Making Money Last in Retirement

The following is a replay from the 2015 Morningstar Individual Investor Conference.

Adam Zoll: Welcome back. I'm Adam Zoll, and you are watching Morningstar's Individual Investor Conference. It's now time for our second session of the day, "Making Money Last in Retirement." We are going to look at this topic from a few different angles. We are going to first focus on the issue of how long your money needs to last in retirement--the issue of so-called longevity risk. Then we will talk about the investing piece of the puzzle, especially asset-allocation decisions. And then finally, we will talk about the spending part of the equation and look at withdrawal rates and how you can best assure that your money will last throughout your retirement.

A quick reminder that this is a live webcast. If you want to submit questions for our panel, there is a window to the right of the screen. You can submit your questions that way, and we will ask some of your questions to our all-star panel of retirement experts. And I'll introduce them now.

To my left is Mark Balasa. Mark is with the wealth-management firm of Balasa Dinverno Foltz here in the Chicago area. We also have Morningstar's director of personal finance, Christine Benz. And last but not least, Mark Miller. Mark is a Morningstar.com columnist who specializes in retirement issues. Thanks to all of you for being here.

So, I thought I would kick off this discussion about making your money last by discussing the time frame that we are talking about here. In thinking about this particular topic, I was thinking about our parents' generation, our grandparents' generation. Many of them had shorter retirement periods, life expectancies were not what they are today, and also many of them enjoyed a pension, which provided guaranteed lifetime income.

Pensions are also not as prevalent today as they were in years past. So, how do we think about this longevity issue and give people some guidance in terms of how long their money actually needs to last in retirement?

Christine, you and I have had many discussions about this topic. How would you recommend that people approach the longevity issue?

Christine Benz: Well, I think the starting point is looking at your own life expectancy. While you can use some of the tables that are out there as perhaps a starting point for estimating your life expectancy, certainly factoring in your own health history, familial health history, your parents' longevity, and your grandparents' longevity should all be in the mix. Higher levels of wealth tend to be associated with greater longevity, in part, because people at higher levels of wealth tend to have greater access to care and better care in some cases.

I also think if your family has a history of longevity that you also want to think about the role of cognitive decline because we also tend to see a very strong correlation [between] longevity [and] a higher prevalence of cognitive decline. So, for folks in their 80s, the NIH had a study where they found that roughly 25% or 27% of people in their 80s were experiencing some sort of cognitive decline or dementia, and that number jumps even higher if you are in your 90s.

So, the combination of that greater longevity and potentially the need for long-term care would argue for a larger pool of money that you would need to set aside for your own retirement.

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Mark Miller: Adam, I think one of the things that's really troubling and difficult about this question is that when you are talking about the averages, those are averages. So, if the average [life expectancy] for a male in the United States is now about 83, that's the average. Many will exceed it and so on. And longevity, when you look at the overall average numbers, they are not rising evenly. The numbers are rising more for better educated, more affluent people than they are for lower. So, it's a really difficult question, and these are all the right things to be thinking about. But it is still very much of a guessing game.

Zoll: Absolutely. Mark Balasa, when you have a client who comes to you and says, "I'm thinking about retiring; I'm not sure if I am ready yet. I'm not sure if I have enough." How does the longevity question enter into the discussion?

Mark Balasa: Well, I agree with what's already been said. Here's one thing that we try to emphasize to people who come in: Let's say you're 65; [your life expectancy], as Mark mentioned, is usually in your early 80s, right? Fidelity and J.P. Morgan have done some nice work showing that a married couple, if they are 65 at the moment, has a 90% chance of one of them making it to 80, a 70% chance of making it to 85, and a 50% chance of making it to 90.

So, we try to help them better understand that [it may not be the case] for you individually but, as a couple, someone is going to be here probably longer. And so we need to be really conservative when we are running projections--should it be around 85, 90, or 95? So, we help to encourage them to think about it in those terms.

Zoll: And you help them think about the worst-case or best-case scenario--however you want to view it--of somebody potentially living that long.

Balasa: Exactly.

Zoll: It seems like I hear a lot of people who talk about working longer into their retirement years, maybe because they enjoy work or because they don't want to dip in their nest egg. But in many cases, people simply haven't saved enough, and I constantly hear this refrain of "I'll just keep working or I'll work till I drop or what have you."

Mark Miller, you have written about employment prospects for older workers. How realistic is that as an expectation?

Miller: Well, it's a great aspiration, and it's a good idea to work even a few additional years. I hear people saying often, "Well, I will just keep working indefinitely." And if you want to do that, great; but even working a few additional years three to five is very, very salutary for your retirement plan in terms of additional years of contributing to retirement accounts, fewer years of drawing down from that money in large sums, and then the opportunity to delay your Social Security claim. Together, [the impact those things can have on your retirement plan can be] very dramatic.

The numbers tell us that for older workers, over 55, the unemployment rate is about a full percentage point lower than the national rate. People who are out of work and have been thrown out of work during the last recession do find that it takes much longer to get re-employed. Those are two trends that live side by side.

There is also, I think, an acknowledgment that there is a lot of age discrimination in the workforce. So, it is a mixed picture in terms of the possibilities. The numbers also tell us that roughly half of people retire earlier than they expected to because of a health problem or because they are providing care for somebody else, job loss, or job burnout.

