There was once a time, in the not-too-distant American past, when a fellow needed only to pack a lunch pail and punch the clock when the whistle blew, and after 40 years of hard work he could expect a rocking chair by the fire and a financially comfortable retirement.
Times have changed.
“The three-legged stool of retirement (social security, pension and savings) for that older generation has been disrupted,” said South Burlington-based financial adviser Daniel Streeter. “A lot of companies have over promised and under delivered on their pension plans, and that’s only going to get worse. The day of reckoning is coming for pension plans as well as social security.”
Although many economists don’t predict a shortfall in the federal social security system for another two decades and many company pension plans have been rolled into retirement plans, the imminent reality that the three-legged retirement stool will be reduced to a one-legged swivel chair has resulted in a generational shift in fiscal thought.
“I think the reality has set in for the younger generation that they – and they alone – are responsible for their security in their retirement,” Streeter said. “Nobody else is going to provide that for them.”
Don Dempsey, a Williston-based financial planner, had similar sentiments.
“I think the message, especially for younger people, is no one’s going to do it for you,” Dempsey said. “You don’t need to read the Wall Street Journal every day, you don’t need to follow the stock market, but people can do very well with just buying a low-cost index mutual fund and just averaging in over time.”
For many people nearing retirement, the question is simple: how do I replace the income from my salary when I’m no longer drawing a paycheck?
Toward that end, many advisers recommend annuities, of either the immediate, fixed, variable or equity-indexed variety – often with a lifetime guaranteed income rider attached for the latter two categories. Although immediate annuities most closely mimic pensions, the other forms of deferred annuities offer greater earnings potential – with commensurate risks attached.
Fixed annuities aren’t subject to the up-and-down roller coaster of the stock market, but they carry inflation risk. Variable annuities often come with guaranteed income riders to combat market risk, but the rider comes at a cost, and the income stream is based upon the claims-paying ability of the financial institution and can only be accessed in set payments. Equity-indexed annuities, while they won’t lose money in the market, can have zero gain in a down year and can have their caps and participation rates reduced by the insurance company in affluent market conditions.
In most cases, annuity contracts have penalties for early withdrawals – making them unsuitable as a large portion of a person’s overall portfolio – although as part of a diversified asset mix, annuities can help replace income shortfalls in retirement.
Reduce Debt & Save More
Although opinions vary as to the best means of preparing for retirement (traditional versus Roth IRAs, stocks and bonds versus mutual funds, fixed versus variable annuities, etc.) most financial planners agree on two basic principles: reduce debt, and save as much money as possible.
“There’s no one solution for every person,” said Streeter. “It’s just a matter of getting them to acknowledge their current reality and then to get them to move in the direction of making progress.”
For Dempsey, debt is one of the biggest deterrents to a successful retirement.
“Generally, my philosophy is even though interest rates are so low, I don’t like debt in retirement,” Dempsey said. “A retired person is not going to want to be all in the stock market, so if some of the money is in bonds making 2 percent and you’re paying off a mortgage at 4 percent, how does that make sense?”
Even with proper debt management, South Burlington-based financial planner Josh Patrick said the trend is that more people are now working past the “normal” retirement age of 65.
“I think it’s probably a good idea to think you’re going to work until your mid-70s,” Patrick said. “It might be worthwhile when you’re in your 50s to think about what your ‘retirement profession’ is going to be.”
But while 75 might be the new 65, the reality for many seniors is that they will need some form of long-term care in their lifetime.
“Long-term care protection is something we start to have the conversation about once people turn 50,” said Streeter, who works in partnership with Jim Hedbor, a certified financial planner. “We do utilize long-term care insurance if it’s appropriate, but what we’re often doing now is utilizing life insurance with the chronic, terminal and sometimes critical illness riders. A life insurance policy can serve multiple purposes and multiple masters. It can augment retirement, obviously it can be used as a death benefit, or it could be used in the event that you become critically, chronically or terminally ill.”
Dempsey noted that although people should ideally be saving for retirement throughout their lifetime, there’s still hope for those who might not be fully prepared when they reach retirement age.
“Downsizing is always an option,” Dempsey said. “I’ve certainly seen a lot of people who are retired in houses too big that really drain them. It just makes the numbers a lot easier.”
Another option for people whose net worth is mostly tied up in their home is a reverse mortgage, in which homeowners aged 62 or older can access a portion of the equity in their home through a loan program administered by the U.S. Department of Housing and Urban Development.
“(A reverse mortgage) very well may be a viable solution for some people who have their home paid off and are looking for an extra $500 or whatever to augment their income and they have no other source of income other than the equity that’s trapped in their home,” Streeter said.
But Streeter added that there are other less costly options – such as a home equity line of credit – that can be utilized if one is proactive.
“If you’re planning correctly and appropriately, you can completely circumvent the reverse mortgage process,” said Streeter. “With proper planning, one can plan to have full control and utilization of their home equity without a reverse mortgage.”
This article was contributed by Luke Baynes.
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