It is often said there are no guarantees in life and there is truth to this statement. At the same time, many current and soon to be retirees would like guarantees during retirement. Given all the variables in retirement, this is difficult, but I do believe there is a strategy that could guarantee many of the retirement variables. Keep in mind, I am not recommending the following, just pointing out it is an option for current and future retirees who are looking for guarantees.
Before going farther, it is important to note some of the variables in retirement.
- How much income will a retiree need to maintain a lifestyle throughout retirement?
- What are the sources of retirement income and will they last throughout retirement?
- What are the living expenses now and in the future?
- How will health care, especially the possibility of deteriorating health which may require a move to assisted living and eventually long term care, affect finances?
As a hypothetical example of guaranteeing many of retirements variables, let's assume a male, age 70, who is good health with the following financial information and objectives.
- Net of Medicare premium, he receives $20,000 in annual social security benefits. In addition, he has $500,000 in an IRA account which is moderately invested and from which he withdraws 5% or $25,000 for living expenses. He lives in a residence with no mortgage and a market value of $450,000.
- He maintains his lifestyle including, Medicare Supplement, income taxes and real estate taxes on his annual income of $45,000, with some room for excess spending. He is concerned about inflation and maintaining his lifestyle throughout retirement. From an investment perspective, he also is concerned that long-term returns from his moderate investment allocation will be significantly less in the future than historical averages which may lead to a depletion of retirement assets.
- Finally, he is concerned about the possibility of needing either or both assisted living and long-term care in the future. He is especially concerned about the transition from healthy to deterioration of health and does not want to be either a financial or time burden on his family or heirs.
Our hypothetical client is very intelligent and contracts with a fee-only experienced CFP® to discuss his long term financial concerns. He wants independent advice that is not tied to selling a product or managing money. The CFP®, who bills hourly, prepares and reviews a variety of options for the client.
One option reviewed is for the client to sell his residence and move into a specific type of retirement community that provides independent living, assisted living, long-term care, and memory care, all in one complex at a set monthly fee. Generally in these types of retirement communities, the potential new resident purchases a residential unit for a specified price. In addition, the new resident pays a monthly fee which includes most services or amenities in the retirement community often along with some type of meal plan. Example of previous expenses which he has eliminated from his living expenses include real estate taxes, utilities, HOA fees, homeowner upkeep costs to name a fee.
What makes these types of retirement communities attractive for many retirees is once residency begins, the monthly fee does not change unless the resident changes [buys] a different unit. In other words, if the resident's health should deteriorate requiring a transfer to assisted living, long-term care or memory care, there is no change in the monthly fee. The resident does not have to worry about the cost of long-term care in the future and running out of money.
Note: There are a number of these types of retirement communities with a variety of variables including types of units available, initial cost, monthly fees, monthly payment plans and the amenities included with each type plan. Often, retirement communities require a residential applicant to meet both financial and health minimums. The financial health of the community and quality of services are also important variables. Before making any decisions, potential residents should do extensive due diligence.
The hypothetical client, after touring several retirement communities of the above nature, found one with a 1,100 square foot condo he could buy for $250,000. The monthly fee would be $4,000 per or $48,000 annually and includes almost all amenities including a partial food plan. He selects the 90% Plan which means at his death or he should decide to leave the community, he or his estate would receive 90% of the initial purchase price. In addition, his monthly fee is guaranteed to remain the same, even if in the future he requires assisted living, long-term care, and/or memory care. Finally, the staff will implement all the necessary work to transfer from one type of residence to another if health deteriorates.
The hypothetical client selects the retirement community option from the ones the CFP® presented. He sells his current residence for $400,000 and buys the new condo for $250,000 leaving him with $200,000 of remaining cash to invest for income.
With his fee-only CFP®, he reviews various investment strategies including continuing with his 5% Rate of Withdrawal from his existing retirement account. A new option presented to the retiree is to convert his IRA retirement account to a single premium life-income annuity [SPIA] which would pay him a monthly amount for as long as he lived. There are pros and cons to this strategy as with all strategies. The hypothetical client decides to convert his IRA to the SPIA because the guaranteed income for life was very attractive to him. He received several quotes and selected one that paid him $3,000 per month $36,000 annually for as long as he lived. This equates to a 7.2% payout of the initial premium payment.