I write about this a lot. I think it's a great strategy, and it is a great thing to try to do. It is not a plan, though. It can't be a plan.

Benz: I want to pick up on something Mark said. I thought T. Rowe Price did a really valuable study several years ago pointing to the value of working longer. For people who can do it, as Mark said, it's very impactful; but they had an idea where they found that making additional retirement-plan contributions, say, post-age 60 you tend not to get a lot of tax benefit from doing that.

So, their idea was if you can stick it out, continue working, maybe stop making those additional contributions--assuming your retirement plan is in semigood shape--start spending some of that money, and try to enjoy maybe a little bit of what retirement has to offer while you are still earning that paycheck. So, I think that there are many happy mediums that people can consider in addition to maybe sticking it out in your main career. Another idea is perhaps some sort of part-time career that you find more enjoyable.

Miller: That's, I think, a big trend. It doesn't necessarily mean sticking with the thing you've been doing for 30 years. People are transitioning into interesting new roles, new jobs, entrepreneurs, doing consulting work, mixing it up, as you were saying.

Zoll: So, Mark, you mentioned Social Security, and I want to talk about that for a few minutes. For many people, that will be the only guaranteed lifetime income source. I think it's, in many cases, taking on added importance because people are not saving enough for retirement. We could talk probably all day about Social Security. It is such a rich topic. But can you provide some sort of basic rules of thumb? Obviously, the longer people wait to start taking benefits, the more they are going to get. Are there any sort of simple guidelines that you would offer in terms of how to best treat that benefit?

Miller: Sure. At a high level, I think delayed claiming is something most people should think about--especially married couples--because, as has just been pointed out, one person in the couple is likely to well exceed the longevity numbers, and that's where Social Security provides a huge benefit. Oftentimes, you have situations people get into their late 80s or 90s, and they've exhausted the savings, and then Social Security is still there as a bedrock. So, maximizing income in Social Security is a great idea. Delayed claiming is something that people ought to think about. Full retirement age now is 66. It's heading up to 67, and that's kind of the fulcrum against which the claiming runs.

Then, you can get into some of these more complex strategies that are becoming more popular, such as "file and suspend," where for couples that reach their full retirement age, the higher earner can file but then suspend the benefit. The other lower-earning spouse can then file for a spousal benefit, while the higher earner waits to claim later, perhaps as late as 70. And that points to the other broad strategy. In terms of delayed claiming, it's most important for the higher earner to delay as long as possible because, in a married couple, that's where you get the biggest bang for your buck.

Zoll: Good point. Mark Balasa, when you talk to your clients about the role of Social Security, do you generally just recommend that they all try to delay it till 70, or do you sort of take it on a case-by-case basis?

Balasa: We take it on a case-by-case basis. We have software that does much of what Mark just described, which is taking the specific examples and specific assumptions to that family--health issues, income issues, asset issues, and so forth--and run the software to come back with specific recommendations.

Zoll: So, by delaying, does that mean that they have to dip into their savings in order to do so, and is that a trade-off that you recommend that they make?

Balasa: It depends on the numbers. But in some cases, that's exactly what happens. Sometimes, they have their own business, which is a variable in the mix here, or they're working. That's another variable. But when you run the numbers and you can illustrate the advantage of postponing taking the benefit, it's easier for them to say, "OK, let's start dipping into assets to get there."

Miller: I'm sure you are doing this, Mark, but I think it's really important to consider the Social Security strategy in the broader context of what else is there in terms of savings, what is the drawdown from that going to look like, is there a defined-benefit pension in the picture? Social Security shouldn't be considered in isolation.

Benz: Mark, I have a question for you. I know you have test-run some of those Social Security planning tools. Are there any that you really recommend for retail investors who are trying to figure this out on their own?

Miller: Yes. I think, in terms of advice about Social Security, the good news is that's getting to be a bigger, better, more robust area. The options range from services that you can pay a small fee for--Social Security Solutions is one, and Maximize My Social Security is another. The fees run anywhere from a hundred to several hundred dollars, and the potential return on that investment is enormous. These services can spit back a strategy that might generate $40,000 or $50,000 in additional lifetime income. So, [you can get] good return on that.

But there are also other places to turn. One thing that's [becoming more prevalent is] the availability of advice in the workplace, because some of the advisory services are bolted on to 401(k) plans now, such as Financial Engines, Morningstar has one, GuidedChoice is a third. Some of these now have Social-Security-claiming components built in. The Financial Engines tool--actually, there is a free version of that one, too. T. Rowe Price has a really nifty free Social-Security-maximization tool. AARP has one, and there is a retirement estimator on the Social Security website. So, there are a variety of places to go.

Mark can probably speak to this, but I think there is a lot of effort now to educate planners more about how to work with Social Security. I think that is kind of an emerging area. I think it is fair to say that, in the past, lots of planners were not that savvy about the ins and outs of Social Security, but I think that is starting to change.

Zoll: Before leaving the topic of Social Security, I sometimes hear people who are just retiring or about to enter retirement say, "Well, I hear these projections about the solvency of Social Security. I'm worried that later in my retirement Social Security simply is not going to be there for me." Is that a legitimate concern?

Miller: I understand the concerns. There is a tremendous amount of this in the news media. My own viewpoint about this is that Social Security is going to be fine, and I'll say that there are a couple reasons why. The problems in the retirement fund come at about 2033 when the trust fund would be exhausted of funds. At that point, we are looking at a deficit of about $0.25 on the dollar.

