Looking for something good to take away from the forced economic shutdown from Coronavirus-19?

Although the shutdown crimped our lifestyle, it has had the benefit of forcing us to discover our minimal required spending. No travel, no eating out, no shopping, and no activities with friends leaves only necessities to spend money on.

Knowing how much you pay each month for necessities, or your minimal required lifestyle, is a required step to creating a safety-first retirement.

In a safety-first retirement, you cover your necessary expenses with guaranteed income. You don’t rely on the stock market for even $1 of your essentials. The benefit is stress-free living.

Safety-first retirement income sources include Social Security, pensions, annuities, bonds, and cash reserves.

Imagine how stress-free you would have been this year if you had guaranteed income arriving in your checking account every month before, during and after the coronavirus lockdown.

Calculating Your Definition

In normal times it’s very hard to calculate what your essential spending would be because it’s hard to say whether things are needs or wants. Coronavirus however has limited us and created the perfect scenario for us to learn what our needs really are.

We all have different definitions of needs / minimal lifestyle / essential spending. That’s fine, but now you can easily calculate what yours is.

If you look at your average spending in March through June, subtract out any large expenses you had like home improvements, and that average spending is your essential spending. That’s as simple as it will ever be.

Once you know that number, we can investigate safe methods to generate that level of income.

More about Safety-first

This idea of a safety-first retirement is catching on in the financial planning community.

According to safety-first, the objective for retirement is first to build a safe and secure income floor for the entire retirement planning horizon… Once there is enough flooring in place, retirees can focus on upside potential with remaining assets.

Since this extra spending (such as for nice restaurants, extra vacations, etc.) is discretionary, it will not be the end of the world if it must be reduced at some point. The protected income floor is still in place to meet basic needs no matter what happens in the financial markets.

Stated again, the objective of investing in retirement is not to maximize risk adjusted returns, but first to ensure that basics will be covered in any market environment and then to invest for additional upside. [These italicized quotes come from the book titled Safety-First Retirement Planning: An Integrated Approach for a Worry-free Retirement by Wade Pfau.]

With your essential expenses covered, you know you can live a basic lifestyle (like during coronavirus), no matter what happens. If the stock market continues to do well, then you will have money to spend on fun and luxuries.

Why safety-first is a new idea

Financial advisors have generally been recommending clients hold stocks and bonds in retirement and withdraw 4% or less every year. The reason this has been the standard is that most advisors get paid based on the size of their client’s investment accounts. They charge AUM fees.

Safety-first is catching on with advisors like myself who do not rely on investment AUM fees. Andrew Marshall Financial, LLC does not suffer the conflict of interest of losing AUM when recommending you use a lump-sum of your investments to buy an immediate annuity were it the best solution for you. Furthermore, we receive no commission or kickback if you purchase an annuity.

Issues with using safety-first

The difficulty with using this strategy is getting over the fact that it usually requires handing over a large portion of your retirement savings to an insurance company to purchase an immediate annuity. (Pensioners are usually able to achieve a safety-first retirement without purchasing an annuity, but not always.)

A lot of people like the feeling of control from having their investments in an account that they can see and adjust. However, it is important to remember that when you purchase an annuity, you haven’t given up your lump-sum with nothing in return. You have guaranteed yourself food, clothing, and shelter for the remainder of you and your spouse’s lives.

Why it Works

When you purchase an annuity, you are pooling your money with all the other individuals who have purchased that annuity. The insurance company becomes responsible for your retirement investments rather than you.

By pooling your assets with other people, it becomes easier to fund everyone’s goals. If you fund your own retirement, you need to be cautious because you or your spouse may live well into your 100s. Take out too much and you could go bankrupt before then.

When you are part of a pool, the payout can be higher than the recommended 4% for self-funding because not everyone will live into their 100s. In fact, some people will die young. Their investment remains in the pool and is then spread among the remaining annuitants. Currently, a single woman in California aged 65 can receive a 5.3% payout on her purchase amount.

By pooling your resources, you accomplish the actual goal of your many years of investing; providing income that lasts your entire lifetime.

If a safety-first retirement plan sounds intriguing to you, or you worry about how you will cover your retirement spending needs, then please contact us to set up a call.

