In part one of this report we discussed one of the steps to sound retirement planning i.e. Quantify assets and net worth. In this article we shall consider step two to four.
2. Quantify risk coverage
Take stock of all the insurance that you might already have or need — health, disability, life, auto and homeowners. In addition, consider whether you might need long-term-care insurance, especially in light of the cost associated with long-term care and the very real possibility that you might need some assistance at some point in your life.
According to the report, those households with limited assets, say less than $200,000 in financial assets, may need to spend down their assets and rely on Medical Insurance, while those with more than $2 million in financial assets can cover long-term-care costs out of pocket. But those households with assets in between $200,000 and $2 million should include long-term care insurance in their plan. And the best time to buy such insurance is in the late preretirement years.
Of note, there will soon be many policies that combine long-term-care insurance with life insurance and annuities.
3. Compare expenditure needs against anticipated income
The thing about retirement is that it's filled with expenses, which according to the SOA report "can be thought of as the minimum needed to sustain a standard of living, plus extra for nonrecurring needs and amounts to help meet dreams." What's more, those expenses are likely to change over time.
So, to make your retirement plan work in reality you first have to make it work on paper. You need to compare whether you'll have enough guaranteed income to cover your essential living expenses, including food, housing and health-insurance premiums, at the point of retirement and then compare what amount of income you'll need to cover your discretionary expenses, such as travel and the like (if those are indeed what you might consider discretionary expenses).
Your guaranteed sources of income include Social Security, and possibly a pension and annuity. Your not-so-guaranteed sources of income include earnings from work, income from assets such as capital gains, dividends, interest, and rental property.
No doubt, as you go about the process of matching income to expenses, you might find yourself having to revise your discretionary expenses, especially if there aren't enough guaranteed sources of income to meet essential expenses.
4. Compare amounts needed in retirement against total assets
So here's where your math skills (or your Google search skills) might come into play. Besides calculating your income and expenses at the point of retirement, you need to figure out whether your funds will last throughout retirement. In other words, you need to calculate the net present value of your expenses throughout retirement.
Now truth be told finding the present value of your expenses is a bit tricky, especially since there are many factors that can affect how much is really needed, including the date of your retirement, inflation rates, gross and after-tax investment returns and your life expectancy.
But the bottom line is this: If, after crunching the numbers, the present value of your expenses is greater than the present value of your assets you've got some adjustments to make. And the good news is that there are plenty of adjustments that you can make.
You could, for instance, delay the date of your retirement or return to work or work part-time. Those actions might be enough to offset the difference. In addition, you might consider trimming your expenses or consider a more tax-efficient income drawdown plan.eg, Laddered income annuities, deferred variable annuities and life insurance.
Robert Powell is editor of Retirement Weekly, published by MarketWatch.