There are a couple of really--I would say--easy fixes to those problems. They are easy numerically; they are difficult politically. One is to gradually increase the cap on the amount of income that is taxed for Social Security back to the level that Congress intended it to be. More and more income at the high end has been escaping because of galloping income growth at the high end of distribution. But bringing it back to where it was gradually--[the Simpson-Bowles commission] actually said that if you did this over about 40 years, you'd bring it back to about $240,000 in income that would be subject to tax. Right now, it's at $118,500. That's one big way to bring new revenue into the system.

The other way is to very gradually increase payroll tax rates. So, there are some levers available to us that are relatively pain-free because you introduce them gradually. What I don't think is a good idea is to play with the retirement ages because of what we have been talking about earlier.

The last thing I'd like to say about this is that I have relatively high confidence that Congress is going to deal with it. And the reason I say that is because it's hard for me to imagine any member of Congress wanting to go back into his or her district to run for re-election having to explain to voters a 25% cut in Social Security benefits. I don't think that's going to happen. So, the question is when does Congress get to this. But sooner, the better would be a good thing.

Zoll: You mentioned that the worst-case scenario is actually a reduction in benefits, not an elimination of benefits.

Miller: Key point, yes.

Zoll: We actually have some questions from viewers about Social Security and, in particular, how it fits into asset-allocation decisions. Some people say that Social Security should be seen as if it were a bond that is going to continue to pay you throughout your life. How would you recommend viewing Social Security within the asset-allocation framework?

Benz: Jack Bogle would say to think of it as a bond. My view is that people should look at their income needs during retirement, subtract from that certain sources of income that are coming in the door--pension, Social Security payments, maybe some sort of fixed annuity payments. The amount that is left over, that's what the portfolio will need to replace. Then, I think you create a sensible asset allocation for that portfolio plan. So, I wouldn't necessarily consider it a fixed-income substitute directly. Indirectly, yes. But I think there are some tricky behavioral issues that can crop up if someone has this all-equity portfolio because, over here, is their bond--Social Security. The person in 2008 might see their all-equity portfolio drop by 30% or more; they might not be comfortable with that level of volatility in the actual portfolio.

Zoll: Mark Balasa, does your firm view Social Security as if it were a fixed-income component of the asset allocation?

Balasa: We don't, and it's for the reason that Christine mentioned. Conceptually, it makes great sense, as it does with the actual pension plan, to say, "Gosh, that's a bond equivalent; so, because of that income stream, I have a $2 million bond portfolio, by default, relative to the rest of my assets." That sounds good in theory, but it's the behavioral aspects that are tough. If you go back to 2008-09, if you had taken that approach--including Social Security--with a typical investor, that means they would have had a lot of equities, and they would not have been able to stay the course. And so, although it's nice in theory, maybe on the margin it works, but as a complete solution, no, I don't think it works for a typical client.

The other thing I will mention is about some of Mark's comments; I agree that the Social Security administration plan is funded, if you will.

For older people, Simpson-Bowles [offers some sustainable solutions]. As Mark said, most of their suggestions are for 35 or 40 years out. But for younger people, as they look at their future, there's maybe more of a debate about how robust the assets will be in terms of keeping up with inflation for younger folks. So, for them, maybe another suggestion would be to take a closer look at what they think is going to happen that far down the road.

Miller: Well, Social Security benefits are adjusted for inflation. It is true that Social Security benefits are becoming less valuable over time, mainly as a result of the reforms that were implemented in 1983, which raised retirement ages. So, for most young people today, their full retirement age will be 67. That's implicitly a benefit cut because you have to wait longer to get to the full retirement age. Other factors that are reducing the value of Social Security include the possibility of rising health-care costs, which take a bite out of benefit, if you will. And there are a few other factors as well. So, it's true the benefits are becoming less valuable; but from a solvency standpoint, I think young people should feel confident about Social Security.

Benz: Mark, I loved your comment to me, one time, where you said that younger clients say, "Oh, leave Social Security out of my retirement-planning calculations." So, then you do that, run that projection for them, and they say, "Can you put it back in?"

Balasa: Exactly, Christine. It's a big number.

Zoll: I want to move now to a broader discussion of asset allocation. Christine, you are going to be talking in our next session about model retirement portfolios. But let's talk a little about some basics. If you are trying to build a portfolio that's going to last for a 25- or 30-year retirement or longer, what are sort of the basic components that you need to focus on?

Benz: Well, I think a balanced portfolio really is a great starting point. So, you absolutely need equities for the longevity risk. You need that growth portion of your portfolio. When you think about the fact that starting bond yields have historically been a pretty good predictor of what you might expect from bonds over the next decade, well, at 2% on the [Barclays U.S. Aggregate Bond Index] right now, that's not a return engine for many retirees. They'll be lucky to keep up with inflation at that level. So, you absolutely do need stocks in the portfolio.

My concern actually--just anecdotally, in talking to retirees recently and hearing from our users--is that there is some complacency about equity-market risk, that, in fact, retirees are perhaps too comfortable with their equities. They have forgotten what it felt like during the bear market. So, if anything, I think many retirees seem to be erring on the side of having too much equity risk in their portfolios. You absolutely do need those stabilizers, and that's why my model portfolios include cash, they include high-quality bonds--miserly yields and all. But the idea is that those are the ballast for the return-engine piece of your portfolio.