This post is a reprint of our newsletter sent to subscribers in June 2020.

Stock market

When the next massive event threatens the stock market, you should feel some comfort knowing that the government will step in and do everything it can to keep the stock market up. After all, our capitalistic society relies on the stock market.

Every working person’s retirement account, every insurance company, and every pension fund depend upon the stock market maintaining a certain level. Without the stock market, investments in new companies and ideas would not happen.

If the stock market were to collapse and not recover, there would be far worse rioting in the streets than we are seeing now.

The government (by which I mean the Federal Reserve and / or Congress) may not get the recovery right first try, or it may take them longer than is comfortable, but eventually they get there. The fact that this shut down caused market reactions similar in many ways to the 2008 crisis meant the government knew what to do and was able to step in quickly.

The Federal Reserve’s credibility has gone a long way towards calming these markets. Their forward guidance (what they say they will do in the future, even if they don’t really do it) was convincing enough to the big money managers, and they have responded the way the Fed hoped they would.

Bond markets are working again, and the stock market has recovered.

How do we apply this? You should be comfortable owning stocks. Stocks are a long-term investment and have always bounced back. Review your asset allocation if you were nervous in March when the stock market was falling fast, but by all means continue to own stocks.

From an economic standpoint, we are in a similar situation to 2009. From 2009 until the emergence of the corona virus in 2020, the stock market had its longest bull market run in history. That history could repeat as stocks will again attract more investment than low yielding bonds.

Bonds

The Federal Reserve has said it will enter the bond market to keep interest rates low. Let me explain how this works.

Bond interest rates and prices move in opposite directions. For me, it is easier to think through the price side first since price movements are the same regardless of what item people are buying.

Let’s take a real estate example. If several couples are trying to buy houses, then to ensure that one couple gets the house they want, they must pay a bit more than the other couples. If they do, prices are rising.

Bond prices work the same way. If more people are buying bonds, then in order to ensure they get the bonds they want, investors will have to pay a little more than the other buyers. Bond prices are going up in this case.

If the bond price is going up, then the interest rate will go down. This makes sense because if there are a lot of buyers, the issuer of the bond doesn’t need to give a high interest rate to entice the buyers who are already keen to buy.

This same scenario works in the reverse. If few people want to buy, price will go down, interest rates will be higher to entice more buyers.
How is the Federal Reserve able to manipulate interest rates?

They have stated they want to keep interest rates low. To keep interest rates low, there need to be a lot of buyers of bonds. A lot of buyers mean high prices and low interest rates.

In this case, the Federal Reserve itself becomes “a lot of buyers”. They have unlimited money to buy, and can continue buying government bonds for years.

The Federal Reserve Chairperson, Jerome Powell, said on June 10th that they will be buying at least $80 billion of US Treasuries and $40 billion of mortgage backed bonds every month!

How do we apply this? Owning bonds for yield will be an impossible situation for at least several years. Investors will need to use a total return strategy, not choose investments based solely on their yield, and remember that the most important reason to own bonds is to offset stock losses.

Low interest rates make paying off your mortgage more attractive. Say you have a 3.5% mortgage. There is no bond investment available today, other than a high yield (read “risky bond” which you shouldn’t buy), that will give you anywhere near a 3.5% yield.

The Vanguard intermediate bond fund (VBILX) is yielding 2.38%, but you must pay taxes on that. The Vanguard tax-exempt California Muni bond fund (VCADX) has a distribution yield of 2.33% currently.

The average total return on 10-year US Treasuries for 2009 – 2019 was 2.94%. Paying extra towards the 3.5% mortgage looks better under today’s circumstances.

For retirees, buying an immediate annuity with the money you currently have allocated to bonds becomes more attractive. Immediate annuities do not have the fees of variable annuities and accomplish the goal of providing income for the rest of your lifetime.

It’s like buying an additional Social Security payment.

A joint immediate annuity for a 70-year-old couple currently pays 5.55%. Of that payment, only 14% is taxable.

Hopefully you and your family are healthy and doing well. If you want to schedule a meeting just email me at andrew@andrewmarshallfinancial.com.

