Okay, you've had your retirement party and received your retirement watch. You said goodbye to your colleagues and . . . well, never mind what you said to the boss. Now comes the fun part . . . Or, maybe not entirely. Managing your money during retirement will probably be more difficult than it was to build wealth. The paychecks stop coming in; no more reassuring bank deposit every two weeks or so. What do you do now? We discuss basic considerations in this section. The next section covers ways to make your money last.
Spending a lot early in retirement is costly. Once you've retired, you may want to take the six-month world cruise right away, while your health is still good. That’s understandable, but your standard of living will be reduced if you spend a lot in the early years of your retirement. Take the cruise if you’re prepared to make that sacrifice. But understand that now, more than ever, your financial resources are finite.
Avoid borrowing after retiring. Your hard earned savings should not be used to enrich a bank with interest payments.
Maintain a solid financial foundation. Have an emergency cash fund with three to six months of living expenses, or more, for the unexpected expenses (most likely to be medical). Health insurance, homeowners coverage, and auto insurance remain important. When you reach 65, you'll probably have to enroll in Medicare A and B. You will probably want to look into Medigap coverage (for the coverage gaps in Medicare) and Medicare D (for prescription medications), unless you have a employer sponsored retiree policy that covers these costs. If you’ve accumulated a fair sized net worth (i.e., six figures or more), an umbrella policy may be a good idea. You may also want to consider long term care insurance if you have a significant estate (i.e., six figures or more); but it will be expensive if you purchase the policy in your 60’s or 70’s.
Marshal your financial resources. Evaluate your resources in an organized way, so that you figure out the most advantageous way to generate the income you'll have in retirement.
Should you sell the house? It depends on whether or not you need more money to live on, and whether or not you want to move elsewhere. Review the cost of alternatives carefully. If you sell the house and rent, with a 30-year retirement, you’ll have 30 years of rent increases. That will add up in a big way. Whether you stay in your current house or move, try to own your retirement home outright (with no mortgage or home equity debt).
Should you borrow against your home? Generally, no. But a reverse mortgage may make sense for people who want to stay in their homes and lack other financial resources. Reverse mortgages have limitations--sometimes, you can borrow only 25 or 30% of the value of the house. They have high fees, and the total costs of borrowing (fees and interest) may be so great that your heirs won’t inherit any value from the house. So the reverse mortgages can be costly in many ways.
Should you take a lump sum payout of your pension or monthly payments? Figure out which choice is more valuable—calculators on the Internet can help or you could consult a financial planner. Think about whether you’d spend a lump sum quickly; if so, monthly payments are probably better even if a lump sum is arithmetically more valuable. Also consider whether your employer is financially sound enough to stand behind its pension plan. You may be better off taking a lump sum if your employer isn’t doing well. If you don’t need the pension, take the lump sum and invest it for the future. It can be an inheritance, a charitable donation, an emergency fund or a combination of all three.
Should you roll over your 401(k) account into an IRA or leave it where it is? That depends in part on whether you can manage the money more easily and cheaply in one account versus the other. Look at the investment options and fees of the alternatives. You can give your heirs a tax advantage by specifically naming them as beneficiaries of an IRA. That allows them to stretch withdrawals out over their lifetimes. You can’t do this with a 401(k) account.
Prepare for potential incapacitation. One of the toughest problems for retirees is how to deal with mental incapacitation. If your mental faculties diminish, how will you be taken care of? How will your finances be managed? It’s a good idea to give someone you trust a power of attorney for financial affairs, to take care of your finances. If you don’t have someone to step in and take over, your finances could unravel quickly and require expensive court proceedings to straighten out.
You may wish to sign a power of attorney for health care, so that a person you designate can oversee your medical care. Also think about whether or not to sign a living will or directive to physicians to specify what kind of care you would like if you appeared to be close to death.
Maintain purpose. Money won’t buy happiness. You know that. And you should focus on it as part of your retirement planning. Retirees who have purpose and focus tend to be happier, healthier and longer lived than those who play endless rounds of golf. Find something you care about and make it part of your retirement activities. Even consider working part-time. It reduces reliance on your savings and, depending on your work history, may even give your Social Security benefits a little boost.