Zoll: I suspect one reason that seniors are focused on equities maybe as an alternative to bonds is that there is this interest-rate anxiety that's been with us for years now. We got a little bit more news this week that interest rates maybe are not going to be rising in the next few months; but it appears that a hike is imminent, and it seems that many investors are very skittish about owning bonds for that reason. But do you still feel that it is important to have that bond exposure in your retirement portfolio?

Balasa: Yes, definitely. To Christine's point, the expectation for rates to rise obviously is here. It's been here for a long time, but eventually it's going to happen. Earlier this week, I was at a conference where Ben Bernanke spoke, and he talked about his view about what's going to happen. It's like pretty much everyone else's view--that either in June or this fall there is going to be a rate increase. But what they also say in the same breath, though, is that if the rate increases are going to be as advertised--which is always an unknown--there could still be positive bond returns for [the Aggregate Index] and other shorter-term maturities. And as bond rates increase over time, that's good long-term returns for bondholders. Again, to Christine's point, if you go back to 2008-09 and you look at the anxiety that came out of an event like that, people sometimes need to be reminded that it's classic behavior. It feels good; it feels comfortable. Expectations for bonds are pretty modest, so what's the other alternative? All equities. So, there's no question, in our opinion, that bonds still have place in the portfolio.

Miller: Do either of you think that moving to more of a dividend-equity focus is part of the solution in terms of answering the income question that people have?

Balasa: For us, not so much because the volatility still comes with that dividend. So, you might get a similar income stream, but you're still taking on a lot of risk to get it.

Benz: I would certainly argue that as people move into retirement that dividend-paying companies should take up a bigger share of their equity portfolio, but don't necessarily supplant the fixed-income exposure.

Zoll: Christine, you are sticking with bonds in your model retirement portfolio, correct?

Benz: I am, but we watch duration closely. I think it is reasonable for retirees who are looking at bonds to roughly match the duration of a bond fund that they are considering with their holding period. That's something that we do when we put together the portfolios. If a bond fund has a duration of five years, we are definitely thinking of at least a five-year time horizon for it.

Zoll: Now, traditionally, retirees are encouraged to have some sort of inflation protection in their portfolio, whether it be real estate, commodities, or TIPS. We haven't really had to worry about inflation for a long time now. Mark Balasa, do you think that inflation protection still has a place in a retiree portfolio?

Balasa: I think there is always a place for it. I will go back to Bernanke's comments earlier this week. He said, as far as the eye can see, in his opinion, inflation is not going to be a concern; he listed some of the obvious reasons--energy prices, and so on. With that being said, the central banks--either ours or the ECB or Bank of Japan--might make a mistake. There are always opportunities. For that reason, I would say yes. But when you put these inflation hedges in the portfolio, you still need to be aware of valuations. Commodities haven't done well lately; real estate has had quite a run; TIPS, of the three, perhaps may be the most attractive, in our opinion. My point is that you shouldn't put inflation hedges in the portfolio blindly. Pay attention to valuations.

Miller: I would just add, though, that while it's probably right that overall general inflation is probably going to stay quiet, one thing that's important for seniors is that they are more affected by health-care inflation, disproportionately. And that continues to run, unfortunately, higher than general inflation--less than it has, but there is still a debate as to whether health-care inflation could take off again in a way that could be really damaging. I don't know what the solution to that is, but I think it needs to be considered in the overall risk picture with respect to inflation that affects retirees.

Benz: I love that idea of customizing your own inflation targets--thinking about your consumption basket. Another area--and, Mark, you may know more about this--but I believe that food costs, historically, take up a larger share of retiree budgets than they do for the general population. The cereal boxes seem to be shrinking. The pasta boxes are shrinking, and food costs are on the rise in many cases. So, that's something to keep an eye on.

Miller: And if you are not a homeowner, rent costs, for example, have been soaring. So, it can be somewhat, as you say, of an individualized picture.

Balasa: I'd just like to make a final point about that. The point you raised--going back to some of the work that J.P. Morgan has done. J.P. Morgan is interesting. They are spending a lot of time on collecting data and analysis for retirees. In their view, they like to be part of the policy discussion in Washington. Katherine Roy's work there shows that, for retirees, the inflation assumption they have for medical costs is between 6% and 7%, to your point.

Miller: Right.

Zoll: I also want to talk in terms of asset allocation maybe for higher-net-worth investors who are focused on leaving a legacy, an inheritance for their heirs or if they their spouse outlives them. Should somebody in the situation be using a more aggressive allocation in that circumstance? Mark Balasa, how would you factor that into the equation.

Balasa: I missed the beginning of that. I apologize. For an IRA?

Zoll: Well, just in general, for your asset allocation, would you recommend a higher asset allocation for a higher-net-worth individual if they were more focused on leaving an inheritance?

Balasa: The short answer would sure. It's an interesting question in that when people come in and meet with us who have, let's say, three or five times what they need to live on, we always tell them, "You have the best of our worlds; you could have almost all of your assets in CDs or muni bonds and you are going to make it. But there will be less left for the kids or charity. Conversely, you could have almost everything in equities, and you would have more for the kids and potentially for charity."

