Note to viewers: Filmed in late April 2013, this Morningstar presentation was part of Money Smart Week, a series of free classes and activities organized by the Federal Reserve Bank of Chicago and designed to help consumers better manage their personal finances. Morningstar is a Money Smart Week partner.
Christine Benz: I'm so glad that Morningstar can participate in several of these Money Smart Week events this week. I think it is terrific that we can contribute to the cause of financial literacy.
Before I get into our presentation, which is called "Investing Well at Every Life Stage," I wanted to just give you a little tiny bit of background on Morningstar, because sometimes I run into people, who say, "Morningstar … you guys are the veggie burger people, right?" And so, I have to quickly say who it is we are and what it is we do. And one way I often shorthand it is by saying that at least as retail investors, individual investors, are concerned, we think of ourselves as kind of the Consumer Reports of the financial services industry.
So, our objective is to help you make well-informed decisions, and we don't have a vested interest in who you do business with. So, we don't care if you are an all-Vanguard investor or an all-Fidelity investor. Our goal is to help match you with the right investments, given your goals. So, that's just the short-form explanation of what Morningstar is. I think that you will see as we go through this presentation that we do aim to be objective. We're not selling any one particular type of investment or philosophy. Overall, we believe that investors should do their homework and they should, generally speaking, stick with very low-cost investments, if they can find them. And we think that they usually can.
So, in this presentation, we have divided it really into two groups. [Morningstar.com assistant site editor] Adam [Zoll] is going to tackle the first two life stages that we have identified, at least in terms of financial accumulation. He's going to talk about young accumulators, what the priority should be for people who are in their 20s and 30s, just starting out in their careers, just beginning to get a jumpstart on retirement. He will also talk about what people should be thinking about and prioritizing when they're in that multitasking mode, when they're in their 30s and 40s, for example. They know they've got to continue to save for retirement, but they may also have college funding on their radar. So, Adam is going to share some tips and strategies for people at those two life stages.
I'm going to tackle the second half, which is people who are pre-retirees and getting ready to retire, people who are in their 50s and 60s. This is a group that I focus an awful lot on for my work on Morningstar.com. I talk about how to tell if you're ready to retire, some of the key things to go through as you evaluate retirement readiness.
And then in the last part of this presentation, I'm going to share some tips for retirees. And this is another group that I spend an awful lot of time on in my work--helping retirees think about constructing their portfolios, wringing the income they need from their portfolios, which is a big challenge these days, given how low yields are on very safe securities. So, I'm actually going to share some model portfolios for people who are in retirement or getting close to retirement.
So with that, I'd like to introduce my colleague Adam Zoll, who is assistant site editor for Morningstar.com.
Adam Zoll: Thanks, Christine.
As Christine mentioned, each of the age groups we are going to be talking about here today faces its own unique set of financial challenges. And for people in their 20s, these include getting out of debt, staying out of debt, kick-starting their retirement savings plan, and saving for near-term goals. And as you're probably aware, many people in their 20s today are leaving college not only with a diploma, hopefully, but also with a mountain of student loans that are sort of providing a headwind as they plan for their financial futures.
Also, you may be aware that many college students rack up credit card debt. As you know, credit card companies love to market to college students, and there is a good reason why.
For people in their 20s who are facing these college loans that they're paying off, these credit cards that they're having to pay down, paying off the highest rates loans first, should always take a priority. You want to get the higher rates off the table, so you can concentrate on paying down the lower-rate loans and credit cards, and then move forward, so you can start to establish yourself financially.
One possibility if you do have college loans is loan consolidation. There can be advantages to this. One is convenience--only having one source to have to pay to. However, there could be some drawbacks also, especially if you've had any special discounts with any of your college loans, those will go away if you consolidate your loans, so that's something to be aware of.
One thing that I'd recommend to people in their 20s, and really to anybody who hasn't already done this, is to do a monthly budget to familiarize yourself with your own spending habits. We tend to concentrate so much on our income and where is our income coming from, and we don't really focus on the big picture of where that income is going out of the door, and where we are using and spending it on. So, by doing a budget using a site or an app from a source like Quicken or Mint.com, you can really get a handle on your spending habits and places where you can cut back, save some money, and then consequently be able to save more money for yourself.
Staying out of debt should be anyone's goal, but for people just starting out especially, you want to establish an emergency fund that can cover at least three months' worth of living expenses. If you are in the field where you think it would be difficult for you to get a new job if you were to lose your job, you may want to push that out to six months or even longer in terms of an emergency fund.
You want to keep your emergency savings liquid by using a bank money market or regular savings account. You don't want to mess with this money by putting it in the stock market or locking it up in a CD even. You want to keep that money as accessible and as liquid as possible.
You want to concentrate on building up your credit history when you're just starting out your financial life. That means paying your bills on time, really watching your use of credit cards. Having multiple credit cards in and of itself will not harm your credit score. It's how you use the cards. If you are racking up large balances and using a large portion of the credit that's been offered to you, that can have a detrimental effect on your credit score.
If you're having trouble paying off the balances on your credit cards every month, that might be a sign that you are spending too much. You might want to consider using a debit card if you think that will help limit your spending and keep you confined to what you can afford to spend each month.
Last but not least, in terms of staying out of debt, it's really a very simple equation. Just don't spend more than you take in each month, and then you'll be OK in the long run.
So for people just starting out, especially when you're just out of school, you are facing student loans and other debts, saving for retirement probably is one of the last things on your mind. It seems so far off in the distance. It's just not front-and-center for you, but that's actually the best time to start saving for retirement. While you may not have a lot to invest, you do have a tremendous advantage over other, older workers and savers--that is the advantage of time. Any money you put aside now has longer to grow, longer to compound. In your situation, if you're in your 20s, you have up to four decades of growth and compounding. So whatever you can put into a retirement savings plan of some kind is going to really serve you well down the road.
In terms of prioritizing your options, if you are fortunate enough to work for an employer who offers a 401(k) plan, at a minimum you should contribute enough to earn the company match. Whatever that match is, is essentially an immediate return on your money. If your employer matches 50 cents on the dollar for every contribution you make, that's a 50% return immediately. So that should be your first priority in terms of retirement savings.
Then you might want to look at something like a Roth IRA outside of your plan. Some 401(k) plans, in fact an increasing number now, are offering Roth 401(k) options, in which case you may not need to open a separate Roth IRA if you still want to take advantage of the Roth option. Maximum contributions for an IRA, Roth or traditional, is $5,500 per year for this age group, and maximum 401(k) contributions or 403(b), 457, is $17,500.