Managing your wealth in retirement is tougher than saving for retirement. The paychecks no longer arrive, but you have plenty of expenses: the costs of day-to-day living, the grand tour of the Hindu Kush, 7 days a week of golf, and a night or ten at the opera. If you have significant health problems, your medical expenses could be substantial. And your expenses only rise if you move into an assisted living facility or nursing home. If you retire before you start collecting Social Security, you may have to rely heavily on your savings for a while (unless you have a pension). If you retire before 65, you will not be immediately eligible for Medicare, and would have to obtain health insurance on your own (unless you’re lucky enough to have employer sponsored retiree health insurance).
Thus, there will be many wants and needs in retirement, and they won’t be spread evenly over your golden years. You will have a finite pool of money to pay for these expenses. It’s not unusual for people to spend 20 or more years in retirement. Indeed, the safe assumption to make is that you will live to at least 90. How do you make your savings last?
Retirement Survival Basics
Let’s start with a couple of basic points.
1. Early spending is costly. As we discussed before, money that is invested a long time compounds and builds; but money spent is gone forever. If you spend a large part of your retirement savings early in your golden years, you’ll have less money for your later years. Even if your savings have been burning a major hole in your pocket during your working years, don’t go on a spending spree. You don’t want to experience that sinking feeling of being 84 and broke. If you take the long-deferred trip to Shangri-La, be prepared to spend less on your day-to-day expenses. There's nothing wrong with spending the money required for such a trip. Just be prepared for its long term costs.
2. Avoid debt. If you’ve spent a lifetime building wealth, don’t dissipate it in retirement by enriching a bank with interest payments. Many people experience a significant drop in income when they retire, and no longer can support the levels of borrowing they had earlier in life. Borrowing is a way of spending your retirement savings early—you consume a lot now but have to reduce future consumption to pay the debt back. It would impose financial pressure just when your means are diminishing. After decades of financial pressure, why take on more in your golden years? Pay off all your debt before you retire. Most importantly, this means burning the mortgage and paying off the home equity loan or line of credit. You should own your house completely free and clear of all debt, because it could be your asset of last resort. (Just about the only loan you should consider in retirement is a reverse mortgage, which we discuss below). Pay down the credit card debt, and don’t run it up again. Pay cash for cars and other major expenses. Sleep better at night.
Foundation for Retirement Finances
Okay, now let’s turn to the foundation for your retirement finances. Just as in your working years, you need a solid foundation for your retirement finances.
A. Maintain the cash reserve. Remember the cash reserve of three to six months living expenses that (we hope) you faithfully maintained throughout your working years? Don’t do anything with it. Keep it intact to cover the large expenses that are likely to pop up sooner or later. Assisted living and nursing home expenses are shockingly high. If possible, build up the cash reserve with a little bit of your retirement income each month, so that you can pay cash for large expenses like cars and long vacations.
B. Maintain health insurance. Health care costs are likely to be among the largest expenses for most retirees, so good health insurance coverage is essential.
For starters, enroll in Medicare A and B—they are your basic hospital and outpatient care coverage. If you have employer sponsored retiree insurance, it may require you to enroll in Medicare A, and perhaps Medicare B. Make sure to enroll if required. If you are still actively working at age 65, you may or may not need to sign up for Medicare—again, check with your employer’s health benefits plan. Also check on whether and to what extent your retiree or employer health benefits cover your spouse as s/he approaches age 65. Your spouse may have to sign up for Medicare A and B at 65, as well.
Medigap Insurance and Employer Sponsored Retiree Insurance
There are “gaps” in Medicare coverage. Without additional insurance, you would have to fill those gaps by paying cash out of your own pocket. There are two types of insurance policies that can help to cover the Medicare gaps. First, if you’re lucky enough to have employer sponsored retiree health insurance, keep it nice and warm, well fed, and purring. Employer sponsored retiree policies can be a relatively inexpensive way to fill the gaps in Medicare.
Another way to cover the Medicare gaps is with “Medigap” insurance. There are a number of choices offered by competing private insurance companies. These policies are legally required to have one of 12 standardized coverage plans, but their premiums can vary by insurer. Choose the coverage level you’d like and compare the premiums charged by competing companies. If you have employer sponsored retiree insurance, compare its coverages and costs against the Medigap policies. People with employer sponsored retiree insurance may find that Medigap coverage is unnecessary. Additionally, persons with long term care insurance should compare its coverages against Medigap before making a decision. Long term care policies may, in certain respects, reduce the need for Medigap coverage. Medigap coverage is pretty expensive (as much as a few thousand dollars a year, depending on the policy’s scope and where you live). Everyone, including spouses, must individually buy Medigap policies—there are no family policies. So the premiums for a married couple could be as much as several thousand dollars a year.