So, it really comes back to a preference for them. And when you can go through and scenario-plan for them and show them the different options, they settle in on what's a nice mix in terms of stocks and bonds and so forth to get to where they want to go between the children and charity.

Zoll: You mentioned IRAs. Many people, of course, hold the bulk of their retirement assets in a tax-advantaged account. I want to talk about some rules of thumb for maximizing your tax-advantaged accounts. One, for example, some people say that any Roth assets should be held and withdrawn last because of the tax-free compounding and the value of that. But there may be some cases in which withdrawing from a Roth earlier than last would make sense. Christine, what would be some instances when that would make sense?

Benz: Well, there has been a lot of research in this area; there had been these standard rules about sequencing withdrawals in retirement so that you'd go through taxable [accounts] first, then tax-deferred, and then leave Roth until last. And I think the thing that has emerged is that that sort of withdrawal sequence doesn't make sense in every case. The goal should be, on a year-by-year basis, that you try to keep the person in the lowest possible tax bracket, and that can mean pulling assets from a variety of account types. That means you don't need to be dogmatic and shouldn't be dogmatic about those withdrawals. And I think a tax advisor who is well versed in these issues can really give retirees a helping hand on this problem.

Miller: One other thing that's interesting about the tax question has to do with something we talked about earlier--people working longer. Well, the ordinary-income picture starts to get kind of interesting for people who are past that usual retirement age but maybe still working. Then, there might be some Social Security income, income coming out of an IRA or 401(k). It gets more complicated. It also starts to trip some unwanted consequences, such as greater taxation of Social Security, you move into these surcharges on Medicare premiums that kick in around $85,000 in adjusted gross income for an individual, significantly higher Medicare premium. So, there is a variety of things that are now in the picture with the working longer part of the story that I think weren't there before.

Benz: That's true. And RMDs are in the mix, too. We've had a very strong equity market--a very strong market, overall--that has lifted really all boats. So, one thing that a lot of retirees are grappling with right now is that their RMDs are higher than they had been for many years. So, that would argue for perhaps pulling from some of those accounts where you would face lighter tax consequences to do so, such as Roth or perhaps a taxable account.

Balasa: I'll give you a couple of specific examples to illustrate the points just made. We have one client who is a business owner here on the north side of the city, and he is in the process of starting of living off of his IRA today before the RMDs start. He is 68. This is for two reasons. One is that we are trying to maximize his lower tax bracket, get up to the highest end of the 33% tax bracket; but more importantly, because he has a taxable estate, the IRA is the least tax-efficient thing for his family. And so we want to start to run that down now as opposed to paying income tax and estate tax on the IRA, because the taxable assets get a step up in basis. That makes them a more efficient gift to pass on to the rest of the family.

Benz: It seems that those years between retirement and when RMD commence are kind of your "sweet spot" to do some of these tax-management techniques.

Zoll: Well, this discussion of RMDs is a perfect segue into our next topic, which is spending and drawdown of your assets in retirement. For many years, this 4% rule has been sort of the rule of thumb. You withdraw 4% of your assets during your first year of retirement and make an adjustment for inflation every year thereafter. Nowadays, with bond yields as low as they are, some experts are saying maybe 3% is a more comfortable way to go about it.

Mark Balasa, how do you guide your clients in terms of giving them some input with regard to how much they can safely take out each year?

Balasa: It's a great question. You said that you could spend an hour [talking about] Social Security; you can spend an hour on this one.

Miller: Probably two hours.

Balasa: It's one of those rules of thumb that is really tough. For us, it's rarely correct because there are so many other extenuating circumstances. There's a pension, there's Social Security, there's an inheritance, we're going to downsize our home, we're going to sell the business. All of these things come into the mix. So, the 3% to 4% rule, if all you have is a single pot of money and you're going to live all by yourself, maybe that works. But for most people, you have to use some of the software that Mark mentioned; a lot of it is in the public domain. You can buy some on your own. But do some scenario-planning for yourselves because there are so many variables. That rule of thumb doesn't answer most people's specific circumstances.

Zoll: And it also doesn't allow for changes in the market's performance and other factors that may weigh on the decision of how much to withdraw.

Miller: It might be OK as a starting point--a back-of-the-envelope calculation. But as Mark is pointing out, there are so many factors. There has been a lot of interesting research suggesting that 4% is a little on the high side. There has also been some great stuff written, suggesting a more flexible approach. Assess it as you go. And the only other point I'd make about this: There has also been some terrific research indicating that spending in retirement doesn't just move in a straight march upward; it tends to taper off when people hit their 80s. They are less active; they are spending less on entertainment and travel. And so the straight-line version of this is really not going to get it done for most people.

Benz: But I think common sense is really helpful, too. You can run some of the scenarios, and I'm sure that would help you finely tune things. But certainly, pulling back on distributions in those terrible market years will go a long way toward preserving your principal and making your money last. I think it's also important to consider time horizon as part of this consideration. Certainly, younger retirees--people who have, say, a 40-year time horizon in retirement--should not be using 4% as a starting point for distributions. They should be lower. And people who, for whatever reason, want to have a very conservative asset allocation should also be more careful; 4% is probably too high if they have a portfolio that's heavy on bonds and cash.

Miller: It's not just the 4%. It's the 4% plus inflation every year.

Benz: Yes.

Miller: So, it can be, in certain circumstances, an aggressive figure.