Note: When considering a SPIA, it is important to find a highly rated insurance company and review all variables including period certain which guarantees the payments for a specified period of time. For example, with a 10-year period certain SPIA, the payments are guaranteed for the life of the annuitant, but in the event of death after five years, the payment continues to beneficiaries for the remaining five years of the period certain. The longer the period certain, the lower the monthly payment.
Including his $20,000 from social security and $36,000 from the SPIA, our hypothetical client has a fixed income of $56,000 with a fixed cost of $48,000 which covers all of his living costs including most of his meals. He has $8,000 of annual excess cash flow, however, about $6,000 of this will go to state and federal income taxes leaving about $2,000 or $167 per month.
Keep in mind that there is $200,000 of excess cash from the sale of the residence. Our hypothetical client decides to keep $100,000 in a money market account from which he can withdraw cash for additional expenses as he has them. He does not expect to withdraw more than $5,000 annually in most years and sometimes less. With the remaining $100,000 he has several guaranteed options.
- He can invest in a tax-deferred fixed annuity where the interest will be guaranteed and tax-deferred until needed. He can take withdrawals at any time for supplemental cash needs. He also has the option to convert the tax-deferred annuity to a SPIA at some point in the future for additional income.
- If he is healthy, he can purchase a tax-deferred annuity with a long term care rider. This insurance product combines the benefits of a tax-deferred annuity with long term care protection. The rider provides a monthly benefit if the insured meets the policy requirements for long term care benefits. In this situation, our hypothetical client does not need to worry about long-term care because his monthly fee is guaranteed by the retirement community. However, if his health deteriorates to the point he needs long-term care, the rider would kick in and pay part of his monthly fee of $4,000 which means this amount is essentially added to the insured's money market or checking account increasing the estate for heirs. This is not necessarily important in this specific situation, but for many individuals or couples in a retirement community, it could be very attractive.
- Again, if healthy, the hypothetical call can purchase a $100,000 single premium whole life insurance policy with a long-term care rider. This is a unique product with a number of options. For cash needs, funds can be withdrawn or borrowed from the contract depending on the type of contract. It can be converted into a SPIA for additional income. If the owner is transferred to a long-term care unit, the long-term care benefits kick which again essentially goes into the owner's money market account. In the event of death before needing to long-term care, the death benefit will significantly exceed the cash of the contract increasing the amount to the estate heirs.
Though there are a number of variables and moving parts, the bottom line is the hypothetical client has guaranteed much of his retirement including almost all living expenses, potential future assisted living, long term or memory unit care costs and has a guaranteed income for life including options to increase it. Finally, depending on the option selected for the $100,000, he has options including increasing his estate for his heirs. Keep in mind, the estate would already receive 90% of the initial purchase price at the owner's death.
This strategy can work for an individual or a couple. The monthly fee for a couple would be higher than for an individual. .
Finally, is this a strategy I would recommend? There are variables and it depends on the client, income, assets, and objectives. However, for a client who wishes to guarantee as much of retirement as possible including the possibility of needing assisted living, long-term care or memory care, it is a strategy that can be attractive. There is another component that can be important to many individuals and couples which is the reduction if not the elimination of the time and financial burden for children and/or other family members if there is an emergency and/or general deterioration of health.
In summary, the hypothetical retiree has accomplished the following:
- The retirement community monthly fee covers the majority of his living expenses and it will not change for the rest of his life as long as he stays in the same unit.
- The combination of social security benefits and his new SPIA exceed his monthly fee and are guaranteed for the rest of his life.
- His monthly fee will not change if the deterioration of health requires a transition to assisted living, long-term care, and/or memory care.
- His remaining cash has been invested in fixed or guaranteed accounts which will provide him supplemental income going forward.
- He knows he will be neither a financial or time burden to his family or heirs if his health deteriorates in the future. The retirement community will implement all necessary transitions and provides 24/7 emergency services.