You may have access to cheaper alternatives to Medigap policies, including programs called Medicare Select, Medicare Advantage HMO’s, and Medicare Advantage Private Fee-for-Services Plans. Many of these programs limit your choice of physicians and other health care professionals, something to think about carefully. If you’re dissatisfied with the services of plan physicians, it could be very expensive to see non-participating physicians. However, these alternatives may well have lower premiums than Medigap policies with equivalent coverage. Moreover, many of them offer prescription drug benefits, which could reduce the need for you to separately buy prescription drug insurance.
Review your options for prescription drug insurance. If you have employer sponsored retiree insurance that provides prescription drug benefits, compare that against Medicare Part D plans (which are Medicare sponsored prescription drug plans). The employer sponsored plan may well be cheaper. If you have no prescription drug insurance available other than the Medicare Part D plans, think seriously about enrolling in one of them when you first become eligible. If you defer enrollment until later, your costs could be higher.
If you’re looking into a Medicare Part D drug plan, make sure you understand the “doughnut hole.” For 2008, Part D plans begin paying benefits after a participant pays $275 out of pocket as a deductible. Then the next $2,235 of medications will be subsidized by the plan (although the participant will have paid as much as $558.75 in co-pays, in addition to the $275 deductible). When the participant hits the 2,401st dollar of drug costs, many Part D plans do not provide any more subsidy until the participant has spent another $3216.25 out of pocket. Finally, when the participant gets to $5,726.25 in total prescription expenses, these plans provide subsidies thereafter. In other words, there is a gap, or doughnut hole, in benefits between the first $2,510 in prescription expenses and the point where you reach $5,726.25 in prescription expenses. Makes a lot of sense, doesn’t it?
The doughnut structure of these plans is something that only politicians could have thought up. Everyone gets some benefit initially. Then there is protection against catastrophic expenses if your prescription drug costs exceed $5,726.25 a year (although you’d still have some co-pays). Catastrophic protection makes sense. But the cost to the government of full subsidies would apparently be astronomical, so they inserted the doughnut hole coverage gap between $2,510 and $5,726.25 to limit the government’s costs. Fiscal responsibility is something that is sorely needed in the federal government. But this is a strange way to get it. Because the doughnut hole structure is so different from other insurance policies, many people may unknowingly subscribe to a Medicare Part D plan, pay premiums and more than $800 in deductibles and co-pays, and then get coal in their stockings at the 2,510th dollar. At that point, they have to keep paying the premiums to maintain their prescription drug “coverage” yet fork over another $3216.25 out of pocket before they see further benefits from the plan. (What's with the $0.25 at the end? Can't they spare retired folks a quarter?) In total, you’d have to pay about $4,050 out of pocket (plus premiums) before the catastrophic protection kicks in.
People unable to pay can sometimes get help from prescription drug assistance offered by pharmaceutical companies or their home states. Not all companies and states provide such assistance, but many do.
By now, you’ve no doubt figured out that if you have access to another prescription drug insurance plan (like employer sponsored retiree health insurance), you should take a careful look at it. It may well be better than a Medicare Part D doughnut special. The doughnut hole plans are probably better than nothing for people who have no alternative. But check to see if you have an alternative. There are Part D plans that do not have a donut hole, although these tend to be expensive. Employer sponsored retiree health insurance, if you have it, may turn out to be the best available deal.
C. Maintain Auto, Homeowner’s and Umbrella Insurance
As in earlier years, it’s important for retirees to maintain the insurance policies that protect them against liability to others. These would include auto, homeowners and umbrella policies. If you suffer losses from lawsuits and other such claims, as a retiree you will have a very hard time making up those losses now that you are no longer working.
D. Maintain Long Term Care Insurance; Bag the Disability Coverage; Drop Life Insurance Coverage Except for What's Needed for Your Estate Plan.
If you already have long term care insurance, this coverage should be maintained since you’ve now reached the time when you are most likely to benefit from it. If you haven’t already purchased long term care insurance and have a substantial net worth, you may wish to consider buying it. But it will be quite expensive for those in their 60’s or 70’s; compare the costs against the benefits.
You can ditch your disability insurance. It won’t help you once you stop working. Life insurance also diminishes in importance, since you’re probably done with raising children and the cost of term coverage will be quite high in your later years. An exception would be to maintain any life insurance coverage needed as part of an estate plan. But that will usually be important only to people who’ve accumulated millions and have done some fancy estate planning.