Let's talk for a moment about Roth versus traditional accounts. This applies both to Roth IRA and traditional IRAs, and Roth 401(k)s and traditional 401(k)s. So, just for those who may not be familiar with the distinction, in a traditional IRA or 401(k), you don't have to pay taxes on the contribution you make today on that money. But, when you retire and you take the money out, you are going to have to pay taxes on those distributions.
With the Roth, it's the reverse. You are going to pay taxes on the money that you contribute today, but when you retire and take the money out, you're not going to have to pay any taxes on that. So that had some obvious attractive benefits for many people.
It can be difficult to know what makes sense for me. If I'm in my 20s, I have no idea what my retirement is going to look like. A general rule of thumb is that if you think you're going to pay a higher or a comparable tax rate in retirement, a Roth is often the best option. If you expect to pay a lower rate later in retirement, then a traditional might be a better option. And what many people do, especially if you're really uncertain what your retirement tax bracket would be like--and many 20-somethings, I'm sure, are uncertain about that--you can use both. You can put some of your assets in a Roth account and some of your assets in a traditional account, and then you're sort of hedging your bets in terms of diversifying your tax exposure.
You'll see throughout the presentation these allocation pie charts that track an asset allocation that's age appropriate for each of the age groups that we're looking at. These are compiled by Morningstar's retirement experts, research experts, and they are from Morningstar's Lifetime Allocation Indexes.
So, we see here for people in their 20s what's recommended. This is considered a moderate portfolio, so not terribly aggressive, not terribly conservative. What's recommended is an allocation of 54% to U.S. stocks, 35% to non-U.S. stocks, 6% to U.S. bonds, 1% to non-U.S. bonds, and 4% to commodities. And you'll notice here a very heavy allocation to stocks, totaling about 89%.
So, when you're young or you're in your 20s, you have a long time to ride out the ups and downs of the stock market. Stocks generally offer better returns than other asset classes. So, it makes sense to tilt your portfolio pretty heavily toward stocks at this stage.
Other near-term goals that you may be considering in your 20s include things like buying a car, saving for a down payment on a home, a wedding and honeymoon, starting a family, additional education and training if they're thinking about going back to school eventually. Any money that you want to save for these goals, if these goals are within five years, you want to keep away from stocks. You don't want to expose them to the volatility of the stock market and risk potentially losing money on this money that's earmarked for these specific purposes. So, instead you want to use things like money market, CDs, and short-term bond funds.
Moving on to our next age group: We have the multitaskers. These are people in their 30s and 40s, and at this stage of life, hopefully you've started paying off your loans, maybe they're in your rearview mirror, hopefully. You may be making a little bit more money at your job, and you have different concerns and issues coming up in terms of your financial priorities. These include maximizing your contributions to your company retirement plan and IRAs, retaining your emphasis on long-term growth through stocks, saving in taxable accounts, and saving for college.
So, if you do find that you have more money available to you that allows you to maximize your retirement savings options, that's certainly a good idea. You still have decades ahead of you in terms of growth and compounding. Again, the same maximums apply: $5,500 per year for IRAs, $17,500 for work-sponsored retirement accounts.
Another important possibility for people if you are starting a family, let's say, and one partner is going to stay home with the child and not work, you can use what's called a spousal IRA. Typically you can't make a contribution to an IRA that's greater than the amount of income you have. But with the spousal IRA, as long as the working spouse makes enough, the non-working spouse is allowed to fund an IRA, and that's pretty critical because people who drop out of the workforce, let's say, when they start a family, lose by not contributing to a 401(k) plan, for example, they lose many, many years of compounding of that money, and it leaves a gap in their long-term retirement financing. So, it's a great benefit if a spousal IRA is an option for you.
Here we see the recommended allocation for people in their 30s and 40s. Not a huge amount of difference here in terms of the allocation. It is shifted a little bit more toward U.S. stocks: 57% U.S. stocks, 30% non-U.S., 7% U.S. bonds, 1% non-U.S. bonds, and 5% commodities.
Some people look at an allocation like this and wonder why the commodities are included. Commodities are basically a hedge against inflation. Inflation can erode the spending power of your retirement portfolio over time. Commodities are a useful hedge against inflation. So, they provide a safety net in that regard.
So, if you're building up your assets in a taxable account, a few things to keep in mind. First of all, there's no reason you can't save for retirement in your taxable account if you've already maxed out your tax-advantaged accounts, such as your 401(k) and your IRA. So, a taxable account can serve that purpose. You can use it for money that you're going to need long-term or near-term, but only money that you think you will need more than five years out really should be invested in stocks.
With a tax-advantaged account, such as an IRA or 401(k), you don't have to worry about your annual tax bill, because you're not paying the taxes on any gains or dividends in those accounts. However, in a taxable account, that's a real consideration. You want to keep in mind that some mutual funds, for example, trade a lot and the capital gains that are incurred from all that trading get passed on to the shareholders.
Also expenses, you want to keep your expenses low, and this is true not just in taxable accounts, but also in any mutual funds that you're investing in. You want to always keep expenses in mind, because the expenses have a dramatic effect over many, many years and decades. The same compounding that you see with gains in your portfolio, the same happens if you're investing in high-fee funds, for example. That's a much larger portion of the gain that you are being deprived of. So, we always recommend sticking with low-fee funds.
Some people prefer to invest in individual securities. This gives you a tax advantage in that you control when capital gains are incurred. You can decide when you want to sell out of a position and when you want to pay the taxes.
One thing to watch out for if you're investing in individual securities is, first of all, you want to stay diversified in your portfolio--that goes without saying--but you also want to watch transaction costs. If you're trading frequently, let's say 5 or 10 times a month, and your brokerage is charging you $10, $20, $30 per trade, that is really going to add to your transactional costs of holding this position, and it's really going to eat away any gains that you may be realizing from the position.
Next, we move on to saving for college. For people who are starting a family, hopefully they're also thinking about the cost of college one day. Just as saving for retirement as early as possible makes sense, saving for college as early as possible makes sense, because it affords you the opportunity to have your contributions grow and appreciate and compound over time.
Some popular vehicles for saving for college include the 529 college savings plan. These provide tax-free growth and distributions. Contributions also may be tax-deductible on your state income taxes. And, of course, when we say 529 college savings plan, these are savings vehicles that often offer a menu of mutual funds. They are very often age-based portfolios that gradually shift from stock-heavy portfolios to more fixed-income-based portfolios, as the student approaches the age at which they would enter college. So, these are a kind of analogous to target-date funds in a retirement plan, if you're familiar with those.
529 prepaid plans have the same tax advantages as the college savings plan does; however, they work in a different way. You're not investing in mutual funds; here you're buying credits for college tuition at today's rates, but the credits can be used at a later date. So, you're essentially locking in tomorrow's tuition payments at today's tuition rates, which, if you keep track of the rate of tuition inflation in this country, can be a real advantage.
