Friday, February 10, 2017

The Long Goodbye

The associate minister at my church once said he lost his mother twice—once when she no longer recognized him and once when she passed away. His mother suffered from Alzheimer’s disease. According to the Alzheimer’s Association “2015 Alzheimer’s Disease Facts and Figures,” more than 5 million Americans are living with Alzheimer’s disease. It was the fastest growing cause of death by disease diagnosis in the U.S. from 2000 to 2013 (up 71%). Currently no way exists to cure, prevent, or effectively slow the progression of Alzheimer’s and other forms of dementia. In addition, more the 15 million Americans are providing care for an individual suffering from Alzheimer’s or another type of dementia. In 2015, dementia and Alzheimer’s was estimated to cost approximately $226 billion (with about $153 billion of that being borne by Medicare/Medicaid). Planning for this type of disease poses many challenges; we will discuss some of them here.

Warning Signs of Dementia

According to the Alzheimer’s Association, the disease has ten warning signs. These signs do not always indicate Alzheimer’s but may be useful in diagnosing the problem. Every individual will not necessarily have all ten symptoms. These ten signs are as follows:
  1. Memory loss that disrupts ordinary life—forgetting dates/events or asking the same questions repeatedly.
  2. Difficulty with planning or problem solving—monitoring and paying routine bills.
  3. Difficulty in completing routine tasks—driving to a familiar place or repeating common tasks at work.
  4. Confusing Time and Places—forgetting where they are and how they got there.
  5. Trouble understanding visual images and spatial relationships—the inability to judge distances (a significant problem in driving).
  6. Having a problem with words in writing and speaking—not remembering the name of common items.
  7. Misplacing items—putting an item in an unusual place (car keys in the refrigerator) and not remembering how they got there.
  8. Declining or poor judgement—large, unnecessary purchases or donations to telemarketers.
  9. Withdrawing from work/social activities—no longer participating in long standing activities which previously had brought enjoyment.
  10. Changes in personality---becoming more easily upset, depressed, or confused.
Stages of Decline

Dementia is a progressive disease. The earlier the identification and diagnosis, the easier to plan effectively.

In the early stage, financial mismanagement is one of the most frequently displayed signs of the disease. The inability to manage a bank account or inability to pay routine bills becomes more obvious. Misplacing items and trouble remembering things becomes more prevalent. Family members may begin to see these signs first; this situation becomes more problematic if they lack direct contact with individual on a routine basis. At this stage, work with the individual to begin preparations. Since dementia will progress, a finite “window of opportunity” exists to establish all planning and legal work necessary to prepare for care.

Consult with medical personnel to confirm a diagnosis. Discuss the implications of the disease on the legal, financial, and caregiving items associated with the disease. Elicit comments/preferences from the individual in these matters. Make sure all estate planning documents are up to date and represent the individual’s wishes. Of critical importance is the appointment of powers of attorney (giving another person the power to act on behalf of the diagnosed family member). Ask your family member to take you along on meetings with doctors, attorneys, tax advisors, and financial advisors.

In the second stage of moderate decline, financial skills deteriorate even further. The family member may become more easily frustrated and begin to withdraw socially. Wandering may begin at this stage, and a caregiver may become necessary. At this stage, the appointed power of attorney should become the manager of the family member’s financial affairs. Being the caregiver for a family member at this stage can be extremely time consuming and stressful. If the caregiver is also a family member, preserving the health of the caregiver is extremely important (see below). An excessively stressed caregiver cannot provide the needed care to an affected person in an efficient manner.

In the final stage or severe decline, the dementia patient will have a difficult time remembering (discussions, events, meetings, etc.). Caregivers may notice mood changes or changes in personality, and the patient may need assistance with the activities of daily living (eating, toileting, etc.). At this stage, institutional care may also become necessary.