E. Marshal Your Financial Resources
As you approach retirement, marshal your financial resources to figure out where you stand. In particular, if Social Security and your savings aren’t enough to cover living and other expenses, you must find ways to generate more income. For many people, their homes will be their principal asset, and a key question will be whether or not to sell the house or stay in it. Many want need to sell in order to have more cash for living expenses.
If you have a pension, you may have a choice between taking a lump sum payment or lifetime monthly payments. If you have a retirement account from work, such as a 401(k), you’ll have to decide whether to leave it with your former employer or roll it over into an IRA.
A large number of retirees have half or more of their net worth in their home equity, and may wonder whether or not to sell their homes. The answer depends on whether or not they can get by with their other financial resources. If you own the house outright (i.e., no mortgage or home equity debt), it will be a very low cost place to live and the owner won’t raise the rent. Staying where you are will probably provide cheaper housing than selling your home and renting. Why? Think of the rent increases that could be imposed over a 25 year retirement and you’ll love the idea of outright ownership of your home. If you rent and the monthly payment increases an average of just 3% a year, your rent would double within 25 years (a time in which you’ll be drawing down your retirement assets).
Yes, if you sold your house, you’d have a lump sum of cash that could be used to pay that rent. But you’d probably have to downsize and rent a smaller place to make the numbers work. Let's assume you sell your house because you don't have much money saved up. The annual rent for a property often runs in the range of 3 or 4% of its value (although this number can vary depending on where you live). If you sold the house and used the money to live on, you couldn’t spend more per year than about 4% of the money you got from selling the house. Otherwise, you might run out of money late in life (see our discussion of making your money last). Therefore, if you rent an equivalent home, by the time you finished paying the rent, you would have little or no money left over for food, clothing, medical expenses or anything else. You might as well stay in your current home. (The unused portion of the money from the sales price could be invested and produce returns, but the rent is likely to increase and those rent increases could eat up a lot or even all of the investment returns after taxes are paid.)
To make the sale of your house a viable way to finance retirement, you'd have to rent a place that costs, say, 2% per year of the amount you get from selling the house. That would probably involve a significant downsizing or moving to an area with a substantially lower cost of living (which could be a long way from family and friends).
If you do sell your home, try to buy a less expensive home for cash, so that you have a roof over your head without rent payments. Rent increases are unpredictable. If property values in your area rise sharply, the landlord may raise the rent to cover property tax increases. Sometimes, the landlord faces a major expense—such as upgrading the heating and ventilation systems--and raises the rent sharply to cover it. Another common scenario is the rental property is sold and the new landlord buys the property by borrowing heavily. You may face rent increases to cover those borrowing costs. Renters have little control. Avoid renting in retirement if you can.
If you need a lot of space in retirement, consider selling your current home and buying an equally large home (or a larger one) in a lower cost area. If you are tired of home maintenance, mowing lawns and shoveling snow, and don’t want to hire someone to do it for you, sell the suburban castle and buy a condo or townhouse. In either case, pay cash.
Retirees can have problems with property taxes increases. Some towns and cities provide property tax relief to people above a certain age, such as 65. Look into this possibility.
If your other financial resources are adequate to cover your retirement living expenses, refrain from tapping into the value of your home. Homes generally tend to hold their value (except if your in a housing bubble that is popping), so a house usually serves well as an asset of last resort. If you do sell your home, pool the sales proceeds with your other financial assets and draw down your savings slowly, as we discuss in the next section on making your money last.
2. Should You Borrow Against Your Home?
Generally speaking, no. Debt seriously erodes a retiree’s financial strength.
If there is still a mortgage on your house, the question will be whether or not to pay it off at the outset of your retirement. Many people experience a significant drop in income when they retire and find the mortgage to be unmanageable. In that case, you either have to use savings to pay off the mortgage or sell the house. Whatever choice you make, try to replace the house with a new home that you buy for cash.
You may have seen or heard suggestions that, if you own a house, you would profit from borrowing against the house and investing the loan proceeds in the stock market. This is a bad idea for a retiree. Retirement is not a time to leverage the roof over your head in order to speculate in stocks. A 38 year old with a thriving career and a large six-figure income might rationally do this. But a retired person should not place the risks of the stock market on his or her home.
People who feel strongly about staying in their homes but need a way to tap into their home equity may benefit from getting a reverse mortgage.