Coverdell Education Savings Accounts, also sometimes referred to as an educational IRA, is another potential college savings vehicle. With a Coverdell, you can invest in pretty much anything you like; it can be held within that kind of account. You're not confined to a specific menu of options the way you are with a 529. One thing that I think is a real advantage of the Coverdell is that you can use it to save for college, but you can also use it for K-12 educational expenses. So, let's say that you are sending a child to private school or a child needs special tutoring lessons, you can use this as a savings vehicle for those purposes as well.
One drawback to the Coverdell is that there is only a $2,000 annual contribution limit. So, as a college savings vehicle, saving $2,000 a year isn't going to get you as far as the higher amounts that you can contribute to a 529 plan, for example.
Custodial accounts, such as the UGMA/UTMA account, have a tax appeal in that they are taxed at the child's, the beneficiary's, tax rate. The downside is that technically the assets belong to the child, which means first of all that when the child turns either 18 or 21, depending on the state, the child takes control of the assets. So, if you've earmarked funds for college for of a beneficiary, and when that beneficiary turns 18, he or she could decide, I'm not going to use that money for college. I'm going to take it and go buy the car I had my eye on or something like that. So, that's one risk.
Also, assets that are held in the child's name, such as these custodial account assets, may have more of a negative impact on financial aid calculations than assets that are held in the parent's name. And 529 assets are considered to be parental assets. So, that's something to take into account before opening one of these custodial accounts.
Last I would say about college savings: Understand the role that financial aid plays in your college planning. There are a lot of misunderstandings and misconceptions about financial aid. Many people don't realize that when a school is offering financial aid, that may be in the form of loans. So, it's not necessarily "free money." I would encourage people to educate themselves a little about how financial aid works, so that you can get a sense of whether or not that is going to be a part of your college planning picture. In fact, many schools have financial aid websites in which you can type in your own personal financial parameters, and they will give you a sense of whether your child for this coming academic year would be eligible for financial aid, and in what form. And I think that can be a useful exercise, just to familiarize yourself with the sorts of information that will be asked and what your odds are of getting financial aid.
So in terms of 529 savings plans, we have a great team of 529 plan analysts here--they are actually from our fund-of-funds team--that look at each state's 529 plan and rate them. One thing that we often recommend to people is that the first place to look if you're considering a 529 savings plan is your own state's plan, especially if your state offers an income tax deduction. If that's the case, and your state's plan is a decent plan, then that may be the right choice for you. If your state does not offer an income tax deduction or if the plan is kind of so-so, you may want to look at Morningstar.com's 529 Plan Center, for example, and look at what our analyst team says about various state plans.
Many people don't understand that the location of the 529 plan is really irrelevant to where you live and where the student goes to school. You can live in Illinois, use a Utah 529 plan to send your kid to school in New York. There's really no relationship between the location of the plan and the location of the account owner or where the student attends school.
Top-rated 529 plans, according to our analyst team, include plans from Alaska and Maryland, which are managed by T. Rowe Price, and plans from Nevada and Utah, which are Vanguard-managed plans.
Since we have an Illinois audience here today, I'll just let you know about our own state's 529 savings plans--and we do have a prepaid 529 plan in Illinois as well--but Illinois' 529 plans include the Bright Start direct-sold plan. This is a plan that is sold directly to investors. That plan is rated Bronze by our team and it is managed by Oppenheimer and includes Vanguard funds.
There's also a Bright Directions 529 plan. That's an advisor-sold plan that's also rated Bronze. It offers funds from a wide variety of fund companies.
Then there is a Bright Start advisor-sold plan as well. That's rated Neutral and that uses Oppenheimer and American Century Funds.
And now I'll turn it over to Christine to take us into our 50s and 60s.
Benz: Thanks, Adam for getting us through our 40s and getting the kids through college, although I know a lot of people in their 50s who are still getting their kids through college, too.
I'm going to focus on priorities that folks should be thinking about when they're in their 50s and 60s, when they're in that pre-retirement phase.
So, the key priorities I would identify for this life stage would be continuing to save aggressively for retirement, gradually taking risk off the table in the portfolio. So Adam's model allocations were heavily tilted toward stocks. You will see in the portfolios that I will present here, the portfolios begin to have more bonds and more in safe securities. The reason is that we need to reduce risk in the portfolio because once you get into your 50s and 60s you might not have time to recover from big losses like the market shock we had back in 2008.
We'll talk about paying off debt, and one thing that I often hear from pre-retirees and retirees is one of the best things they did for themselves coming into retirement was looking at all of the debt on their balance sheets and prioritizing paying it off, particularly if they intended to stay in the same home. So, I'll talk about doing that calculation and thinking through whether mortgage pay-down specifically is a good idea for you.
Another thing I'll talk about is assessing retirement readiness: how to know if, in fact, you're ready to retire. So, I'll talk about some of my favorite tools on the web for assessing your retirement readiness. I'll also talk about how to do your own back-of-the-envelope calculation. If you're one of those people who likes to see the numbers, I'll talk about how to run the calculation on your own.
I'll also talk about Social Security and retirement-date strategies. This is another area that I think tends to be pretty under-discussed, but the date at which you take retirement and the date at which you begin taking Social Security can be very, very impactful, and in fact it can be one of the best things you can do to ensure that you don't outlive your money over your lifespan. So I'll talk about how to set those dates.
And then finally I'll touch a little bit on formulating a plan for long-term care in case you should need to move into a nursing home or should require some living assistance in your own home. I'll talk about how to think about those costs, talk about the insurance question, or thinking about funding those costs out of your own pocket, and I'll also share some basic estate planning guidelines. And of course that's another big area we could devote a whole presentation to, but I'll talk about the key things that everyone should look at when thinking about estate planning, and these run across all income bands. Estate planning isn't just for people who are very wealthy.
So in terms of saving aggressively for retirement, one thing that kicks in once you turn age 50 is the ability to make what are called catch-up contributions. So beginning in the year in which you turn age 50, Jan. 1 of the year, you are able to contribute $23,000 to your company retirement plan--whether it's a 401(k), 403(b) or 457--and you're also able to put a little bit more into IRAs. So the contribution limit for 2013 for people over 50 is $6,500. So, that gives you a little bit of an extra way to play catch-up if you've run the numbers and it looks like you aren't saving enough or aren't on track to retire when you hope to. You can begin kicking in extra if you possibly can find the money to do so.
Spousal IRA contributions, Adam mentioned these in the course of his presentation. I think it's also important to mention it for people at this life stage who may have spouses retiring on different dates--maybe one spouse wants to retire earlier, the other later. The one who is continuing to work, who continues to have earned income, can make spousal contributions on behalf of the non-earning spouse. So, that's another important lever to make sure that the couple is growing the portfolio as much as possible.