Caring for the Caregiver

Alzheimer’s patients have an average lifespan of four to eight years after diagnosis of the disease. However, some individuals may not be diagnosed in a timely manner or may have a physical constitution that extends their lifetimes. Caring for family members with Alzheimer’s takes a toll (both physically and mentally) on the caregiver. The Alzheimer’s Association has prepared a list of ten indications of stress on the caregiver:
  1. Denial-Mom/Dad doesn’t have this and things will get better.
  2. Anger-at the patient (having to answer the same questions over and over again).
  3. Withdrawal-from the activities or social life once enjoyed (“I don’t have time for that.”)
  4. Anxiety-about what the future holds for both the patient and caregiver.
  5. Depression-an inability to cope with the situation.
  6. Physical Exhaustion-being too tired to physically perform daily activities.
  7. Lack of Sleep-constantly aware of the pressures to avoid the patient’s needs or wandering.
  8. Irritability, Moodiness, etc.-things that can lead to negative actions on behalf of the caregiver.
  9. Lack of Concentration-pre-occupation that leads to an inability to complete normal tasks.
  10. Health Problems-physical deterioration of the caregiver’s own health.
After all, if the caregiver becomes incapacitated, the problems compound. Available resources can help the caregiver. The Alzheimer’s Association Alzheimer’s and Dementia Caregiver Center (alz.org/care) is a good place to begin; it can help gain  a better understanding of what the caregiver can expect as the disease progresses. A support helpline is also available (Alzheimer’s Association 24/7 Helpline- 800-272-3900).

Unfortunately, we at Paragon Financial Advisors have experience with dementia situations. We have worked with clients and/or family members facing these problems on behalf of a loved one. No easy outcome exists, but proper planning can ease some of the stress. If you should see the need in your family, please call us. We can help with the financial preparations required. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investment management services to our clients. 



 

Thursday, January 12, 2017

What’s New in Social Security?

Changes in 2017.

Changes in Social Security benefits for 2017 have been announced. The cost of living adjustment is an increase of 0.3% (an increase of $5 per month for the average recipient). A small increase, but an increase none the less; there was no increase in benefits for 2016.
 
Social Security taxes are paid by both the worker and the employer. Each pays 6.2% of earnings (or 12.4% of pay in total) to support the Social Security system. There is a maximum amount of earnings on which that tax is paid (the “taxable wage base”); no taxes are paid on earnings above the taxable wage base. In 2016, the taxable wage base is $118,500. The wage base will rise to $127,200 in 2017.
 
Individuals who elect to start taking their benefits before their full retirement age (66 years or more) have their Social Security benefit reduced for each dollar of earnings they have over a certain amount. For each $2 a beneficiary earns above that amount, Social Security benefits will be reduced by $1. The earnings limit in 2016 is $15,720; in 2017 that amount increases to $16,920.
 
What’s Next?
 
Now that the election is over, President Elect Trump and Congress will face some challenges with the “entitlement” programs of Social Security, Medicare, and Medicaid. According to the Wall Street Journal (Wed, Nov. 9, 2016, pg. A18), those programs account for 10% of the US economy and that percent is rising. The deficit in 2016 is projected at 3.2% of GDP (in an economy growing at less than 2%). Medicaid spending has been increasing with the increased coverage under Obamacare. In addition, the US (and other developed economies) has an increasing population age. More individuals will become eligible for entitlement benefits. Our current system is not sustainable; be on the lookout for more changes to come.
 
We at Paragon Financial Advisors assist our clients in evaluating their Social Security options. Please call us to discuss your specific circumstances. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investment management services to our clients. 
 
 

Tuesday, December 20, 2016

Living on the Financial Edge

 Living on the Financial Edge

At Paragon Financial Advisors, we recommend our clients have a 3-6 month cash “ready reserve” to meet unexpected expenditures. For most Americans, accumulating that amount appears to be much easier said than done. In the May, 2016 The Atlantic magazine, Neal Gabler wrote an article entitled “The Secret Shame of Middle Class Americans.” Some of the items he mentioned (and the sources he quoted) are shown below.

Unexpected Expenses

A Federal Reserve Board survey designed “to monitor the financial and economic status of American consumers” found that 47% would not be able to cover a $400 unexpected expense unless they borrowed, sold something, or could not cover it at all. David Johnson (University of Michigan) surmised that Americans usually smooth consumption over their lifetime: borrowing in bad years and saving in good years. People are now spending any unexpected income (bonuses, tax refunds, etc.) instead of saving it.

