FDIC Changes for Trust Accounts

Effective April 1, 2024, accounts held under the name of a trust will be insured by FDIC for up to $1.25 million, rather than the current $250,000 limit. Revocable trust (which include informal trust accounts such as Pay on Death (POD) or As Trustee For (ATF)) accounts are insured up to $250,000 per beneficiary per FDIC bank.

If we have created several taxable accounts at different FDIC banks, we may be able to consolidate into fewer accounts with higher balances (while retaining FDIC protection) if the trust has more than one beneficiary (to a maximum of 5) after April. We will review this at our meeting(s) if it is relevant to your finances.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Guidance on inherited IRA RMD – IRS Notice 2023-54

The original SECURE Act, signed into law in December 2019, changed many of the long-standing rules governing IRAs and other retirement accounts, and no single measure in the legislation had a more seismic impact on retirement planning. Specifically, the law stipulated that “Non-Eligible Designated Beneficiaries” (i.e., neither surviving spouses or disabled/minor beneficiary) would be required to empty the inherited retirement account by the end of the 10th year after the decedent’s death (and would no longer be able to ‘stretch’ the distributions over their own life expectancy).

While we expected that Non-Eligible Designated Beneficiaries would not be required to take annual distributions in addition to emptying their accounts in the 10-year period, the IRS in February 2022 issued Proposed Regulations that would make a subset of these beneficiaries subject to BOTH the 10-Year Rule and annual Required Minimum Distributions (RMDs). The caveat, however, was that these were merely proposed regulations.

In October 2022 we were informed that there wouldn’t be a penalty if beneficiaries didn’t take a 2022 RMD but by October most had already! Unfortunately, they failed to address the requirements for 2023 and onward.

Finally, this month the IRS released Notice 2023-54, which provides relief once again by eliminating any penalties for failing to take (potential) RMDs for 2023 for these specific beneficiaries. Once again, they punted the RMD decision another year (2024). Keep in mind that these beneficiaries MUST still empty the IRA account by the 10th year.

Although we monitor notices on RMD rules changes and discuss RMD requirements with each of you as needed each year, your engagement in this topic ensures that we understand the relevant regulations for your financial plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Charitable Deductions

There are many ways to give to charitable causes without risk of IRS wrath. We agree that there is a lot of value in making contributions to charities partly with dollars that would be paid in income taxes, but each person has to recognize that you must simultaneously give away non-tax money. For example, a gift of $1M can in some cases reduce your taxes by about $400K (or 40% of the donated dollars) BUT you must accept that the other $600k will be funded from your savings (non-tax dollars).

The tools used to make charitable contributions can be simple direct donations to a charity or to many using Donor Advised Funds (DAF), or a specific group using a charitable trust or use of Family Private Foundations. The type of contributions can be cash, stock, shares in a company, or any asset. What is important is that the charitable deduction follow IRS proven process to the letter. This will prevent negative consequences of having to pay taxes and tax penalties years later.

This month, we have a case (Braen, et. al v. Commissioner of Internal Revenue, TC) that disallowed a $5.22 million charitable income tax deduction claimed by the Braen family in connection with a sale of a property in NY made through S Corp shares. The rejection appears to be based on not adhering to standard timing/practices and on property valuation misstatements. Unless they appeal, the family will have no deduction and must pay substantial penalties to the IRS.

What does this mean for you? There is nothing risky about using known and established ways to reduce your tax liability and particularly advantageous if you can also use it to fulfill your philanthropic plan, but this must be implemented using proven processes. Let us know if you are ready to create your philanthropic financial plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Inherited IRA Beneficiary Rule – A brief overview

An inherited IRA from a loved one used to be a gift to beneficiaries that was easy to implement with little tax impact and a lifetime of reward. In the last four years, the rules have changed dramatically and now inheriting an IRA can result in a surprisingly large tax liability. It now requires detailed understanding of the rules to ensure the correct ones are applied without additional tax liability.

Below are the rules and the process that we follow with inherited IRAs. We first separate beneficiaries into three large categories: (1) eligible designated beneficiary, or (2) a non-eligible designated beneficiary or (3) a non-designated beneficiary.

Once we know the type of beneficiary we can drill down and verify by using decedent details (below is a chart for non-spousal beneficiaries).