And then as Adam highlighted in his presentation, saving in taxable accounts for people who have the assets to maximize their contributions to company retirement plans as well as IRAs, they can think about saving within those taxable accounts, and one thing that I have spent a lot of time looking at is that, once you are retired, having assets outside of the confines of traditional IRAs and 401(k)s becomes really valuable, and the key reason is when you begin withdrawing assets from traditional IRAs and 401(k)s, you have to pay taxes at your ordinary income tax rate on that money. And so, by having taxable assets, by having Roth assets, you aren't having to pay the full freight on those withdrawals, which can be a very valuable lever for keeping your total tax burden down on a year-to-year basis.
So, we can see from the sample allocation that I've shown here that the equity portion, while it's still quite large, is beginning to step down based on these sample allocations for people in their 50s and 60s. So, we still have quite a high equity allocation, about 66% total going to U.S. and foreign stocks, but we're also seeing the bond piece of this portfolio en large, and we're also seeing the inflation protection piece of this portfolio step up.
So, under the heading of inflation protection, I would put both Treasury Inflation Protected Securities and commodities. Treasury Inflation Protected Securities, for those of you who aren't familiar with them, are Treasury bonds that include an adjustment at the principal level to keep pace with the Consumer Price Index.
So, if you own a TIP bond, as they're sometimes called, what happens is when CPI goes up, your principal also receives a slight nudge up. And so the idea is that you're buying yourself some inflation protection. We've also got some commodities in this portfolio. As Adam explained, the value of commodities is mainly as an inflation hedge. So, as you are paying higher prices for groceries, higher prices for gas, higher prices for whatever you are doing in your life, by having some sort of commodities tracker index, you are able to kind of participate in those price increases. So, as you're paying more for your stuff, you are also seeing some investment gains in your portfolio with this commodities tracking investment.
You can see, though, that this commodity slice is very, very small as a percentage of this portfolio, and the key reason is that commodities are tremendously volatile. So, if you take them much higher than 5%, you probably have a lot more volatility in your portfolio than you would want, particularly at this life stage.
And just to back up and talk about why we want to be taking risk off the table at this life stage, the key reason is that you just don't have time to recover from big losses if your entire portfolio were to be staked in stocks. You need to start adding some ballast to that portfolio as you get closer to needing to fund your living expenses. So, that's the basic concept behind taking risk off the table in the investment portfolio.
I wanted to touch on this question of debt pay-down, because I do think it's an important part of the process when you think about retirement readiness, and one thing I talk about is how the return you get on your investment through mortgage pay-down is a guaranteed return on your money. And if you have money in savings accounts and other guaranteed sources of savings, what you know is that returns there are very, very low.
So, even if you have a seemingly mild interest rate on your mortgage loan, the pay-down on that is going to deliver a higher pay-off than you can earn on your very safe investments. So, I think for a lot of people, particularly, those who do intend to stay in their homes, prioritizing that mortgage pay-down while simultaneously continuing to save for retirement can be a very impactful thing to do.
The other point I would make on this topic is that if you have been paying on your mortgage for many years, the mortgage interest deduction probably isn't saving you that much relative to the standard deduction. For those of you who have mortgages you know that initially, a lot of your mortgage payments are going to interest, but as you go further in the mortgage, more and more of those payments are going to principal, and so that mortgage interest deduction probably doesn't amount to as much as maybe you thought it did or certainly as much as it did when you were earlier in the life of your mortgage.
In terms of assessing retirement readiness, I've listed a couple of my favorite tools here. I don't have the links here, but you can simply Google their names and come up with the links yourself. One that I often refer people to is T. Rowe Price's Retirement Income Calculator, and the reason I like it is that it's a nice holistic tool. So, it takes into account other sources of income, non-portfolio sources of income, such as Social Security. It also takes into account the general complexion of where you are holding your assets, and that's really important in terms of determining whether you can retire. If you have more, say, Roth assets, that's more money that you have that you will be able to put to work for yourself in retirement than if all of your assets were in traditional IRAs and 401(k)s. So, I like that T. Rowe Price Retirement Income Calculator. Fidelity also has a lot of nice tools on its site. One I would point you to is Fidelity's Retirement Quick Check.
Then I also mentioned that I would run you through how to do your own quickie calculation about retirement readiness. And the first step is to start with your desired annual income in retirement. And that might be a hard figure to come up with. People often talk about the 80% rule for income replacement in retirement as maybe a starting point, and the key reason is that you won't any longer be saving for retirement once you retire. So, that's probably a big chunk of change right there. You are not paying FICA taxes, for example, that's another piece. And you don't have maybe transportation costs to and from work and so forth.
So, you can set your own income replacement rate, but try to come up with a number of how much you expect to need in retirement, and subtract from that number any certain sources of income that you know you'll be able to rely on in retirement. So, you can look at Social Security, pension income. If you have an annuity or know you'll have an annuity, you'll want to subtract those certain sources of income. And the amount that you are left over with, the dollar amount that you are left over with, is the amount of income you're going to need that portfolio to replace.
So, the standard rule of thumb for testing the viability of how much you've managed to save is … you would divide your desired starting rate of income by your portfolio balance, and if that is less than 4%, you're in pretty good shape. If it's over 4%, it's time to consider some other strategies, consider saving more before you actually retire.
I want to just share a quick look at how this would actually work in practice, giving an actual example. So, let's assume that a couple wants to have $60,000 in annual income during retirement, and Social Security is going to supply about half of that, or $30,000. So, they need their portfolio to replace the other $30,000. If their portfolio value is $800,000, using that 4% rule again, they are in generally OK shape as far as the long-term viability of their nest egg. So that assumes a 60% stock/40% bond portfolio, and it also assumes a 30-year time horizon. There's been a lot of research done about what is a viable withdrawal rate in retirement, and a lot of it points to 4% being a reasonable rate of withdrawal.
If you get much higher than that, you start running into the risk that you will outlive your assets. I know a lot of financial advisors, by the way, sell their ability to let people pull out more than, say, 4%. They might say, you can safely withdraw 6% or 7%. I would come back to this research and say that it really has been stress-tested by a lot of academics who have looked at 4% as being the sweet spot.
But this is an area that planners are hotly contesting as well. In fact, one of my colleagues here at Morningstar recently suggested that actually a 3% rate is perhaps a better starting point, in part because the returns that one could expect from bond investments in the decades ahead are so low right now. So, in general, you want to keep that number in the realm of 3% to 5%. You definitely don't want to go over 5% for that year-one withdrawal.