A 2014 Bankrate survey found that only 38% of Americans had enough in savings to cover a $1000 emergency room visit or a $500 car repair. Nearly one-half of college graduates could not cover the expense through savings. In 2015, A Pew Charitable Trust study found that 55% of households didn’t have enough liquid savings to cover one month’s living expenses.

Another study by Annamaria Lusardi, Peter Tufano, and Daniel Schneider asked whether a household could raise $2000 within 30 days for an unexpected event. More than 25% could not; another 19% would have to pawn something or use a payday loan to raise the money. Nearly a quarter of households with an income of $100-$150,000 per year could not raise the $2000 in one month.

Liquidity or Net Worth

Is this situation only a liquidity problem or is net worth (the net sum of all assets including retirement accounts and home equity) also at risk? Edward Wolff, an economist at New York University, reported that net worth has declined significantly in the last generation. Net worth declined 85.3% from 1983 to 2013 for the bottom income quintile, decreased 63.5% for the second lowest quintile, and decreased 25.8% for the middle quintile. He looked at the number of months a household could fund its current consumption by liquidating assets if the household lost all current income. In 2013, the bottom two quintiles had no net worth; hence, they couldn’t spend anything. The middle quintile (with an average income of approximately $50,000 per year) could continue spending for 6 days. A family in the second highest quintile could maintain current spending for a little over 5 months.

Research funded by the Russell Sage Foundation found that the inflation adjusted net worth of the median point of the wealth distribution was $87,992 in 2003. In 2013, it had declined to $54,500—a decline of 38%.

Debt

Value Penguin did an analysis of Federal Reserve and Transmission data pertaining to credit card debt. In 2015, credit card debt per household was $5700. Thirty eight percent of households carried some debt; the average debt of those households was greater than $15,000. Apparently the rise of easy credit availability has supplanted the need for personal savings. The personal savings rate peaked around 13% in 1971, fell to 2.6% in 2005, and has risen only to 5.1% now. These debt levels reflect only personal debt; no serious attention is being paid to our $19 trillion government debt.

What’s Going On?

Financial products are becoming more sophisticated, both in quantity and complexity. Such additional products should provide a better way to manage personal financial “hiccups.” Lusardi and her associates (in a 2011 study) found that the more complex a country’s financial and credit market became, the worse the problem of financial insecurity becomes for its citizens. That study measured the knowledge of basic financial principles (compound interest, risk diversification, the effects of inflation, etc.) among Americans ages 25 to 65. Sixty five percent were basically financially illiterate.

Why are we at a financial advisory firm writing about this situation? The United States finds itself in the midst of a most unusual political situation. Some candidates for President of the United States are espousing theories or programs outside the normal capitalistic structure. Are conditions such as the ones described above partially to blame?

A crucial part of managing investment portfolios is attempting to monitor the economic, political, and social conditions that might affect the investing environment in the future. What will that environment look like and how will it affect the selection of assets going forward? We at Paragon Financial Advisors don’t have a crystal ball for the future, but we do try to help our clients invest for the long term. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investment management services to our clients. 


Friday, November 18, 2016

The Retirement Plan-Success of Failure

When one reads about retirement planning, the writer usually focuses on planning for retirement. An equally important part of that plan needs to focus on what to do after retirement. A spending plan normally covers the adequacy of income over expenses during retirement and whether or not that income is sufficient over a long period of time. A well-developed spending plan is much more than that. Increasing life spans (and the corresponding lengthening of retirement years) has some interesting consequences.