I have been doing Zoom meetings and it is very convenient. I have found virtual meetings make it easier to help some clients because we can share screens, and I can talk them through how to buy/ sell shares, see what their accounts hold, and they can see me check or update their financial plans.

The following newsletter was originally sent to email subscribers on March 27, 2020.  If you would like to receive my email newsletter once per quarter, please sign up here:

Congress Spends $2 Trillion. It Won’t be Enough.

Hello,

I hope you are all doing well, you and your family are healthy, and you are staying sane in these strange times.  It has been difficult to believe the virus is as bad as we are told.  Walking around Carlsbad, it seems like there is no reason for the isolation.

However, a college friend of mine’s father died of COVID-19 last week in Kansas.  That along with the news coverage showing hospitals in Italy and Spain overloaded with patients make it seem a lot more real.

The number of new cases is rising here in San Diego county.  It looks like a fairly steady rise and not an exponential rise at this point.  Hopefully it doesn’t turn exponential.

The shutdown could continue for a lot longer than people are thinking.  Wuhan has been shuttered since January and won’t be opening for another nine days.  That same time frame puts us on lockdown until June 8th.  The risk of having a relapse of the disease spreading will keep the lockdown policy in effect for longer than first anticipated.

Economically, things are going to get a lot worse from here. This week, 3.3 million people filed for unemployment benefits.  No one is going back to work any time soon (apart from new hires at Amazon, Costco, and grocery workers).  I expect the high unemployment numbers to continue.  The slew of bad economic numbers that will be coming out in the next few months will trigger another round of stock selling, in my opinion.  Until the trajectory of the virus is known and understood, the stock market will test the recent low.  I think there will be opportunities to buy stocks in the future.

Longer term, this ordeal is going to exaggerate the wealth gap in America.  The “little guy” will have a much more difficult time without earning income.  I can see a lot of small businesses not reopening this summer when the lockdown is lifted.

What steps can you take now? 

The stock market selloff opens opportunities for those with a long-term outlook.  The amount of money governments around the world have put into the economy means the low bond yields forcing investment into stocks for returns will continue for many more years.  It should be obvious that the government will do everything it can to keep the stock market going.  Long-term that means you should continue to stay invested in stocks, even if it is scary at this time.

The next couple of months may be a good time to do a Roth conversion.  Converting in a down market means you will get more shares for the same amount of money.  If your income will be lower than expected this year, you may be able to convert a larger amount and stay within the same tax bracket.

Those who are taking required minimum distributions (RMDs) will not be required to take this year’s withdrawal.  This exception is part of the CARES Act that Congress passed today. If you have enough to live on and don’t need to take your withdrawal, you should not take it this year.  Leave the money in your account to grow tax deferred.

If you have Federal student loans, your interest will automatically be set to 0% for at least 60 days.  If you do not want to make a payment during this time, you should contact your loan issuer and ask for a forbearance.  Making a payment now means the entire amount will be applied to the principal, which will be helpful if you can afford the payment.

Now may be a good time to refinance your mortgage.  There has been a lot of volatility in the mortgage market the past few weeks, but you may be able to get a good deal right now.  If not, try again in a week.  Things are moving that fast.

Now is also a good time to look at your estate plan.  Make sure you have a Will, Power of Attorney for both healthcare and finances, and an Advance Healthcare Directive.

If you have concerns or would like me to assess your situation, please make an appointment.

In February, I attended two days of insurance training in Clearwater Beach, Florida.  I don’t sell insurance, but part of creating a comprehensive financial plan is understanding if clients are fully covered by their various policies. 

Two training sessions were on long term care insurance policies (LTCi).  I came away from the sessions with an understanding of the risk a couple is taking by going without long term care insurance and the tax benefits of owning a policy.  

Risks of Not Owning LTCi

We all know that health care costs are increasing rapidly each year as are long term care costs for all types of care: in-home, assisted living facilities, and nursing homes.  The costs are shocking when you first hear them.  Here is a link to a website that will show you an estimate for the price in your area of the country:  Genworth Cost of Care Survey. 

The general strategy that most retirees are using for LTCi is to wait and see.  They plan to use their investment assets or their home equity to pay for any assisted living or nursing home costs. 