The reverse mortgage is a relatively safe way for a retiree to borrow against a home. But it can be very expensive. This is a special kind of mortgage, available only to persons 62 or older. The reverse mortgage provides them with a lump sum, a line of credit, or a stream of monthly payments. Or, you can take some combination of these choices. The homeowner has no obligation to repay the reverse mortgage until he or she sells the house, permanently moves away from the house (such as by moving into an assisted living facility or nursing home), or passes away. Thus, the principal advantage of a reverse mortgage is that it allows the homeowner to continue living at home and not make any payments on the mortgage until he or she doesn’t need or want to live in the house any more. Other alternatives, such as a home equity line of credit, require immediate monthly payments of at least the interest on the loan. That may put a lot of strain on a retiree’s finances at exactly the time when he or she cannot handle a lot of financial strain.
Reverse mortgages tend to have high closing costs (maybe as much as 8% of the value of your home when you add up government insurance charges, lender’s fees and other closing costs), and may have monthly charges as well. Therefore, think carefully before you take one out. If you decide to go ahead, analyze the costs closely and comparison shop. Contact several lenders. Review the terms of the reverse mortgage documentation closely because it may be complex and contain surprising features. Sometimes, the lender will want to do more than just make you a loan. Do not buy annuities or other financial products a lender offers along with a reverse mortgage. These additional products will probably be charged to your home equity but could be of little or no real value. Also beware of features that directly or indirectly allow the lender to profit from the future appreciation in your home. These features may be characterized as “shared appreciation fees” or something else. The appreciation in your home should be yours, not the lender’s.
The large majority of reverse mortgages are made through a program of the U.S. Department of Housing and Urban Development (“HUD”), which is administered by the Federal Housing Authority (FHA). Banks make the actual mortgage loan and HUD guarantees that the bank will be repaid. The HUD sponsored loans are called HECMs (for"home equity conversion mortgage"). The federal guarantee is why these loans are so popular, and you may get a lower interest rate on a HUD guaranteed reverse mortgage than on many other reverse mortgages. (That means you can borrow a larger amount under a HUD guaranteed mortgage.) Information about the HUD program is available at www.hud.gov/buying/rvrsmort.cfm.
The amount you can borrow through a reverse mortgage depends on a variety of factors, such as your age, the value of the house, and interest rates. The loan amount for a HUD HECM might be as much as almost 50% of the value of the house for a 65 year old (assuming interest rates prevailing in early 2008), with the older persons able to borrow a higher percentage. (If you go to another source of a reverse mortgage, such as the Federal National Mortgage Association, or Fannie Mae, the percentage could be much lower, such as around one-third of the value of the house.) The logic of the comparatively low loan amount for a younger person is that the interest isn’t being paid each month and accrues (i.e., builds up) over the life of the loan. Since the value of the house is the primary source of repayment and a 65 year old could live another 20, 25 or more years, the amount of interest that accrues over time could be quite large. Thus, the original amount of the loan is kept to a relatively low percentage of the value of the house to ensure that the loan plus accrued interest will be fully repaid. The later in life you take out a reverse mortgage, the more you will be able to borrow. Delay taking out a reverse mortgage as long as possible, in order to get the most out of the house. Try to save the house for a time when you truly need it.
Reverse mortgages can pay you a lump sum, provide a line of credit, or make monthly payments. You can also use a combination of these features. Even though you don’t have to repay the reverse mortgage as long as you live in the house, there is a limit to how much you can borrow. That means you could still run out of money even if you can’t be kicked out of the house. Draw down the reverse mortgage cautiously because you have only a finite amount of home equity and if you use it up too quickly, you could end up in a heavily mortgaged house with just Social Security and no way to get more cash.
One consequence of taking out a reverse mortgage is that your heirs may end up getting little or nothing from the house. This is because much and perhaps all of the value of the home will be used to repay the loan. If leaving an inheritance from the house matters to you, consider selling the house and finding as inexpensive an alternative living arrangement as possible. That might preserve more of the value of the house for your heirs.
Some states and municipalities also make reverse mortgage loans. These may be among the least expensive reverse mortgages, so it’s probably worth investigating if you can get one of these loans. But many can only be used for limited purposes, such as paying property taxes or repairing the house, and are made only to persons having low or moderate incomes.