A symposium at the recent Financial Advisors “Inside Retirement” conference (May 5-6, 2016 in Dallas, Texas) included a discussion on why people “fail” at retirement. Failure is not defined as “bankruptcy,” or inability to retire; , only a failure to live retirement as originally planned. Some of the items discussed for such failure include the following:

  1. Health Care—Health care costs are increasing, even if one has health insurance. A retired couple could easily face medical costs in the hundreds of thousands of dollars over their life spans. A USA Today article (March 14, 2015, “How much will health care cost in retirement?”) quoted a study indicating that a man will spend $116,000 on health care in retirement; a woman will spend $131,000. Fidelity Investments has projected that a 65 year old couple retiring in 2015 will spend $245,000 on health care during their retirement.
  2. Divorce—Surprisingly, an increase in divorces in the 50 plus age group has appeared. The reduction in assets from such a separation means a potentially lower standard of living for both parties. Multiple marriages (through divorce or death) may also bring the necessity of planning for a subsequent re-marriage. Pre-nuptial agreements, especially where a disparity of assets exists between the couple, can prevent many future problems and are a definite item to consider.
  3. Overspending—Prior to retirement, a couple may spend more (especially on week-ends when they are not working) than they do in the normal course of living with a five day a week job. At retirement, every day is Saturday! Spending patterns may need to be adjusted significantly (i.e. reduced).
  4. Children-Parenting never stops. Many children return home after college to save money until they “get established.” Helping a child with bills, a substance abuse problem, or even a special needs child can add significantly to retirement outflows.
  5. Second Home-A second home purchased prior to retirement might be easily maintained financially while working. In retirement, property maintenance, insurance, property taxes, etc. may become more of a financial burden.
  6. Business-Starting a business in retirement may sound appealing, especially if another family member (see “Children” above) is involved. Some basic rules apply: a) It will cost more than you think, and b) revenues will come in more slowly than you plan. Always have a good business plan and, if other parties are involved, have a written agreement spelling out what is to be done. Allocate a set dollar amount (the maximum which you can afford to lose in entirety) to prevent “throwing good money after bad.”
  7. Identity-Many individual’s identity and self-worth are associated with their professional, work life. Retirement can change that significantly. Prepare for that transition. Retire to something, not from something.
Most individuals work long and hard during their active career; they look forward to a retirement period that matches their expectations. We at Paragon Financial Advisors assist our clients in developing plans for and during retirement. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investment management services to our clients.



Wednesday, November 2, 2016

“It’s the Life Insurance Guy Again”


How much should I own?

How do I know how much death benefit is appropriate for my family? This is where working with a Financial Planner can help you accurately assess how much exactly your family would need today if you were to pass. How much of your current debts, future college costs and retirement would you like covered if your family were to have to cover these costs without your income? Many times life insurance agents will try to sell more insurance coverage than is needed to earn more commission on a higher annual premium. We always recommend consulting with Paragon Financial Advisors before buying a policy.

What type of life insurance should I own?

Term Insurance- this is the most affordable way to purchase a death benefit; you can lock in your premium for a set amount of years or “Term”. Many term policies allow you to convert the policy from term or temporary coverage to a permanent policy at the same risk class you were approved on for your term policy years prior. But why would you want to do that? Let’s say that Bob was approved at Select Preferred for a 20 year term policy and a $500,000 death benefit. At year 10 of the policy being in effect, Bob gets a rare disease that could potentially cause him to die prematurely in the next 10-20 years. With the conversion option, Bob has the ability within the life of the 20 year term policy to convert it to a permanent life policy at his select preferred rating without going through medical underwriting again. Otherwise, it’s very likely he would be uninsurable and denied life insurance coverage.

Universal Life Insurance- this is a form of permanent life insurance that allows for flexibility on the premium payment each year. Universal life is generally a less expensive means to a permanent life insurance policy offering the same death benefit compared to other forms of permanent insurance. Additionally, VUL (Variable Universal Life) or IUL (Indexed Universal Life) contracts offer higher potential returns than some other fixed insurance contracts. With a VUL or IUL contract the insurance and administrative expenses are not fixed and could increase as the insured nears mortality age. As interest rates continue to fall since 2008, many Universal Life policy holders from pre 2008 have received notice that their premiums are going up. The flexibility that these life insurance companies offer comes with flexibility on their end as well. Another disadvantage to Universal Life policies are surrender charges to cash values, which can vary from company to company, but many times are 10 years or more. This limits your ability to access the full portion of the cash values until the surrender schedule has been met. Let’s quickly explain some of the different types of Universal Life contracts.