And by the way, the 4% rule assumes that you will take that amount in year one of retirement and then gradually inflation-adjust that amount as the years go by. So, for this particular couple, for example, their initial withdrawal could be $32,000, but then they could take $32,960 in year two of retirement. So, that assumes a slight inflation adjustment in year two.
Develop a Social Security and retirement-date strategy. These can be very impactful decisions, as I mentioned. A lot of people don't have the luxury of delaying retirement. They either have health issues or job issues, or they've got to take care of a spouse who isn't healthy. So, even though a lot of people say this is their plan, to delay retirement, in reality it's not a possibility for everyone.
So, I always say, if possible don't let this be your only fallback plan for retirement because sometimes it just can't work out that way. But if you do have health on your side and if you don't have any other work or family issues that will keep you from working, it is a great idea to consider delaying your retirement date and consider delaying Social Security receipt as well.
Delaying Social Security can deliver a very powerful benefit. In fact, … for each year you wait past your full retirement age, you pick up a full 8% in your benefit. So, it's a tremendous return if you can possibly wait past your full retirement age. By the way, there's no benefit for waiting past age 70. So, no one needs to delay Social Security past that date, because it really just doesn't deliver a benefit. You need to sign on by age 70.
So, some tools for doing this decision-making include the Social Security's website. They've got a lot of great tools on the site that, in fact, allow you to pull your own Social Security information. I would suggest that everyone set up a profile on the Social Security site, so that you can track your own information, because they're not going to be mailing out those statements any longer that give you your personalized earnings information and information about the benefit that you might expect. So, I'd suggest creating your own profile on the site.
Here again another T. Rowe Price tool I like--this is a new tool--It's their Social Security Benefits Evaluator that lets you play around with different variables, because Social Security planning can get very, very complicated, particularly where you have spouses with different ages and different earnings histories. There are a lot of different things the spouses can do to maximize the couple's total benefit from the program. In fact, this is an area, too, where I'd say, if you wanted to use a fee-only financial planner to help check-in on this decision-making, to help you make sound decisions on this front, I think that can be money well spent.
I'm often dismayed when I see the data that so many people actually start Social Security as early as they possibly can. So, a lot of people take Social Security right at 62. If they can possibly delay, it can deliver a very, very powerful benefit.
Formulate a long-term care and estate plan--two huge topics here. Long-term care is one that I've spent a lot of time thinking about and writing about over the past few years. The insurance, if you have been tracking it in any way, you know that there've been a lot of problems there. So, for people trying to sign on for new policies, the premiums have shot through the roof. And for people who already have policies, they too have seen their premiums skyrocket. And so it's been a very problematic area. One reason the policies have gotten so expensive is that interest rates are so low. … So if the insurer is taking in your money, they know they can't earn very much on that money. So, they need to charge policyholders that much more.
The other big reason in addition to the current interest rate environment is just that the claims experience for many of these insurers has been very, very negative. They've had more people filing big claims for long-term care than they expected. So, we've seen premiums go up. We've seen some insurers get out of this business altogether.
So, this has been a really vexing area for people who are getting ready to retire, who may have first-hand experience with family members who ended up needing a whole bunch of costly care at the end of their lives.
So, I have a couple of ideas if you are thinking about the long-term care problem. One is, if your company offers some sort of a group plan, the rates there, the premium rates, can oftentimes be much more advantageous than if you're buying the insurance on your own.
Another idea is to simply insure against a minimal amount of care. When you look at the statistics, what you see is that even though you sometimes hear of these nursing home stays that run five or even more years, the typical nursing home stay is right around 18 months.
So, think about buying yourself maybe that baseline worth of care that will tend to be cheaper than going whole hog and getting wall-to-wall 100% long-term care insurance, which might be very cost-prohibitive.
Finally, one tip from some of our Morningstar.com users is that typically these policies come with an inflation rider, and that's very valuable protection to buy yourself. So, you're buying yourself insurance against rising long-term care costs, but maybe not going for the 5% inflation rider, maybe thinking about a 3% inflation rider to help, again, keep your premium costs down.
I'll just touch briefly on the importance of estate planning, and this doesn't mean setting up fancy trusts and so forth using tools that are generally for very wealthy folks. But this also means having the baseline documents drawn up that you need to help people make good decisions on your behalf, if you die or become disabled.
So, this would include a will. This would include a living will--sometimes called an advance directive--so your family members know how you want them to deal with situations like life-support equipment, your attitudes toward these issues. And also naming the powers of attorney to handle your financial matters, powers of attorney to handle your health-care matters as well. And certainly for parents of minor children, they'd want to make sure they have guardians in place for their minor children as well. But that's usually not going to be an issue for people in their 50s. But certainly I would say having these baseline documents set up is a very important consideration for people who are at this life stage.
In terms of people who are already retired or well into their retirement years, here are the key priorities that I would identify for this subset. Again we're continuing to reduce risk in the investment portfolio. We're thinking about segmenting that portfolio by time horizon, and this is called the "bucket strategy to retirement planning." This is something I've focused a lot on in my work on Morningstar.com. The idea of bucketing is that it essentially allows you to back into an appropriate cash-bond-stock mix, given your near-term income needs. So I'll share some bucketed portfolios later on in this presentation.
I'll also talk about, once you're in liquidation mode where you're taking money out of your various pools of assets, how to do that in the most tax-efficient possible manner. That should be a big priority because those tax savings can be very important.
And finally, once you've set that withdrawal rate that you're using, regularly revisit it to make sure that it's still sustainable for you. That's a very important part of the process for someone who is in the decummulation years, where they're actively tapping their portfolios for living expenses.
So, here you can see that the portfolio's equity weighting--this is for someone who's in his or her late 60s or 70s--the portfolio's stock weighting is coming down quite a bit. So, it's now under 50% for this life stage. Again, the idea is that you need to take risk off the table. You need to reduce the effects of big equity market losses on your standard of living during retirement.
So, the equity stake has come under 50%, and the bond allocation has increased. One other thing that you'll notice is that the total global exposure in this portfolio declines. So, in the earlier portfolio--some of the portfolios that Adam showed for example--they had very, very heavy weightings in foreign stocks. For people who are in decummulation mode, you want to think about reducing the foreign exposure in the portfolio, and the key reason is that you have foreign currency fluctuations typically that accompany foreign investments, and that's a wildcard that you just don't need at this particular life stage.
You want to have a little bit of global exposure in the portfolio, because some of the best growth is coming from overseas markets, but you definitely want to be taking it down as the years go by, because you couldn't stand, or it wouldn't be prudent to have a portfolio that was heavily exposed to foreign currencies, if, in fact, the foreign currencies endured a big drop relative to the dollar.