Zoll: I do want to get to a reader question here about withdrawal rates. Someone sent in this question: "I am a small-business owner, age 70 and in good health. Although I will face RMDs from qualified retirement accounts, those withdrawals are not necessary for maintaining lifestyle. If relying on my nest egg can be postponed until age 75 or 80, how does that change a safe withdrawal rate?" So, presumably, for somebody who is not withdrawing until 80, the 4% rule is kind of out the window, right? The shorter the time frame, the higher your potential withdrawal.

Balasa: Correct.

Zoll: OK. Nobody has anything to add to that one. I want to move on now. I think we touched a little bit on health-care costs. I think this is also a very rich topic for us to talk about. Health care, probably one of the biggest swing factors in terms of making your money last in retirement. We have had lots of discussions on Morningstar.com about long-term-care insurance. Mark, in fact, you just wrote an article this week about some recent research that found that many people will need long-term care of some kind, but perhaps not for the duration that had previously been assumed. How should people look at the health-care question, in terms of figuring out their spending patterns?

Miller: So, long-term care fits into the picture as kind of this significant tail risk for most people. So, [thinking] the big picture, before we dive into the specifics on long-term care, I would start with Medicare because most of us are going to file for it at 65. So, Medicare does a really good job of smoothing out the more general, routine health-care costs. And [some not-so-routine costs as well]; if they need to go into the hospital, it covers a great deal of that. So, the main thing for our viewers to think about, there, is to just be on top of the game, in terms of making smart decisions about Medicare.

And this is another topic we could spend easily an hour on, but there's a lot of great information on Morningstar.com about this. But there are some rules of the road to follow--[for example,] making sure you file on time to avoid penalties for late filing. That's a whole long discussion. The basic decision is whether you want traditional Medicare or the managed-care version, which is called Medicare Advantage. It can save some money for some people, but I still regard traditional Medicare as the gold standard because it gives you the greatest flexibility in terms of seeing providers. It costs a bit more, and it requires more paperwork because you're putting together the different layers on your own. You sign up for Part B, which is outpatient; then you add a drug plan, which is Part D. And you probably add a Medicare supplement plan. So, there are more moving parts; but for a lot of people, it's the way to go because they don't want to worry about just seeing in-network doctors.

So, let's leave it there, but I think there's a lot to be said for paying careful attention to managing your filing and [managing the other elements] of Medicare. If you do that, you have really gone a good way toward helping control your health-care costs in retirement.

Benz: I was going to say, though, Mark, Fidelity comes out with that annual study where they look at health-care expenditures for couples over their retirement. Those are high numbers, and they don't include long-term care. What is it? $220,000 a year--

Miller: Lifetime, for a couple.

Benz: Yes.

Miller: So, there's a significant amount of out-of-pocket expenses for the co-pays, for things you just walk into the drugstore to buy--

Benz: Supplemental policies.

Miller: Yes. But the numbers do include what you are paying for premiums. So, the Fidelity numbers do include your Part B premiums, your drug premiums, your [supplemental insurance plan], and all of that. So, I'm just saying, in terms of risk, in terms of fluctuation, Medicare is going to smooth a lot of that out.

Zoll: What about long-term-care insurance itself? Every time we bring up this topic, our Morningstar.com readers have a very lively conversation. There are those who feel that it's not worth the high cost in many cases. Others feel that it provides great peace of mind and, therefore, it is worth the cost. Mark Balasa, I'm curious as to whether long-term-care insurance is something that you recommend for your clients.

Balasa: It depends on the scenario. In many cases, our typical client can self-insure. They have enough assets that they don't have to worry about getting it. That being said, some still like it because of the psychology around it. They've seen how their own families have been devastated by end-of-life costs, and so they might buy just a starter policy, even though they don't really need it. Others, of course, want it and they can't get it because they can't pass the underwriting. So, it comes back, unfortunately, to specifics. Do you have enough assets? And it's a catch-22 because if you don't, then it's hard to afford the premiums. But there is a case to be made for people whose children aren't around or if [they face longevity risk], and so on. It comes back to doing the actual scenario-planning for them.

Miller: Mark, how do you think about the self-insurance question? Do you just run a test against the client's plan to see what would happen if this person has an outsized nursing-home expense late in life? How do you actually make a decision about whether they can self-insure?

Balasa: So, what we typically do is we ask, "What do we assume for the cost per month in today's dollars?" It's usually somewhere between $8,000 and $10,000 a month. The average stay is somewhere around four to five years, so we'll put that into their plan, inflate it, and see whether they can withstand that.

Miller: And actually, four to five [years] is a very conservative assumption. Average stays are actually lower; but I think if you're testing it to be as conservative as possible, you would use a number like that.

Balasa: Exactly. And if [the client] can pass that with flying colors, then they're typically--not all--but many are good. They say, "Great, we'll self-insure." But like I said a minute ago, even that, for some people, isn't enough.

Miller: The long-term-care insurance policies, that whole market is kind of a dysfunctional area. It's not growing; a relatively small number of people buy it. Morningstar viewers will be glad to hear their perspectives validated by that. There has been a lot of volatility on premium increases for current policyholders. [There have been] massive increases because the underwriters have had trouble figuring out how to properly price these things. Some people think we're through the worst of that, but [the increases have] been scary. There have been like 40% increases. And for people who have seen those increases, it usually makes sense to hang on and ride through it, because you've already invested in the policy. But it's been very, very tough.