  • Guaranteed Universal Life: a “GUL” contract accrues little cash value, maintains a level death benefit and a level premium guaranteed to a certain age (Most are to age 100 or for life). This looks and acts very similar to term insurance, except it is for the insured’s lifetime.
  • Variable Universal Life: a “VUL” contract does accrue cash values and has a potentially increasing death benefit with a minimum guaranteed face value that stays in force as long as the premiums are paid. The accrual of cash values and the death benefit is tied to the performance of “separate accounts” which for all intents and purposes are mutual funds. These contracts offer the policy owner market participation via these separate accounts. If the policy underperforms than it could require the policy owner to dump more money into the contract to keep it in force.
  • Indexed Universal Life: “IUL” contracts are the most popular universal life policies currently sold. Unlike a VUL contract, they are actually a fixed interest rate product that offers a crediting rate tied to an index, mostly the S&P 500. Insurance companies generally offer several crediting methods: monthly sum, monthly average, a trigger method, or the most popular point to point. These policies many times offer a “floor” or minimum crediting rate to the policy of say +.5% even though the S&P 500 Index return for the year was negative. However, they also “cap” the upside potential of the return of the index and it’s important to note that the insurance companies do have the ability to lower the cap rate and the participation rate on inforce policies. Many IUL policies offer 100% participation up to 12.5%. One final note, the crediting rate applied based on the return of the S&P 500 does not include dividends, a sizeable portion of the total return over 10, 20 and 30 year time periods.

Whole Life Insurance- this is a permanent form of life insurance that accrues cash value and has a guaranteed “face” value or death benefit. Most whole life policies have a contractual guarantee on the return of cash values, many of the large mutual insurers offer 4% currently. It is important to note that this is not a 4% return on your total premium paid but a guarantee return on the net amount applied to cash value after all expenses have been taken out of your premium for the cost of insurance and operational expense. In addition, whole life policies may pay “dividends” into the policy, though these are not guaranteed. This term is not to be confused with the dividend that you receive from some of your stocks in your investment portfolio. Dividends from a mutual company are a return of surplus profits from their investment earnings, mortality experience (death benefits paid) and expenses over that time period and returned to their policy holders, hence the name participating life insurance. When contemplating a whole life policy, generally a well-designed one should reveal positive net cash values at the end of year 5 or 6 under the Current Assumptions Illustration.

What is the purpose of life insurance?

Risk Management: depending on how long your debts and future expenses extend, will help you determine the appropriate length of time you need coverage and what amount of coverage is needed. Many times term insurance will suffice for this need.

Estate Tax: the goal of this policy is to get the highest return of your premium on the death benefit. Many times a husband and wife will get a joint, last survivor policy that pays on the death of the second insured’s passing. This usually allows the insureds to get more death benefit for the same amount of premium. Also, when dealing with estate tax issues, it’s important to note that life insurance does offer an income tax free death benefit, but this amount is included in the value of the estate. In order to exclude the death benefit from the inclusion into the estate value for estate tax purposes, an Irrevocable Life Insurance Trust or “ILIT” is often used.

Creditor Protection & Cash Accumulation: life insurance is a creditor protected asset in the state of Texas and allows the policy holder to enjoy creditor protection on their life insurance values. Once you have maximized your retirement vehicles, life insurance if designed appropriately, may be a good place to put some excess cash.

Tax deferral & Tax Free Distributions: life insurance cash values do enjoy tax deferred growth as the policy values accumulate. In addition, after all premiums have been withdrawn, policy holders can take out cash via loans as a tax free distribution assuming the policy is not a Modified Endowment Contract

What is a Modified Endowment Contract?

A ‘MEC’ is essentially a policy that’s cash value has been “overfunded” based on the limits under the Internal Revenue Code. When a policy is classified as a MEC, any distributions from cash values of the policy are received on a taxable basis first or Last In First Out “LIFO” accounting method. The interest received on premiums is taxed at ordinary income rates and then the premium portion is returned tax free. A ‘MEC’ still benefits from a tax free death benefit, tax deferred growth and creditor protection. To determine if a contract is a MEC, a premium limit is set. This limit (referred to as a seven-pay limit or MEC limit) is based on the annual premium that would pay up the policy after the payment of seven level annual premiums. This limit is based upon rules established by the Internal Revenue Code, and it sets the maximum amount of premium that can be paid into the contract during the first seven years from the date of issue in order to avoid MEC status. Under what is known as the MEC test, the cumulative amount paid at any time in the first seven years cannot exceed the cumulative MEC limit applicable in that policy year.

