Planning for Financial Surprises

Any prudent person has experience making plans throughout life. We plan family vacations, birthday parties, weekend projects and holiday dinners. No matter how well we plan for life’s events, there are always a few surprises along the way.

Financial planning is just what it sounds like: another plan. And there are surely plenty of financial surprises happening all the time. Some surprises are big, while others are small. Finding $20 under your couch cushion is a surprise. So is watching a bundle of highly rated mortgage loans that were believed to be safe collapsing and bringing the entire global economy into a financial crisis, coupled with a 40 percent decline in the stock market. Good financial planning does not try to predict exactly when a surprise may occur or what it may be. Rather, it involves building a sustainable plan that can withstand whatever surprises come up.

Financial surprises early in life are generally less devastating because you have time to recover, learn from any mistakes, and move on. But a major financial surprise during or near retirement may have more severe consequences.

Here are five types of major surprises that could arise during retirement, all of which should be anticipated and planned for.

1. Major market decline – Anyone who retired in 2008 can relate to this first surprise. Prudent investors have investment plans and appropriate asset allocations in place during their careers. But after they retire, investors don’t always think to shift to a more conservative asset allocation (generally by moving a portion of their assets from equities into fixed-income securities). An aggressive 80 percent equity and 20 percent fixed-income portfolio might be perfectly reasonable during your working life. Yet if you left that allocation in place during retirement, a major decline in equity markets – especially if it happened early in your retirement – would significantly damage your nest egg. You might be tempted into emotionally selling at the bottom of the market as a result, locking in these losses. Your portfolio would have little chance to recover. It’s important to revisit your asset allocation a few years before retirement and during the transition out of work life to make sure you have an appropriate plan in place that will allow your assets to grow, but at an acceptable level of volatility for your situation.

2. Higher than expected inflation – Another long-term investing consideration is the effect of inflation on your portfolio’s purchasing power. Based on data from the U.S. Bureau of Labor Statistics, inflation has averaged approximately 3 percent annually since 1913, and 4 percent annually during the past 50 years. There have been periods when inflation has been even more severe. From 1917 to 1920, annual inflation was more than 15 percent. Between 1974 and 1981, inflation averaged over 9 percent per year. If your income is fixed, high inflation can significantly cut into your purchasing power. This is why it’s important to continue to maintain some exposure to more aggressive investments during retirement, including equities. Being too conservative with your investments during retirement can end up a costly mistake if inflation gets out of control.

The two points above may seem contradictory, but the truth is that some investors are too aggressive with their retirement portfolios, while others are too conservative. Of the two, being over-conservative is the more common error for recent retirees. Retirement is not a single point in time toward which you work; it’s a process, and that process can often last 20 years or more. Some of the assets in your nest egg are not for your immediate spending needs the day you retire, but rather for your needs 10 or 20 years down the road. This is why retirees should maintain a growth component in their portfolios to ensure their assets last throughout their retirement years.

3. Major medical expenses – Many people planning their retirement assume Medicare will cover most medical expenses (assuming they don’t plan to retire before age 65). But Medicare does not cover everything. If you face a major medical issue, or require long-term care, you may have to tap into your savings much faster and much more deeply than you expected. Workers approaching retirement often make lowball projections for their medical costs in retirement because they are in perfect health at age 55. But health can change quickly, especially as we age.

Medical cost inflation is also generally much higher than general inflation. Some are tempted to rely on a long-term care insurance policy as protection. As we have previously written, however, such policies are often extremely costly, and many issuers are leaving the market altogether because the economics of the product just don’t work. Good planning should incorporate especially conservative assumptions about medical costs during retirement in order to cushion unpleasant surprises. After all, it’s much nicer to have unexpectedly good health and excess savings, rather than the alternative.

4. Premature death of a spouse – The death of a spouse is always hard to handle, but it will be all the more difficult if it leads to a financial surprise. It’s important for both spouses to understand how their income is generated and what will happen when one spouse dies. Going from two Social Security checks to one can represent a significant drop in income. So can the loss of a pension benefit, or a cut in the survivor’s benefits. The rules governing all these sources of income are well-defined, so it’s both possible and important to understand in advance how a premature death would affect the finances of the surviving spouse. Social Security benefit planning, acquiring life insurance and setting up annuities are all possible solutions to mitigate this type of financial surprise.

5. Inheritance – Some financial surprises can be good, even in retirement. As longevity increases, it’s becoming less uncommon to receive an inheritance from your own parents during your retirement. (You could also receive an unexpected inheritance from a sibling or more distant relative.) While the unanticipated wealth from such a surprise can be a boon financially, it can also create issues in your own retirement and estate planning. For example, if the inheritance is significant, you may have to worry about estate taxes (at the state level, if not the federal). You may also need to revisit your estate plan to incorporate your new wealth. A financial adviser or attorney may need to help you redraft estate planning documents and update your financial plan.

The situations above cannot always be anticipated. A true surprise is just that – a surprise, which is unexpected by definition. What’s important is to understand that a few surprises will surely come up during retirement, even if you can’t know which ones. Remain calm, periodically revisit your plans, and do your best to enjoy life – surprises and all.

About Larry M. Elkin 553 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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