I have generally gone along with this idea but realize now that this will only work well under certain conditions.  Those conditions include having a sizeable net worth, when there are no goals for passing assets on to kids or charities, and when the long-term care is needed after one spouse has already passed away. 

The big risk of not having LTCi is, how will the healthy spouse’s life change after paying for the long term care needs of their spouse?  

Commonly, the healthy spouse will look after the ill spouse at home for as long as possible, but it eventually gets overwhelming.  The physicality of transferring someone into and out of a shower or a bed is really hard work.  The time and effort spent being a caregiver really depletes the caregiver’s quality of life.  As the caregiving spouse gets older, the more likely a need to hire someone will arise.   

If they use their investments or tap their home equity to pay for it, then the resources remaining for support of the healthy spouse’s life can get depleted quickly.  This will leave the remaining spouse with a very different lifestyle than what they were used to or what they dreamed of as retirement living, before their spouse became sick or incapacitated. 

Let’s look at some financials to see what the aftermath of a nursing home stay could be.

Long Term Care Costs for an Example Couple

The average time spent in a nursing home is 18 months.  The median (or middle) time is 6 months.  There are some really long stays that pull the average out. 

Let’s look at an imaginary example and say the male of our married couple had a stroke and didn’t recover well.  He had to be moved into a nursing home and was able to stay alive for two years thereafter. 

The total cost for two years in a San Diego area nursing home is $273,750.  If this couple uses their investments to pay for this nursing home, how much will it actually cost them? 

By using their investments to pay for it, long term care needs could actually become 20% to 50% more expensive.  Why?  Their tax rate. 

Depending on the tax bracket and what type of account the investments are in, withdrawing to cover LTC expenses will create taxable transactions. 

Best Account Types to Pay for Long Term Care

The best option is to use a Roth IRA account.  There are no taxes due on a Roth IRA withdrawal.   

The next best option is to pay capital gains tax on withdrawals from a taxable investment account.  This will most likely be taxed at a rate of 15% Federal, plus state taxes.  

The costliest option would be to pull from an IRA account.  IRA withdrawals are taxed as ordinary income.   

Chart of After-tax Long Term Care Costs

We will assume our example couple is in the 22% federal tax bracket.  That corresponds to a 2020 annual taxable income level of $80,251 to $171,050.  In this tax bracket, long-term capital gains would be taxed at 15%.  For both types of taxable withdrawals, the California State income tax would be an additional 10.3%. 

Cost of care per year: $136,875 

This chart shows the dramatic increase in actual cost they would pay after tax for self-funding a nursing home stay.   $202,178 versus $136, 875.  A 47% increase on already expensive care!

Two ways to minimize the cost of a nursing home stay are to use a Roth IRA (if it is large enough) or own an LTC insurance policy.  With a long-term care policy, the costs are paid by the insurance company, and you receive those benefits tax free! 

That leaves the investment accounts untouched and able to continue growing and supporting life’s other expenses. 

Long Term Care Insurance Premiums 

When we are comparing the premiums for a LTCi policy with self-funding, we must compare the after-tax cost of self-funding care to make a valid comparison. 

The total cost for two years of nursing home care in San Diego county in this example is $273,750.  How much would premiums need to be to come out ahead? 

If this couple buys a policy at age 55 and the gentleman needs his two years of care after X years, let’s look at a simplified example to see what premium amount they could pay and still come out ahead on an after–tax comparison basis.  (This chart is simplified because premiums and cost of care are not increasing with inflation.) 

If their premium is lower than the column on right, they come out ahead by purchasing long term care insurance in this example.  

The caveat being that premiums will increase as time goes by.  But, so will the cost of care.  Investment account values may not increase enough to keep up.   

By buying LTCi, they are passing the risk of affording the future costs to the insurance company rather than trying to keep up with the costs through their own investment accounts.   

If costs rise by 5% annually for LTC, as they have been doing, then their investment account must also increase that fast.  For an investment account to average a 5% or larger return, it requires a large allocation to stocks.  Perhaps more than most retirees are comfortable with. 

Conclusion 

Owning long-term care insurance can effectively protect the lifestyle of the remaining spouse.   

There are more variables to look at than are discussed in this post, but the idea is to show you that incorporating long-term care insurance in your financial plan may be worth a close examination. 