What company should I use?

First, it’s important to make sure the life insurance company you’re considering is a stable and functioning company able to pay claims to its policy holders with enough reserves set aside to meet these obligations. You never want to purchase a policy from a company that is more sick than you are when you need them! Finding one with a Comdex score above 90 or a minimum Moody’s Investors Service rating of AA or higher is strongly recommended.

Secondly, we recommend using a broker to shop your life insurance need out to many different carriers. Career Agents or those working for a specific life insurance company, have strong incentives tied to their personal benefits to sell their company’s policies even though it may not be the very best one for your situation.

Please contact the Paragon Financial Advisors to review your life insurance policy(s) or help you review the available options to meet your life insurance needs. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investment management services to our clients.
 
 

Thursday, July 7, 2016

Longevity of Retirement Income

In early May, we attended an “Inside Retirement” conference sponsored by Financial Advisors magazine; the topics were centered on “income and longevity.” Various nationally known speakers discussed pertinent items related to those themes. We found some presentations worthy of discussion here. Some presentations were individual speakers; some presentations, panel discussions. Various concepts were presented for discussion; we don’t necessarily agree with all ideas presented but did find most of them thought provoking.
 
The World Today
 
Interest rates today are at historic lows. The 10-year US Treasury note yields approximately 1.8%, and some overseas developed countries have negative interest rates for their sovereign bonds. Low interest rates mean lower earnings available from an investor’s bond portfolio to supplement retirement income. Also, since bond prices relate inversely to currently low interest rates (as interest rates increase, bond prices decrease), bond prices are currently high.  The Federal Reserve Governors have continuing discussion about when (not if) to raise interest rates.
 
The stock market also poses some interesting challenges. Volatility in the market is significant, and some market analysts feel that stocks may be overvalued. Low interest rates have made some investors move into dividend yielding stocks in search of return—taking increased risk in the stock market in exchange for a higher current yield. Note that this higher current yield could be offset by loss in value if the stock prices decrease.
 
Other sources of retirement income have come into question. Social Security, a major source of retirement income for many Americans, faces funding shortages in the not too distant future. Changes are needed; however, the nature of those changes is still to be decided.
 
Finally, retirement life spans appear to be increasing. As life expectancies increase (and people are not working significantly longer), the length of time spent in retirement increases. Couple that increased longevity with potentially higher health care costs, and we face increasing pressure for financial longevity.
 
What to Do?
 
Much has been written and discussed about retirement planning (or the lack thereof) of Americans. We believe that retirement should also have a defined plan. Such planning should include planning for contingencies, structuring an investment portfolio, and a distribution strategy from any qualified plans. Since our major discussion above was related to investments, that’s what we will discuss here.
 
Market volatility is a fact of life. Stock market downturns will occur: the questions are when and how much. A retiree needs a stock component in a retirement portfolio. Stocks provide the long term growth necessary to preserve buying power over the long term—especially given the longevity previously discussed. Consequently, an investment portfolio should be structured to provide several characteristics.
 
  1. Liquidity--enough liquidity to cover necessary expenses over years when the stock market is down. This structure implies cash equivalents and bonds to cover 4-5 years of needed income without having to sell stock in a down market. Liquidity also means the ability to readily convert a portfolio holding into cash. In the 2008 downturn, some securities (auction rates) could not be readily sold at a fair market price.
  2. Total Return—low interest rates practically guarantee that an investor cannot meet all income needs from interest income only. Therefore, consider an investment plan that encompasses interest/dividend income with harvesting some of the investment gain in the portfolio. That’s “total return” investing where the income needs from the portfolio are met from a combination of dividends, interest, and gain from appreciated securities.
  3. Diversification—much has been made of the need to diversify assets. That diversification should include asset classes that may not have been utilized in the past. Use of alternative investing strategies (hedging techniques, conservative option strategies, etc.) and asset classes (commodities, etc.) may be warranted in selected portfolios. Note that alternative investing may be used to reduce risk, not just as a yield enhancement.
 