Benz: Arguably, I think I'm more on the side that the worst might be over in terms of premium increases. Michael Kitces, the financial planner--you quoted him in a recent article, Mark--does think that insurers have been savvier about how they are pricing new policies--

Miller: Well, they have boosted their prices a lot.

Benz: They have.

Miller: Prices are still rising about 8% a year, and they are trying to get up as quickly as they can to where they think they have a better cushion.

Benz: Right. And interest rates are in the mix, too.

Miller: Right. Absolutely.

Benz: So, if the long-term-care insurer takes in your money, they are only going to be able to make a certain set of assumptions, employing the current low-interest-rate environment when they price that policy. So, that's really been working against the purchasers of these policies as well as existing policies.

Miller: That's been a big factor, that the insurance companies can't get a decent return on their portfolios. But there have been some interesting ideas floated as to how to approach this problem because the market is kind of dysfunctional. There's a relatively small number of people that really can self-insure. Then, we've got a bunch of people who arguably should have a policy but don't, and then Medicaid pays about half. So, this is just not how this should be working. I've been at a few conferences where there's been very interesting discussion of research around how to fix the problem.

So, there are a couple of interesting thoughts. One is maybe that there could be some kind of an option within Medicare Advantage plans to add a long-term-care insurance policy. I saw a paper suggesting more flexibility on 401(k) drawdowns to pay for things. You can use annuities. There are hybrid life insurance policies, which are also gaining in popularity. While traditional LTCI is on the decline, those hybrid policies are seeing some growth. There are lots of ins and outs, pluses and minus to that, but people are trying to figure out whether there is a better approach to skinning this problem.

Zoll: We do have a reader question: "Is there any reason to be concerned about the financial health of long-term-care providers?"

Miller: Well, so many of them have already exited.

Benz: Exactly.

Miller: Genworth is the biggest player. They created some headlines recently with a third consecutive quarter of negative earnings news mostly because of their LTCI business. It's a concern, but remember that these insurance underwriters are all regulated at the state level. Most states have a backup insurance guarantee. It's something to look for. I think you want to go with the highest-rated insurer you can possibly find.

Benz: I think it's also an argument against buying a policy very early. So, if you are, say, a 50-year-old and you are looking at this as a possibility for yourself, that is a benefit that you may not have for another 35 years. You better be pretty sure about the claims-paying ability of the insurer that you are sending those premiums to.

Miller: Most people, when they buy this stuff, buy it in their early 60s. That's the time you would want to buy it because, as Mark mentioned earlier, there is medical underwriting. So--

Zoll: Don't wait.

Miller: --it gets harder to get it.

Benz: Well, I was daunted by your comment in your article that they are starting to look at parental health history as well.

Miller: Yes. Genworth, in particular, has been aggressive in trying to take a tighter look at various underwriting, even looking at family history.

Zoll: Interesting. In the time we have left, I want to touch on a couple of other topics. Mark Balasa, when I spoke with you in advance of this session, you said that one of the challenges that your clients face in retirement planning is that not only are they trying to think about their own financial well-being for the rest of their lives, but they may also be financially supporting an elderly parent, possibly adult children. How do you help them strike this balance of meeting these competing needs? I hate to call them that, but that's really what they are.

Balasa: That's exactly what they are, and this comes back to the question about the 3% to 4% spending rule. [This kind of situation] blows that thing apart. So, for us, it comes back to the same thing many families have to face. You've got one pitcher of water and you've got seven cups; you can't fill them all up, so what are your priorities? So, for them, we would say, "OK, what do you need?" Because the overriding thing that we hear the most often is, "I don't want be a burden on our children, so how can I solve for that?" Next, [they might say], "I have to take care of my parents because of X and the kids may need help, too." There are all kinds of scenarios. So, we try to say, for the family, "Let's scenario-plan: If we do this for you and we take a little bit down, if we help Mom and Dad, how much is left for the kids?" Back and forth until they come up with something that balances all of the competing needs.

Zoll: Another topic, Christine, that you and I talked about is that, in the course of planning for your retirement, you also want to think about what happens if you are no longer able to manage your own financial affairs. How do you put things into shape where somebody can take that responsibility while you are still alive and still make sure that the bills are being paid and your money is still being spent responsibly and is going to last for the rest of your life? What are some tips that people can do now to put those kinds of safeguards in place?

Benz: I often talk to groups of retired investors who are very much engaged, do-it-yourself investors, and one of the things I counsel them on is even if you are perfectly comfortable doing this yourself, lay some basic succession planning in place. So, that means, as you get older, certainly as you get into your 70s and 80s, simplify that portfolio, document everything that you are doing, make some sort of a directory--here is where I hold this asset, here is how much I have roughly. Put that all in some sort of master directory and give it to a trusted loved one, whether it's an adult child or some other family member or friend.

And also think about identifying an advisor in advance. A lot of these retired people who I talk to say, "I have a spouse who is not into this stuff at all." So, do that pre-emptive work because it does take some knowledge to pick a good advisor. You don't want your non-financially-savvy spouse out there attempting to make those decisions. Do that, pre-identify the person, and also take the step of making that introduction; because even if you say, "Call this person," someone else may come along who is maybe a nice person on the doorstep shortly after you pass away and that recommendation that you made may go by the wayside unless you have taken that additional step of making that recommendation.