If you participate in Medicaid, SSI (Supplemental Security Income) or another program for persons of limited means, and are considering a lump sum reverse mortgage, investigate whether or not having that lump sum in your bank account might affect your eligibility for the program. Don’t take out the reserve mortgage until you have a clear answer.
Because you can only borrow a relatively small portion of the value of your house through a reverse mortgage, you may be tempted to resort to other types of loans, such as traditional mortgages or home equity lines of credit. But where will you get the cash to repay these loans? If you have used up your other financial resources, and have no income except Social Security and perhaps a pension, consider whether it’s really feasible for you to repay a more traditional loan. Other types of loans, such as home equity loans, may seem attractive because they have low fees. But they’re sensible only if you have substantial income from other sources to repay the loan (in which case you should just use those other resources to live on, rather than take out a loan). If you’re counting on the value of the house to repay the mortgage, HELOC, or other conventional loan, you’ll have the sell the house sooner or later (and probably sooner). If you have no other resources and don't want a reverse mortgage, simply sell the house now and live off the proceeds. That's easier and less costly than borrowing, paying closing costs and interest, and then selling the house.
Choosing between selling your house and taking out a reverse mortgage is a matter of your needs and your preferences. If you want to live in the house where you’ve been living for a long time and leaving an inheritance isn’t important, a reverse mortgage may be the right choice for you, especially if you can qualify for a HUD sponsored HECM.
3. Should You Take a Lump Sum Payment From Your Pension?
If you’re lucky enough to have a pension, you may have the option of receiving a large lump sum payment that relieves your employer of any further obligations to you, or getting monthly payments for life. Which should you choose?
Start by comparing the value of the lump sum payment against the value of the monthly payments for life. This comparison is especially important if you're retiring early because some companies may offer lump sums to early retirees that are effectively less than the value of monthly payments. Take your life expectancy (factoring in any known or likely medical issues that could affect your personal life expectancy), and calculate the value of an immediate fixed annuity that could be bought with the lump sum offered by the company. This involves some math, but a pretty simple way to do it would be to use calculators available on the Internet (such as at www.immediateannuity.com). Input the amount of the lump sum and see how much of a monthly payment you’d get from the annuity. Make sure that the type of annuity you look at matches the features of your pension plan. For example, your pension plan may have a spousal benefit where your spouse continues to get payments if you die first. If so, make sure that the annuity to which you are comparing it also has a comparable survivor's benefit.
If the annuity gives you a larger monthly payment than the company’s pension plan provides, you get more value taking the lump sum. If the numbers are the opposite, you get more value taking the monthly payments.
For example, let’s say that your pension plan will pay you a lump sum of $100,000 or monthly payments for life of $625, with the payments going to your spouse for his or her life if you die first. The calculator at www.immediateannuity.com would indicates that, at interest rates prevailing in early 2007, you could use the $100,000 to buy a “joint life” annuity (for you and your spouse) and get about $600 a month as long as either of you live. This comparison tells you that taking the lump sum from your pension plan is not as economically valuable as taking monthly pension payments. But if the pension plan offered monthly payments of only $575, taking the lump sum would put you farther ahead.
Economics aren’t necessarily the only considerations. If you haven’t saved much money during your working years, you probably aren’t a model of financial restraint. What would happen to a large lump sum of cash in your hands? How long would it last? And what would you live on after the lump sum was gone? You may be better off taking monthly payments.
But, if you have a relatively large pension ($50,000 a year or more) also consider whether your employer is financially strong. If you’re likely to spend 25 years in retirement, a weak company might not last as long as you do. In theory, companies are supposed to fully fund their pensions so that you aren’t at risk when you retire. But not every company is diligent about doing this. Some financially weak companies declare bankruptcy and dump their pension plans on a government agency called the Pension Benefit Guaranty Corp. ("PBGC"). This agency would pay you your promised benefits up to certain limits ($51,750 in 2008 for a pension covering just the employee, and $46,575 for a pension that covers the employee and provides a 50% survivor's benefit to a surviving spouse). If your pension is less than these limits, you should be covered by PBGC. If your pension would exceed these limits, and the company is financially shaky, a lump sum may be the better choice. If you’re likely to spend the lump sum quickly, use some or all of it to buy an annuity from a financially strong insurance company (annuities are covered in the next section on making your money last).
