughts, feelings or directions to your heirs. It can include things like burial wishes or even final words of wisdom and encouragement. Unlike the will, the letter of instruction remains private. Keep in mind, however, that anything in the letter is not legally binding.
As always, thanks for reading! Touch base if I can ever help.
Joe
Every year during retirement, everything you buy will cost more than it did the year before.
Such is the nature of inflation. In 1990 a stamp was 25 cents. Today it has almost doubled to 44 cents. A gallon of gas was $1.16. Today you can expect to pay triple that. A new home in 1990 was $149,800. Today it is…well, let’s just say housing has hit a bit of a soft patch.
Multiply those increases across all the goods and services you buy during retirement—dinner out, a new car, a vacation—and over a 20-year retirement, you can expect prices to more than double (assuming 4 percent annual inflation). That means you’ll need twice as much income later in retirement to buy the same goods and services you bought at the beginning of retirement.
How can you combat this nemesis of inflation? Most people’s retirement income comes from two different sources: Social Security and personal savings. Let’s look at ways to overcome inflation in each.
Social Security
Social Security has a built in annual cost of living adjustment, so most people assume that it will keep pace with inflation. Unfortunately, that may not be the case. Social Security adjustments are based on the Consumer Price Index or CPI. For decades, the Bureau of Labor Statistics (BLS) calculated the CPI in a fairly straightforward manner. They looked at a basket of goods, and determined how much it would cost. The following year they would price out that same basket of goods and the CPI would go up or down based on the new price.
In the 90s, some in government began to argue that inflation was overstated. They argued that as prices increased people would substitute less expensive alternatives, so the “basket of goods” should be adjusted each year. If steak got too expensive, they assumed that consumers would substitute something cheaper like hamburger. So why not remove steak from the basket, put hamburger in and voila, inflation is under control. Rather than implementing this “variable basket”, the Clinton administration implemented a different process that essentially achieved the same results. The BLS began to weight items in the basket differently. Basically, items that were increasing in price were given less weight than items that were decreasing in price.
To make matters worse, the BLS went on to make another change based on what they called “hedonics.” In short, hedonics doesn’t simply consider the price of an item, but the value that you get from that item. So if the price of a new car increases 10 percent, but there are new features on the car like airbags or heated seats that increase the “value” to the consumer by 15 percent, then the BLS would essentially say that the price of that car had decreased by 5 percent even though you’re paying more for it.
Applying this to your Social Security check, you can see that the annual cost of living increase built into the program won’t necessarily help you to keep pace with inflation if it is based on the fuzzy math of the CPI. A case in point: there were no cost of living adjustments in either 2010 or 2011, even though prices for things like food, fuel, and medical care undoubtedly increased over that period.
The solution:
The best way to overcome this hurdle is to build your own inflation factor into your Social Security benefits. How do you do that? Rather than waiting until full retirement age or later, the average person retires at 62 and takes a roughly 20 percent permanent reduction in benefits. Rather than following their lead, if you wait a few years you can retire on full benefits. Even better, retire a few years “late” and you can add as much as a third to your annual benefit (8 percent per year for those born after 1943 to a maximum age of 70). The annual cost of living adjustment will still be understated, but it will be based on a much higher benefit amount.
Personal Savings
In the same way that inflation eats away at the value of your Social Security income, the purchasing power of your savings and investments are also constantly being eroded. Failure to keep pace will result in your money becoming worth less until it is eventually worthless. As we saw earlier, even a modest rate of inflation of 4 percent can wipe out nearly all of the purchasing power of your nest egg during a 20-year retirement.
To overcome this problem, you need to invest in things that have the possibility of outpacing inflation. Understandably, however, the volatility and uncertainty of the last few years has caused many to shift their investments into things like money markets, certificates of deposit (CDs) and other “safe” investments.
Unfortunately, safe can be risky.
Consider a day in the hospital. In 1980, a day in the hospital cost $344. Today that same day costs around $5,310 (according to statistics published by the Wall Street Journal). For the sake of our example, let’s assume that 30 years ago you wanted to start planning ahead for your retirement. You thought that someday you might end up in the hospital for an illness and you wanted to set aside enough money to pay for a two-week hospital stay. You didn’t want to risk losing the money however, so you just put the cash into your safe-deposit box.
Fast forward three decades and you’re hospitalized with pneumonia for two weeks. When the bill arrives, you remember the cash that you stashed away so many years ago. You make a trip to the bank, open the box, and find exactly $4,816. Looking at the bill, you realize you’re about $70,000 short. By not outpacing inflation, your money lost almost all of its purchasing power.
Now let’s assume that instead you invested that $4,816 into the S&P 500 back in 1980. Even with all the ups and downs, it would have grown to nearly $135,000 by 2011. That’s enough to pay your entire hospital bill with plenty to spare.