Zoll: Communication, also, I would think is important--

Benz: Absolutely.

Zoll: --while both partners still have their faculties about them and can have this discussion. I think in most marriages, from my own discussions with friends and with family, there is always one person who takes the reins on finances, and the other one tends to hold back. But it's really important that everyone is on the same page and understands what goes where.

Benz: That's right. Oftentimes, I think a typical scenario is that you've got one bill-payer--one household manager--and then the investor. And that's where the two split up. They need to come together and talk about what's going on.

Miller: Yeah, I really agree that this question of hiring an advisor can be a very good approach, particularly if there is not another person in the family that's comfortable with or interested in dealing with the more complex financial aspects. It needs to be somebody who both spouses are comfortable with, for the reasons you are saying. So, I think the self-directed person wants to just take the bull by the horns on that issue, too; but you've got to bring the spouse along so that he or she is comfortable in dealing with that person, one on one, down the road.

Benz: That's right.

Zoll: So, we have covered a lot of ground here. In the time we have left, I want to ask one last question: Are there certain aspects of retirement planning that you feel get short shrift--that people are not focusing enough on? And by that same token, are there things that people are more concerned than they need to be about? Are there things that get too much attention?

Miller: Well, I think housing is one that doesn't get enough attention. I think, lately, it's been a mantra that people say they want to age in place; they want to stay where they are, which is great, and I think it's appropriate for a lot of people. There's an interesting new book by a gerontologist questioning that, saying, "Is it a really appropriate in all cases, or are there smarter approaches? [Is it a better idea to get] out of the house where you raised four kids [so that you're not] lumbering around a big house that maybe you don't need? Will you be able to deal with the stairs, and are you going to be isolated when you can no longer drive, and so on?"

So, it's something I think a lot of people tend not to pay much attention to. I think it gets overlooked by advisors because when you are looking through the spending plan, if you just assume a steady state on spending, whatever that is, maybe the house is mortgage-free, maybe there still a mortgage. It's an overlooked important detail on the spending side: What will be the housing plan as you age?

Zoll: And that could have been in our asset-allocation discussion. Some people may look at their house as an asset that they can draw income from in retirement. What do you think about including that in the asset-allocation calculation?

Miller: I think drawing down equity is an option, certainly, to pay for long-term-care risk. Reverse mortgages is another topic we could spend an hour on. I'm not a huge fan of it. I think of using equity as maybe not a last resort but not the first place I would go. To me, it's more of just a utility question. You need housing, and it's something you spend money on. So, what's the right way to think about that, from a planning standpoint?

Zoll: We also received some questions during our session about annuities. Some people are fans of annuities. They really like that lifetime income stream. Others are talking about the high cost and wonder if it's really worth it. There are also various types of annuities. What do you think about annuities, and are there specific kinds of annuities that you would recommend and others that you would not?

Benz: I would tend to start with a very plain-vanilla annuity type. The problem is here, again, we've got interest rates in the mix. Interest rates are really low. Annuity payouts from the single premium immediate annuities are arguably as low as they can go, too. So, it's a timing question. I think it might be an interesting product for someone who wants to just add that baseline of assured income, but the timing issue is certainly there.

Zoll: Mark Balasa, you have said that you don't generally recommend annuities for your clients, is that correct?

Balasa: Yeah. You can make a scenario for them, but in our experience, it's been less often than I think they are typically sold. A lot of times, the cost is an issue, and also the quality of the insurance company backing the annuity. And then, of course, the big concern is people losing the assets at death. There are different payout options for survivors; but when you factor in that the money doesn't pass onto the family, that's for many families a showstopper.

Miller: I think if you are interested in an annuity, the types to look at would be the single premium or the newer form, the so-called deferred-income annuity, which is kind of interesting as a way to add some insurance. It doesn't start paying income until you reach an advanced age, but cost is an issue I think that needs to be considered. Annuities are still a relatively small part of the overall retirement picture in terms of what the marketplace is telling us. People are not buying them droves.

Benz: And it's still a really difficult area to do your due diligence, especially with the more complicated annuity types. You really have to know what you are doing before purchasing or even researching such products. And unfortunately, the good information sources are pretty scant.

Miller: One of the pluses that I could mention, though, for annuities is when you talk about this cognitive decline issue. It is a way of automating that that check is going to arrive every month no matter what's going on. It can be looked at as an automation insurance feature.

Zoll: Really quickly in the limited time we have left here, a reader question: Any suggestions for finding a good advisor?

Benz: I always say there are three things that you are looking for. You are looking for a CFP, you are looking for fee-only, and you are looking for someone who is a fiduciary and is willing to stand as a fiduciary. That means that they will put your interests ahead of their own. Those are the three biggies.

Zoll: Great. Well, we are out of time. This is a topic we could spend the rest of the day talking about, but we don't have that luxury, unfortunately. I want to thank my panelists, however. Mark Balasa, Christine Benz, Mark Miller--thank you all for being here and sharing your valuable insights with us.

Mark Balasa: Thank you.

Christine Benz: Thank you.

Mark Miller: Thank you.

Zoll: Please stay tuned. At the top of the hour, we have our next season. It's with our own Christine Benz. So, Christine can just stay put, and she will be discussing model bucket portfolios for retirees. Thank you very much for watching. I'm Adam Zoll.