The portfolio also steps up in terms of its inflation protection. So, here again we're trying to protect this retiree's purchasing power, and it has a fairly high weighting in Treasury Inflation Protected Securities at this point. It also has a slightly higher weighting in commodities. It has a slight weighting in cash, and here I would point out that this cash weighting is there mainly to improve the risk/reward profile of this long-term portfolio. It's not really meant to be there to fund living expenses. It's just meant to improve mainly the risk level in the portfolio.
So, this is how the bucket approach looks in action, and what you simply have here is a bucket set aside to cover near-term income needs. I call this Bucket No. 1. And in it, you're holding cash. You are not taking big risks with this portion of the portfolio. You are not taking any risk, really, with this portion of the portfolio, because this is the money that you need to fund your living expenses in the next couple of years.
Bucket 2 is a larger bucket. So, this funds living expenses for roughly years 3 through 10 of your retirement, and it steps out a little bit on the risk spectrum. So, it includes some bonds. It might even include a little bit of equity exposure. It might include some sort of balanced fund to give this portion to the portfolio a little bit of growth potential.
And then the third bucket is for years 11 and beyond of retirement, and this is almost all stocks. It might also include a little bit of risky bond exposure, maybe high-yield bonds, emerging-markets bonds, but this is money that you don't expect to need until well into your retirement. And the idea is, by segregating it by time horizon, you can put up with fluctuations in this portion of the portfolio because you know that you will not have to invade it for living expenses for many more years.
So, I think that this sort of strategy can provide a lot of peace of mind for people who are trying to figure out, "Well, I want to stay diversified. What should my retirement portfolio look like?”
I think you could think about segmenting it something along these lines. And of course, you could sort of adjust the size of these buckets based on your own preferences. So, for example, yields are very low. Maybe you'd want to think about having just one year's worth of living expenses in that Bucket No. 1, and then Bucket No. 2 picks up years, say, 2 through 7.So, you can think about allocating each of these buckets based on your own preferences, based on your own risk tolerances and so forth.
And by the way, to use a strategy like this, you don't need to reinvent the wheel. If you have a well-diversified portfolio already, and you're getting close to retirement or maybe already retired, chances are you've got something that will sync up fairly well with this structure. You don't need to completely upend everything and start from scratch.
So here's a sample portfolio using this bucket approach. I've written articles on this topic that look at sample portfolios based on both traditional mutual funds and exchange-traded funds. This is the traditional mutual fund version. So, what I'm assuming here is a couple with a $750,000 portfolio and $30,000 in annual income needs, so that $30,000 initially in withdrawals is 4% of $750,000. So they've got in Bucket No. 1 the income they need for years one and two of retirement. So, this is money they can't afford to lose, so they are holding it all in cash.
Bucket 2 takes a little more risk, so you can see I've stair-stepped it based on the risk profile of the investments in this component of the portfolio. So, we take a little more risk than cash with this T. Rowe Price Short-Term Bond, but hopefully get a little more yield pickup, and then with the core of this portion of the portfolio, we've got out core bond exposure. I've got a couple of funds from Harbor listed here. Harbor is a firm--it's actually I think based here in Chicago and you probably haven't heard of it, but one thing I like about the company is that they use an arm's-length approach to investment management. So they don't have any in-house investment managers. They hire out for all of their investment managers. So, these two funds here, Harbor Bond and Harbor Real Return, are run by PIMCO; Bill Gross running the Harbor Bond Fund and another team running the Harbor Real Return fund. So, they are all what's called "subadvised funds."
And finally, I've got a little bit of conservative allocation exposure. This is a fund that is mainly bonds, Vanguard Wellesley Income, but also does include a little bit of high-quality dividend-paying stock exposure that amounts to maybe 35% of the portfolio. So that's kind of the caboose of Bucket No. 2. That would be the last part of that portfolio that you would tap for living expenses.
And then Bucket 3 is the growth engine of the portfolio, as I mentioned. And here I think you want to generally focus on equities. You might include a little bit of non-core higher-returning bond types, but with the stock portion of the portfolio you generally want to think about high-quality stocks, because you don't want to have a lot of risky stuff. Even though this is the risky part of your portfolio, you don't want to take unnecessary risks.
So I've used Vanguard Dividend Growth as the lynchpin of this portion of the portfolio. I've supplemented it with a good core international fund. I've used a little bit of [Vanguard] Total Market Index Fund, in part because even for portfolios that use entirely actively managed funds, a lot of research points to having even a little bit of index exposure as being a help.
And finally I've got Loomis Sayles Bond, which is a very aggressive, almost equity-like bond fund, as well as Harbor Commodity Real Return, and that is the commodity portion of this portfolio, and you can see, it amounts to roughly 5% of the couple's total assets.
So, this is just a sample, as I said. Chances are if you've got a well-diversified portfolio and you are thinking about retirement or are already retired, you can probably map your portfolio along these lines and have it fit into a similar set of buckets if you wanted to do so.
So, I'll just touch briefly on this issue of sequencing withdrawals from your retirement portfolio. If you are someone who is taking withdrawals from your portfolio in retirement, you know what an onus taxes can be upon you. So, it pays to think about sequencing those withdrawals in the most tax-efficient manner that you possibly can and possibly, if you have a good tax advisor, leaning on him or her periodically to help formulate a strategy about where you should go for money.
I've provided some very rough guidelines in this slide, but the general concept here is that if you have different pools of assets, if you have traditional IRAs and traditional 401(k)s, maybe some Roth assets as well as taxable assets, you want to get rid of the assets that have the highest tax cost on a year-to-year basis first. So, those will be first in your liquidation queue generally, and save the Roth assets, which tend to be most advantageous from a tax standpoint, until last. So, you generally want to think about this sequence, though in most years I think for a lot of retirees mixing and matching will make sense.
And certainly, if you are past age 70 1/2, you have to prioritize those withdrawals from your traditional IRAs and 401(k)s, because you'll pay a big penalty if you don't follow the government's rules on required minimum distributions from those accounts.
But thinking about sequencing the withdrawals is an important strategy and maybe one to consult with if you have a planner you work with or certainly a trusted tax advisor who understands this stuff.
And finally, as I mentioned, it makes sense to regularly revisit that withdrawal rate. So, I mentioned that a lot of planners have been looking hard at these withdrawal rates, and one conclusion that it seems like a lot of planners are reaching is that you can't just set it and forget it when it comes to this withdrawal rate. You can't just say, I am using the 4% rate, and I'm going to stick with that. You need to regularly revisit it. And the reason is that market conditions, in particular, can cause you to be able to take more, perhaps, in some years, or certainly if we encounter another market crash like we had back in 2007 through 2009, that would argue for taking less when the market's down.