Ready to get started on your financial plan?  Click here to schedule a free, first meeting. 

Andrew Marshall Financial, LLC can help you plan your retirement, so you are able to make a smooth transition.

Christine Benz is very well known in retirement planning circles due to her work at Morningstar where she does retirement research on portfolio planning topics.  She gave a talk to the American Association of Individual Investors (AAII) San Diego group in November 2019.

Since I have read many of Christine Benz’s articles on the Morningstar.com website, and the topic of her talk was obviously relevant to my work, I thought it would be good to go and see her in person.

The AAII group meets in Solana Beach once a month and when they have interesting speakers, I try to go.  The meeting is open to anyone and is only $8.

Retirement Date Risk

The first risk Christine Benz talked about was retirement date risk.  Often someone must retire at a point in time other than when they plan to retire or expect to retire. This early or late retirement date could be a result of health issues, family issues, job layoffs, or other reasons.

This is retirement date risk.

Forced retirement is a problem because it decreases the time for saving.  If you have a financial plan, you know you need to save X amount per year for so many more years and your safe retirement spending will be Y.   If your ability to save is cut short, then your retirement spending will have to be cut as well.

For many people who are laid off late in their career, finding a new job that pays as well as the one they left is very difficult to do.

Another major cause of retirement date risk is health issues.  Either your own, or a spouse’s health issues, or someone else in your family like your parents.  This can force you to reduce your work load and therefore your savings rate.

This graph from Ms. Benz’ presentation shows that more often people retired earlier than they were expecting, rather than have to work longer than they were expecting.  25% of pre-retirees were expecting to retire at 64 or younger (blue bars), but 70% of retirees actually retired before 65 (green bars).

Early retirement is very common and therefore you need to be ready in case that happens.

The way to overcome retirement date risk is to save more than you think you should. Rather than planning for a perfect scenario to play out at age 65, plan for having enough money by 60 or 62. Try and save more money so that a forced retirement date does not require you to live the remainder of your life with a reduced spending ability.

Sequence of Return Risk

When you first retire, you are at your most susceptible point in terms of stock market returns.

If the stock market goes down immediately after you retire, your likelihood of retirement success also goes down.

The worst point in time to retire since World War II was 1969. The safe withdrawal rate for a new retiree in 1969 was 4% per year adjusted for inflation.  As a comparison, those who retired in 1981 were able to withdraw 8.5% per year adjusted for inflation without running out of money after 30 years.  That is a huge difference!  That’s the sequence of returns risk.

How does one overcome the sequence of returns risk?  By not selling stocks to cover living expenses.

Christine Benz recommends the bucket portfolio.

With the bucket portfolio approach you keep a few years of living expenses in cash, the next few years of living expenses in bonds, and the remainder in stocks.  The idea is that as you spend the cash, each year you replenish your cash from your bonds and then you replenish your bonds from your stocks when the market stock market is in an up year.

Another take on this idea of retirement withdrawal strategy (that I’ve written about before), is by Michael McClung and described in his book Living Off Your Money.  Essentially his idea is that you sell bonds when you need money and then only replenish those bonds when the market has gone up 20% inflation adjusted.

The benefit of both these strategies is the fact that you’re not forced to sell stocks when they are at their lowest point.

Low-Yield Risk

Another risk for retirees who would like to live off the interest from safe investments is the low yield world we now live in.

I went to a fixed income conference in San Diego in November a couple weeks ago and the keynote speaker, James Bianco, believes we will be in a low rate environment for many years to come.

What this means for retirees is you can’t just buy CD’s and live off the interest generated. Retirees are forced to own a higher percentage of stocks than they were in previous decades.

The way to overcome this low yield risk is to invest not for income, but to invest for total return.

This means that you should consider not just the interest an investment earns, but also the change in underlying value.  Bonds not only pay interest, but they go up and down in value each day the bond market is open.

It is unlikely a retiree will be able to live off the mid 2% interest an aggregate bond fund generates these days (unless they have a lot saved or need little).  To withdraw 4% from their accounts, retirees should consider the 2% interest payments along with both the change in value of the bonds and the change in value of the stocks they own.  The portfolio should be thought of as a whole, as total return.