Investing for long term income in the current environment poses special challenges. Not all items mentioned here are necessarily advisable for all investors. We at Paragon Financial Advisors assist our clients in building portfolios that match that particular client’s goals and objectives. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
 
 

Wednesday, June 22, 2016

Retirement-The Big Picture

In early May, we attended an “Inside Retirement” conference sponsored by Financial Advisors magazine; the topics were centered on “income and longevity.” Various nationally known speakers discussed pertinent items related to those themes. We found some of the presentations worthy of discussing here.

 Alicia H Munnell (Peter F. Drucker Professor of Management Sciences at Boston College, and director of the Center for Retirement Research at Boston College) gave a presentation with the title of this blog: The Big Picture. She has written extensively on income in retirement. Some of her major points include the following:

  • More than one-half of today’s workers will not be able to maintain their current lifestyle in retirement. Why not?
    • People will live longer.
    • In spite of this increasing life span, people will work only a “little” longer before retiring—thus increasing their retirement life span.
    • Health care costs are increasing. The increasing cost of care will be coupled with increased cost of health insurance—both private insurance through the Affordable Health Care Act and through Medicare Part B increases. In 1980, Part B Medicare premium was 6.8% of the Social Security benefit; in 2030 it is estimated to be 19.4%.
    • Interest rates are at historic lows; lower rates reduce the amount of income generated from personal savings.\
  • Retirement income has historically come from a combination of a) Social Security benefits, b) pension plans (either defined benefit or defined contribution), and c) individual savings. Let’s examine each separately.
    • In 1985, Social Security benefits represented 42% of pre-retirement earnings. After Part B Medicare costs, the proportion decreased to 40%. Benefits were not taxable at that time so there was no further erosion due to income taxes. By 2030, those proportions are estimated to be 36% replacement before Medicare and income taxes; 32% after Part B Medicare expense, and 30% after Medicare and income taxes. Note that these percentages represent current replacement rates and do not include any potential changes to remedy the Medicare shortages currently under discussion.
    • We live in a DC (defined contribution) or 401(k) world. The older DB (defined benefit) or pension plan is fast disappearing.  401(k)s limit the employer obligation only to offer contribution of funds to a retirement plan. The acceptance—and performance—of the plan is shifted to the employee from the employer. Here’s where we stand:
      • Employees who don’t join the plan—21%
      • Employees who contribute less than 6% of their pay—53%
      • Plans with high asset fees—54%
      • Plans losing assets through “leakage” (i.e. cash outs, hardship withdrawals, post 59 ½ penalty free withdrawals, loans, etc.)—25%Note: This leakage impact over the life of the plan can reduce the ending amount at retirement by as much as 25%.
      • Retirees who don’t have a systematic plan for withdrawing assets in retirement—99%  How much (and when) should withdrawals be made from a retirement plan? Too much too soon and the retiree can run out of money; too little too late and IRS required minimum distributions can have significant income tax and Medicare Part B premium impact.
  • Individual savings (or the lack thereof) are a topic for a separate writing; they warrant a much greater discussion which we will examine later.
  • So what should a pre-retiree do?
    • Work longer. A longer working career has the dual advantage of allowing retirement savings to grow and reducing the time during which retirement assets are needed.
    • Save more. Savings should be increased preferably through a systematic plan (such as a 401(k)) or a periodic contribution to a savings account.
    • Consider non-traditional sources of retirement income. There are two primary assets for most employees today: their 401(k), and their home. Tapping the home asset is a complex topic—another one that will be addressed in a separate writing. Home assets should be used only after careful analysis and with a full understanding of all their ramifications.
We at Paragon Financial Advisors strive to assist our clients in formulating a “big picture” for retirement. Please call us and we can discuss your individual circumstances.   Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.


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