The reason is that if you are sticking with that static withdrawal rate, and the market incurs a big downturn, you are essentially turning what were paper losses for you into real losses, because you are pulling your money out at a time when your portfolio cannot recoup those losses.
So, regularly revisiting those withdrawal rates, based on market conditions, also based on your own asset allocation. So as I mentioned, that 4% rule has been stress-tested, but it includes some pretty significant assumptions, which may or may not match your own portfolio. So, it assumes a 60%-equity/40%-bond portfolio. If your own allocation is far more tilted toward bonds, for example, that would call for taking a lower withdrawal rate than that 4% rule would call for. You would need to take more in the realm of 2% or 3%.
You also want to factor in your age. So, for people, who are older retirees, maybe in their 80s, they can probably safely take a little bit more than 4%. So, when you think about, if you've ever taken time and looked at those RMD tables, those Required Minimum Distribution tables, you can see at age 70, they start somewhere under 4%, but then they quickly step up from there, and the reason is that the government wants people to get their money out of those tax-sheltered IRAs and 401(k)s during their retirement.
You can kind of use a similar life expectancy updating as you think about your own withdrawal rate. So, for example, I have a couple of parents in their mid-80s, and I am comfortable with them taking well more than 4% of their portfolios, because if we look at the life expectancy tables, they do not have the same life expectancy as they did, obviously, when they were 70.
You also want to think about inflation. So, for example, if your personal inflation picture is pretty benign, you can forgo that inflation adjustment that typically accompanies that 4% rule. You can do without it. T. Rowe Price also did some great research talking about how to regroup from a bear market, how to make sure that your portfolio lasts after a bear market, and they found that simply forgoing that inflation adjustment at times of market distress was a great way to ensure the portfolio's longevity.
And finally another reason your withdrawal rate might fluctuate is simply because your income needs are more or less in any given year. We all have emergency expenses regardless of our life stage, and that's certainly true in retirement as well.
So those are just some quick things to think about as you manage your portfolio at every life stage. Adam and I are going to be available to answer your questions. I'm also happy to e-mail anyone a presentation if they would like. We can send you a copy of the presentation. So, you just need to e-mail us, and I've provided our e-mail addresses here as well.
Audience Member: Are we in benign inflation right now, even though it doesn't seem like it, but…
Benz: The question is, are we in benign inflation right now? And one point I would make is, I think rather than looking at the CPI and the other statistics that you might see about inflation, I think for people, especially if you're retired, it helps to think about your own inflation picture, and your own basket of consumption, the stuff you're paying money for, and trying to evaluate your inflation picture based on that.
The CPI has been tracking an experimental statistic, for example, that looks at the rate of inflation for elderly folks, and what they find is that inflation tends to run a little hotter for people in that age band, in part because health-care costs have been rising more quickly than the general inflation rate. So, I think Inflation is really individualized. I would say that we probably are in a fairly benign inflation picture right now, but it really depends on what you yourself are buying and what your personal consumption pool is like.
And my colleague Jamie is walking around with a microphone too. So, if you could raise your hand if you have a question, Jamie will come to you so that we can all hear you.
Audience Member: Hi, thank you. Very nice presentation.
Two questions, if I may. One is, if you are working freelance with a lot of jobs that don't take out Social Security, but you do have one employer that does, is there some way that you can increase your Social Security payments so later on you can benefit from that?
Benz: Good question. I have to say, I don't know. I would assume that whatever is getting contributed directly to Social Security would be the only way that you'd be able to contribute, but there are planners who specialize specifically in Social Security. You might check in with a planner who focuses on that area for an answer about how you could go about potentially amplifying your return from Social Security.
Audience Member: OK, great. And the other thing is, for a senior who plans to keep working for a long time, a Roth IRA versus a traditional IRA?
Benz: I think, it depends mainly on the tax bracket you expect to be in when you are pulling your money from that portfolio, and that's obviously a really complicated question that depends not just on your own earnings history and your own income tax band, but also what happens with taxes at large. So, I think, realistically, tax rates could go up in the future for the public at large, and so that's one reason I believe that for people especially who have been saving primarily in a traditional IRA or a traditional 401(k), that tax diversification can be very, very valuable.
So, if you don't have any Roth assets, think about at least building a small pool or maybe taking some of the traditional assets--some, not all, because there could be a big tax hit when you do the conversion--but also thinking about possibly converting part of those traditional IRA or 401(k) assets.
Audience Member: Hi Christine. Nice job.
Benz: Thank you.
Audience Member: I have a question about Social Security. Some people say, well, if you take your Social Security earlier, like at age 62, and you decide to retire and you are not working, so you don't run up in any of the income rules, but let's just say that you want to delay, or you want to take it as early as possible, but perhaps you may have enough money at age 70 to have it recalculated and pay them back. Have you heard of that?
Benz: So there are a lot of complex strategies that people can employ relating to Social Security. There used to be a very generous one … that allowed you to essentially start taking benefits, but then say, wait a minute, I actually meant to take them at age 70, when it's more advantageous. So, you would have to pay the government back any benefits you received. I'm not even sure if you had to pay interest on that money. It was a very generous loophole. That I believe was recently closed within the past couple of years. Now I think, you are allowed to restart Social Security once, but you have to do so within a one-year period of having initially started it.
So, one resource I would refer you to is Mary Beth Franklin, who is a writer for InvestmentNews. She recently participated in an hour-long webcast for us on Morningstar.com, along with one of our contributors, Mark Miller, and they talked about all of this stuff.
So, I would say watch that video or read the transcript, and you'll get a lot of great information about how to make smart Social Security decisions, because Mary Beth is just a fountain of wisdom on this topic. She is really an encyclopedia. So, I would check that out.
Audience Member: OK. Thank you.
Benz: Any other questions? It looks there is some way in the back, Jamie.
Audience Member: You often hear, and you also showed, you have different portfolios at different stages in life, but once you set up one thing most of us are too busy to even change things at all, and so how would you recommend how often to revisit, rebalance. Because at first, they always say you take care of winners and you sell them. But then of course you are paying taxes on all of that, which is much worse, and they might keep going up still, so … ?
Benz: Right. I always say less is more when it comes to messing around with a portfolio. So, I think once or twice a year in terms of looking at your portfolio, looking at its overall asset allocations, its sector exposures, and so forth, doing that just once or twice a year is plenty, and rather than rebalancing or making changes to your asset allocation on a calendar-year basis, my guidance is to do that only when you see big divergences versus your targets.
So, you want to regularly revisit those targets, and as our slides have shown, you do see that you are taking risk off of your portfolio as the years go by. So, revisit those targets and make changes if you see divergences in your actual portfolio relative to those targets that amount to more than, say, 5 or 10 percentage points.