The solution:
So what are some ways to preserve the purchasing power of your nest egg? First, as we just saw, you should resist the temptation to be too conservative. You aren’t doing yourself any favors by having a portfolio dominated by “safe” investments like cash, government bonds and CDs. These investments are less likely to outpace inflation and could even lose a significant amount of their value during high inflationary periods. Most investors should keep at least a portion of their investments in quality stocks.
Second, consider investments in real estate, commodities or precious metals. These types of “intrinsic value” investments tend to do well during inflationary times. As we have seen with the current downturn, however, they can also be more volatile and less liquid than stocks and bonds, so keep that in mind.
Finally, consider investing in a real return mutual fund. These funds invest in a wide range of investments that are designed to battle inflation, such as inflation protected treasury bonds, real estate investment trusts, floating rate bonds, non-U.S. debt, natural resource stocks, high yield bonds, currencies and commodities.
Clearly, a fixed income retirement strategy in a rising cost world is a recipe for running out of money. By investing in a well balanced portfolio that is designed to keep pace with inflation, you can help ensure that your money not only lasts for your lifetime, but also provides you with the income necessary for security and independence during retirement.
Thanks for reading. Touch base if I can ever help.
Joe
Retiring in the place you want, with the people you want, doing the things you want, for as long as you want takes money, good genes, and a bit of luck, to be sure. But perhaps what is more important is the role that good decisions play. One of the earliest lessons in life is that actions have consequences and boy is this true in the final third of life. If you’re at or near retirement, the decisions you’re about to make will have consequences for you and your family for decades to come. Unfortunately, it only takes one bad decision to ruin a lifetime of good ones. So what are the biggest mistakes to avoid as you approach and enter retirement?
Imagine that I wrote the name of a city on a piece of paper and sealed it inside an envelope. Giving you the envelope I said: “Without looking inside, drive to the airport and randomly buy a plane ticket to anywhere in the world. When you arrive at your destination, open the envelope and see if it matches with the destination that I wrote on the paper.” What are the odds that you would end up in the right city? Not good right?
As ridiculous as it sounds, that is how most people plan for their retirement. Don’t get me wrong. People save; they just don’t do it with a great deal of deliberation or a clear understanding of the end goal. Instead they do it via a completely random series of 401(k) and IRA contributions. Much like traveling without knowing your destination, saving for retirement without knowing your end goal will likely leave you far from where you need to be.
If asked when you want to retire, your answer should be a dollar amount, not a year. Retirement is about independence, not simply age, and money is critical to independence. You should know exactly how much you need to save in order to fund the type of retirement you want. Without that knowledge, there is no guarantee that your efforts will get you to where you need to be. In fact you are almost guaranteed not to reach your goal. Doing so would be more the result of dumb luck than anything else.
I’ve written about debt here before, but it bears repeating. Too many have gotten caught up in the debt frenzy and now, as they approach a time that is supposed to be about enjoying life and living their dreams, they instead find themselves beholden to their jobs and struggling to make ends meet.
An increasing number of people are entering retirement with no pension, inadequate savings, a big mortgage (sometimes two), an average of about six credit cards, and debt on one or more cars. Work is not a choice at that point any more than it’s a choice for the thirty-year-old with all the same obligations and a growing family to feed.
Having debt adds risk and reduces cash flow, two things that are especially troublesome for a person at or near retirement. Your primary goal should be to retire debt free and have your income at your disposal. If you retire with debt, you will spend precious years of your retirement paying for the purchases of yesteryear instead of using your income to live the life you’ve always dreamed of.
Farming and cooking are two different things. One is about creating and the other is about consuming. Likewise, saving for retirement and turning that savings into an income stream are very different tasks. When converting your savings into an income stream, taking too much, too soon from the wrong account or in the wrong markets could be the difference between retirement bliss and retirement blunder.
A distribution strategy typically occurs in two phases. Phase 1 involves moving the money from pre-retirement accounts (e.g. your 401k) to post-retirement accounts. Phase 2 involves creating an income stream from those post-retirement accounts. The ideal time to begin working through your distribution strategy is with a year or so to go before retirement. You should be thinking about how much you need, where it’s going to come from, and whether your nest egg is up to the task.
When you retire, your portfolio takes over the job that the payroll department handled during your working years, namely to send you a paycheck every month. If you retire when you’re sixty-five and live until you’re eighty-five, it needs to cut you 240 monthly paychecks. There are a host of variables that will affect its ability to do that, such as the distribution rate you choose, investment returns, inflation, how long you live, and good old-fashioned luck. Some of those things you can control and others you can’t, but having a well conceived, sustainable distribution strategy will help ensure that you don’t outlive your money.
Retirement is a major transition. That transition is not always easy and is often fraught with potential risks and pitfalls. By diligently completing each necessary task and avoiding the mistakes that ensnare so many, you can head confidently into what will surely be one of the most fulfilling and rewarding periods of your life.
Thanks for reading! If you found this article helpful, feel free to share it with a friend.
Joe
Note: Portions of this article were excerpted from my book The Bell Lap: The 8 Biggest Mistakes to Avoid as You Approach Retirement. Visit the Resource Page for more information.