Ladies: commercial annuities typically pay women smaller monthly payments than men, because women have longer life expectancies. But company pensions are required to avoid gender based discrimination, so they will pay equal monthly payments to women and men who have the same work histories. That means that your employer may offer larger monthly payments than you could get from a commercial annuity. You may well be better off getting monthly pension payments from the company than taking the lump sum and using some or all of it to buy a commercial annuity. [Gents: the reverse analysis may be true for you—if you want monthly payments, you may be better off taking the lump sum and buying a commercial annuity from a financially strong insurance company.]
Also consider whether or not you need the pension. If you’ve been a diligent saver and can live on Social Security and other financial resources, taking the lump sum may be better. Why? Because it can be invested for long term growth (say, 60% or 70% in stocks and 40% or 30% in bonds), and serve as an inheritance, a bequest to a charity, an emergency fund or some combination of the foregoing.
Some pension plans might allow you to take a lump sum that partially pays the company’s obligation to you, with reduced monthly payments. Should you take this? The analysis is similar to what you did for a total lump sum. Calculate the monthly payments that the lump sum would provide from an annuity. That way, you’ll have a value to compare against the reduction in monthly payments from the company. Then consider whether you’d use the lump sum wisely, whether your employer is in good financial shape, and whether you can use the lump sum as a windfall.
4. Should You Roll Over the 401(k)?
Many retirees will have at least some savings in an employer sponsored retirement account like a 401(k) account. When they retire, what should they do with that account? Their options are to keep it with the employer, or roll it over into an IRA. They also could choose to receive the assets as a lump sum, but that would result in immediate income taxation (with a 10% penalty if they are less than 59 and 1/2). That would be a very bad idea. Keep the money in a tax sheltered account and withdraw it gradually.
There are probably more reasons to roll the assets over into an IRA than to keep it in the 401(k). IRAs generally have more investment options than 401(k) plans, and give you an option for inheritance planning that 401(k)’s don’t offer. If you name specific beneficiaries for an IRA, they can stretch out the required minimum distributions over their lifetimes, which lowers their taxes and helps with their retirement savings. A 401(k) plan often will require a speedy distribution of your account’s assets upon your death, resulting in much earlier taxation to the beneficiaries.
If you have stock of your employer in your 401(k) account which has increased in value from the price that you paid for it, you can get a potential tax advantage by transferring it into a taxable (i.e., normal) stock brokerage account and putting the rest of the 401(k) assets into an IRA. You’d immediately pay taxes at ordinary income tax rates on the original cost of the stock. But the appreciation (or increased value) in the stock would be taxed at capital gains rates whenever you sell the stock. Thus, you may save some taxes, although this maneuver is likely to be the most valuable for retirees in the higher tax brackets. If your retirement income is modest and you are in a low ordinary income tax bracket anyway, separating company stock from other assets in your 401(k) account may not save you much. Moreover, you’d have to find the cash needed to pay taxes at ordinary income rates on the original cost of the stock at the time the stock is transferred out of the 401(k).
Keeping the assets in the 401(k) account after you retire may be sensible if your 401(k) plan offers a pretty wide variety of potential investments and its costs and fees are relatively low. But remember that an inexpensive IRA with a low cost mutual fund company can have fees and expenses less than 0.5% of the assets in the account, depending on the investments you select. If the 401(k) isn’t competitive on fees and expenses, transfer the account to a low cost IRA.
E. Plan for Your Potential Incapacitation
As you enter retirement (or before), you should think about signing a power of attorney for financial affairs, a medical care power of attorney and a living will. These documents come into play in case you become incapable of handling your affairs. Diminished mental capacity is a common problem among the elderly and you should prepare for it. Use a power of attorney for financial affairs to designate someone to step in and pay your bills, keep your finances in order and help with your medical problems.
Consider giving a power of attorney for financial affairs to someone you trust to manage your assets. Powers of attorney for financial affairs allow the person you designate as your attorney-in-fact (that’s the legal term for the person who steps in for you) to keep your finances in order if you are unable to do so yourself. Without a smooth transition in financial management, who would pay the mortgage and utilities? Who would file your tax returns? Who would make financial arrangements for your medical care? Nursing homes want a signature from a fully functional adult when a patient applies for a room. Who would sell your house to pay for your care if you have no other assets? If you don’t designate someone to handle these matters, your family (or friends if you have no close family members) may have to go to court to have someone appointed to be your guardian, which can be expensive and time consuming.