So, for example, if your target allocation for stocks is 65%, and after this really quite good rally we've had over the past couple of years, you are up at 75%, it's time to maybe think about peeling that back toward your target level.
So, I would use that as the basis for my rebalancing rather than doing it every, say, December or something like that--because the reason you don't want to rebalance that much is that there can be trading costs, there can be tax costs, because you may have to sell stuff that has gone up a lot, so definitely less is more when it comes to that.
I would also say a tool we've got on the site, it's a free tool, Instant X-Ray is a tool that lets you plug in your holdings, and you can see its allocation based on what's actually in the funds.
So, for example, if you have some sort of stock fund that has 10% cash as well as the stocks, X-Ray will pick up on that. So, you are looking at a holistic view of your portfolio. So, I would urge people to check out that tool, because I think it is pretty useful.
Audience Member: Can I just add to that--so talking about the same thing, like you mentioned the example that you gave, but should you change your target if you feel that it might be going in the right direction or something? Like, for example, the stock market now, if you think it is going up, should you just wait and let it go up and not bother to rebalance?
Benz: Well, that's a really good question, and one that I have tackled recently in an article. So, right now, for example, we have been through a great rally since early 2009, and most people's equity weightings may be higher than they want them to be. But the question is, should you really take money out of stocks given that the returns for bonds look so weak in the decades ahead? And I would say, yes, just plunge in and get it done. The reason is that your bonds are there mainly to add stability to your portfolio. They're not the return engine, they're not even much of an income engine these days, but when it comes to volatility and when it comes to how they'll behave when your equity holdings are down, they'll be much, much more stable.
So, I would say for people who are in that position, probably it make sense not to delay, to just get that rebalancing done and don't overthink it, because the risks of just letting your equity exposure ride really do increase if your portfolio's allocation gets way out of whack with your targets.
Audience Member: I think you had mentioned fee-only financial planners, which I wasn't aware of. I always assumed there was a secondary gain when they assess your portfolio. Where would one go about finding reputable fee-only, meaning that I assume that they're analyzing your estate without having the added secondary gain of getting you in or out of things based on their own financial benefit?
Benz: Thank you so much for that question. I always tell people to look for fee-only financial planners for the very reason you mentioned, that there aren't any commission products involved. So the person is truly looking at your needs, your situation, and making recommendations for you that are in your best interests, rather than in their own interests.
So, I always tell people to look for a couple of key things when they look for a planner. First, ask are you fee-only? If there's any hemming and hawing on that question that's probably not going to be someone who truly is looking at products that don't involve commissions, so [ask if they are] fee-only.
Ask if they're a fiduciary. There again, any wavering, waffling on that question, walk away.
And then also look for people who have earned the CFP designation, the Certified Financial Planning designation. Those are three key things I tell people to look for.
And so one way to identify planners who work exactly on this basis is to go to an organization called napfa.org, so that's The National Association of Personal Financial Advisors, napfa.org, and you can search by where you live for advisors who work exactly in this manner. So I think that that's a great starting point.
As a side note, I'm also a big fan of the hourly model for paying for financial advice. So, many financial advisors like to charge you a percentage of your assets on a year-to-year basis, and that's fine if you have something complicated going on in your life, like maybe if you have a family business or something, and lots of considerations there.
But if you have a more basic set of investment problems, the hourly model will be much, much more cost-effective for you as the years go by. So, you do have to write this type of planner a check at the end of the engagement, similar to what you would do for a lawyer or something like that, but it will be more cost-effective than having that person take a chunk out of your account year-by-year-by-year.
So, in terms of fee-only hourly advisors, I often urge people to check out the Garrett Planning Network, which is a network of hourly fee-only advisors. I have no financial affiliation with Garrett, but I do like the business model and think it makes sense for consumers.
Garrett is simply [spelled] G-a-r-r-e-t-t. And again, I can't vouch for the quality of the planners, but I do think it's the right business model, and I'd like to see more planners work on that basis.
Audience Member: Thank you, Christine. I thought it was a really good presentation. There's just a lot of opinions about annuities, and they have strong opinions. Do you have an opinion about annuities and whether they have a place in your portfolio?
Benz: Yes, thank you for that question.
Annuities are such a complicated topic. There are lots of different types of annuities. I just finished a piece for the website for tomorrow on equity-indexed annuities, which I had been hearing are being sold really hard by a lot of advisors.
The type of annuity that I tend to like most is the most basic and vanilla annuity out there, that's simply called a single premium immediate annuity--that's where you give the insurance company a chunk of your money, and they send it back to you as a stream of payments for the rest of your life. These are the lowest-cost annuity types, and they are a nice form of longevity protection.
The problem with that type of annuity right now is that, as with long-term care insurance, the return that you get on your money when you buy that type of annuity is keyed off of the current interest rate environment. So, with interest rates as low as they are right now, it's a really ugly time to buy that type of annuity. So, even though that's the one type of annuity I like, I probably wouldn't recommend it right now.
The other types of annuities tend to be much more costly--particularly variable annuities have layers of fees that sometimes can add up to more than 3%, which, if we are in fact in for a sort of a low-returning market environment, I don't think you want anyone taking a 3% bite out of your returns. So, I wouldn't recommend most variable annuities for investors, either.
One other intriguing annuity type is called a fixed deferred annuity, sometimes called longevity insurance, and I think that is interesting because a lot of people are concerned about outliving their assets. The deal with a fixed deferred annuity is that you give the insurance company a chunk of your money and the annuity kicks in once you exceed your life expectancy.
So, if your [life expectancy is], say, 85 that's when the annuity starts paying you money. If you don't make it to 85, you are the loser in this deal. But it is an advantage for people who have a lot of longevity in their families. It's a product to look at.
The problem with this type of product is that it, too, is affected by the current interest rate environment.
So, I like the fixed-type annuities, but probably just not right now.
Assistant: Christine, do you want to do one more question?
Benz: Sure. Let's take one more question.
Audience Member: What about the house that you own, the net worth in that. That's not in the calculation anywhere. Where would you put that, or you shouldn't even consider that as part of the calculation?
Benz: It's a great question. I think it depends on what you intend to do with your house. So, if you intend to live in your house and you don't want to engage in any sort of reverse mortgage or anything, it seems like you should just think of it as a place to live that you are not having to pay for while you are retired. I would probably keep it out of the calculation.
But if you're someone who's living in a much more expensive house than you expect to eventually live in, then you could maybe think about it in your planning. But I think, it depends on what your plans are for housing in the years ahead, and that's how I would evaluate that decision.
Thank you all being here. We really appreciate it.