The incorrect way to overcome this low yield risk according to Ms. Benz is to invest in risky bonds. Retirees should not reach for yield by putting their life savings in high yield bonds or emerging market bonds. The risk it’s just too high and the yield that you get is still minimal.  It is better to use a comprehensive bucket portfolio type approach to create enough money to live off.

Inflation Risk

With 3% inflation everything costs double after 24 years.  That’s inflation risk.

By the time you are 20 years into your retirement, things are going to cost a lot more than they do now.  We have all seen prices go up and know it will continue to happen.

Although inflation has been less than 2% in recent years, the items that retirees spend money on (mainly healthcare and travel) are inflating at a higher rate than general inflation.

Ms. Benz says the way to overcome inflation risk is to make sure you own enough stocks. Over time, the stock market has increased more than inflation and should continue to do so.

I think you should also own some real estate investment trusts (REITs), and possibly Treasury inflation protected securities (TIPS) as part of your bond portfolio.

Another way to overcome inflation risk is to delay Social Security for as long as possible.  Each year you wait to claim Social Security, your check increases by 8%.  Since Social Security has a cost of living adjustment, waiting to claim will not only bring a bigger Social Security check, it will also bring larger increases each year.

Another strategy to overcome inflation risk is to purchase an inflation protected annuity large enough to cover your basic, necessary expenses.  This guarantees you have at least your living expenses covered, no matter what the stock and bond markets do in a particular year.

Healthcare / LTC Risk

As we get older, we generally need more healthcare and unfortunately for older people, health care costs have been inflating faster than other living expenses. That means healthcare becomes an increasingly large portion of a retiree’s expenses as they age.

The way to overcome this is to stay healthy.

Financially the only way to overcome this is to budget for increasing healthcare expenses. There are no easy solutions to this.  One thing working in favor of affording these higher medical expenses is that overall spending in retirement tends to stay constant because as we age, more is spent on healthcare, but less is spent on travel and activities.

Even if you have a Medicare Advantage plan with no monthly fee, the price of Part A and B, your deductibles, prescription costs, and out-of-pocket expenses are likely to increase each year.  For 2020, the increase in Part B is 7%!

Another health care cost risk, that often isn’t thought about, is the fact that if you retire early, you have to go to the exchanges to buy healthcare insurance for the years between your retirement date and age 65 when you begin Medicare.

These rates are often well over $1000 a month for a couple.  An additional $12,000 a year is a very large expense for a retiree. This additional expense is not just for those who have the means to retire early, those who are forced to retire early would have to go to the exchanges for health care as well.

Another risk is long term care risk. Long term care is not covered by Medicare or health insurance, and it refers to things you may need help with if your health has deteriorated or you’re old.  Activities of daily living like bathing, getting out of bed, getting dressed, feeding yourself, etc.

In 2019, the average cost of one year’s worth of in-home health aide in San Diego County is $64,000. That is a significant expense and may be needed for many years.  Nursing home care would cost even more.

The most common plan for long term care costs is to use home equity.  If you don’t own your home, or don’t have a lot of equity built up, long term care needs could use up the vast majority portion of your portfolio.

There are long term care insurance plans available which are usually very expensive.  To alleviate the worry that you’re going to buy long term care insurance and never need it, there are now combination/ hybrid long term care insurance plans with life insurance. This means either you will get the use of the long term care insurance, or your heirs will get a life insurance benefit if you pass without using all the long term care insurance benefit.

Longevity Risk

What if you have a nice long life and live to age 100 or more?  That may seem unlikely or very far in the future, but if it could happen.  For a couple, both age 65, there is a 31% chance (almost one-third) that at least one person will live to age 95.  Future improvements in personalized medicine may increase these odds.

Financially speaking, living that long could take a toll. To overcome this risk, you need to put together a plan that uses all the available techniques.

Invest enough of your assets in stocks, use a total return approach, have a tax-efficient withdrawal strategy, maximize your Social Security and pension benefits, live within your means, and be flexible with your spending, consider annuities, and others.

Those are the 6 retirement risks and how to overcome them according to Christine Benz of Morningstar. If you have any questions about these risks, how they apply to your situation, or want some financial planning advice, please contact me.