You can sign a power of attorney that becomes effective only if you become incapacitated (as certified by a licensed physician, for example) or you can sign a “durable” power of attorney, which is effective immediately and continuously thereafter unless you withdraw it. The advantage of the durable power is that no proof of your incapacity is required before the designated person can step in and take over. For an elderly person who is fading, but perhaps isn’t entirely incoherent, the durable power of attorney can make the transition to the attorney-in-fact easier. For example, what if you are developing Alzheimer’s or some other form of dementia but are still partially functional? You may not be “incapacitated” in the technical legal sense, but still could need help moving into an assisted living facility. A durable power of attorney allows your attorney-in-fact to step in quickly.
Of course, you should give a durable power of attorney (or any other power of attorney) only to someone you trust. There is a potential for abuse of such authority; embezzlement of funds by an attorney in fact sometimes happens.
Persons who are designated attorneys in fact should understand that actually using a power of attorney may be more difficult than one would expect. Many banks, brokerage firms and other financial institutions don’t like to deal with a new person, and may be uncooperative. You might have to provide medical proof of the account holder’s mental disabilities (such as a physician’s note) and negotiate your way through layers of management and into the bank’s legal department. In extreme cases, you might have to go to court.
There are other ways of dealing with these problems. You could make the person who will care for you a joint owner of all your assets. That automatically allows the person to manage those assets in case you cannot. Joint ownership requires a very high level of trust on your part, since the other co-owner could legally walk into your bank and take all of your funds on deposit. Another alternative might be to put your assets into a trust and make someone else a trustee. Again, your trustee should be someone you trust. You might want to consult with an attorney about these alternatives. Have an attorney draft the power of attorney for financial affairs, if you choose to use one. The state law requirements for these powers of attorney can sometimes be extremely technical, and a mistake could be costly. The same would be true if you choose to put your assets into a trust.
Consider a power of attorney for health care. A health care power of attorney authorizes a person you designate to make health care decisions for you in case you cannot make them for yourself. That person can then arrange for your medical care in case you are mentally incapacitated. It lessens the potential for conflicts among those close to you about your health care, since one person will be designated to be the decision maker. The designated person may well consult with the rest of your family about big issues, but it helps to have one person with the final word so that decisions can be made.
Consider a Living Will or Directive to Physicians. You may use a living will or directive to physicians to specify your wishes for medical care in case you appear to be reaching the end of your life. In particular, you can specify whether or not you want all possible medical measures to be taken to keep you alive, including the use of things like respirators and feeding tubes. Some people are concerned that living wills might be used to deny them every possible means to save their lives, and refuse to sign them. For such persons, an attorney can draft a living will or directive to physicians that specifies that you want all life-sustaining measures to be taken. This would be a way of making clear that you do not want to give up the ghost easily. Other people do not want such heroics, and can use a living will to specify that when their medical conditions become terminal, extreme life-sustaining measures need not be taken. This document provides a degree of clarity about your wishes, and makes it easier for your family and friends to ensure you receive the medical care you wish for. Be sure that the document says what you want it to say before you sign it.
F. Maintain Purpose in Your Retirement
It takes more than money to ensure a happy retirement. Okay, you knew that. But do some thinking about it.
Those retirees who maintain purpose in their golden years tend to have happier, healthier and longer lives. Those whose only goal is to improve their score on the back 9 or memorize every episode of their favorite soap have a higher likelihood of mental and physical decline. Find something you care about and make an avocation of it. You can help out at a local charity--whatever your circumstances in life, it usually isn’t hard to find someone who is worse off. Or, how many years have you wanted to coach Little League but couldn’t find the time? You can do something service oriented—many park systems rely on the assistance of volunteers, and a few police departments welcome volunteers who do desk work that would tie up officers needed to patrol the streets. Make the duck decoys you sketched out fifteen years ago—and maybe get someone to pay money for them. Join a book club and really pursue your love of literature. Even if you don’t need money, find a part-time job that fits your interests. Give cello lessons and pass along your love of the instrument to a new generation of musicians. Besides, depending on your work history, working part-time could boost your Social Security benefits a bit.
Other thoughts: (a) maintain your network of friends and contacts, and build new ones to substitute for the daily interactions you used to have at work; (b) define your role at home if you are spending much more time there with your spouse than before; (c) maintain a regular schedule for exercise and relaxation; and (d) establish a daily routine—that way, time won’t feel as heavy and you’ll take out the trash regularly.
A good retirement takes work. But just about anything worth doing in life isn’t easy.
Now let’s return to financial matters and discuss how you can make your retirement savings last.