Why is this important? Because the amount of tax liability is at much higher rates if the withdrawals are forced in 5 rather than in 10 years or over your lifetime. In addition, the custodian needs to be encouraged and educated on the nuances of the applicable rules to your situation so that they don’t choose to use the default 5-year worst case scenario. Sometimes we’ve needed to use legal advice to ensure that the correct beneficiary distribution is implemented by the custodian particularly when the beneficiary is a trust.

The take home message is to make sure beneficiaries are clearly delineated in the IRA account form and that inherited IRA transfers follow the correct inherited IRA beneficiary rules.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Preparing Your Family Finances and Our Role

How do we prepare for the loss of someone who plays a lead role in your family’s financial life? This can be a partner, a spouse, a parent, or even yourself. Aikapa’s role during such a crisis focuses on ensuring that the family will have the available cash flow until the transfer of the estate is completed AND on providing the information that the Estate attorney and CPA require to transition the estate efficiently. Below, I’ve outlined how we can prepare for such a loss.
1. Short-Term Cash Flow: Make certain that emergency accounts have enough cash to support family expenses for 6 months and that the account is available to those left behind. That means that the family has access to the login information and that the account is titled properly (T.O.D., Joint or Trust are the usual titles).
2. Consolidate Financial and Legal Records:  It is useful if the family has access to financial and legal records.
a. We can easily generate financial information needed for accounts that we directly manage.
b. It would be useful for the family to also have original financial records for accounts or finances not under our purview.
c. Similarly, we would benefit from information on former and current employer benefits and contact information.
d. Finally, the estate documents should also be easily available by the family or we should have a copy filed with us for reference.
3. Verify that you have the Appropriate Account Titling:  The accounts that take more effort to transfer are those titled under the individual’s name unless they have a wrapper to make them non-probate assets. We will use a T.O.D. (Transfer On Death) wrapper that bypasses Probate Court if your Estate plan doesn’t indicate otherwise.
a. We can easily adjust the title for those accounts that we directly manage. We regularly review these against your wishes and your Estate plan. 
b. Accounts held at other institutions AND under an individual’s name will need your management and update (check with us if unsure). We will consult with your Estate plan and make recommendations, but it will be up to you to ensure these are implemented. Example of accounts that we find are often missed include checking accounts, savings accounts, employer stock accounts, options, 529 and inherited accounts held at other institutions.
c. Other assets, such as real estate, need to be titled correctly as specified in your Estate plan. We can guide you, but you must implement these yourself.
4. Complete and Update Beneficiary: We sometimes find that although everyone is well intentioned, beneficiary designations are missed. Though we find this most often with employer accounts, we do see it also with other accounts.
a. We can easily review and update beneficiaries on accounts under our management and we do so regularly.
b. Accounts at your employer require that you check and make any needed changes yourself. Ideally you will also keep a copy of your beneficiary selection with your financial records.
c. Your home or other real estate may also need a beneficiary designation, but we follow your Estate plan since different states use different rules.
d. Accounts held at other institutions will also need to be updated with beneficiaries.
5. Availability of All Logins and Passwords. It is essential for the family to have access to login and passwords. This includes your computer, phone and online passwords. If you would prefer not to share this information then let us know WHERE the information is located, and we’ll share the location with family when and if needed.
As you would expect, we each respond in our own way to the death of someone close to us. Some focus on getting things done while others find themselves unable to function. The range of reactions spans the full spectrum of emotions. This is the way it should be and ideally, we strive to let them take the time to grieve without anxiety over finances. If we know all is in order, we can delay most of the initial tasks and allow the family the peace they need to deal with the loss while we create what will be needed by the Estate attorney. Once we know that the family has cash to support spending for 3-6 months, we work on generating a list of assets that are part of the decedent’s estate. We generate this initial information from our records (based on the financial plan and visual asset map). We then work with the family to update this information, but it is only after the family obtains death certificates that we can reach out and obtain exact information on items on this asset list. We need to ensure that we have the correct information on the title, beneficiary on record, total account balance and custodian for each asset. The Estate attorney will be able to begin their work only after they are provided with death certificates, estate documents, and our detailed list of assets. They will create an action plan, outline the process, estimate the costs and provide a potential timeline to settle the estate. The Estate attorney is the one responsible for legal filings and letting us know when the assets are ready for transfer. We are responsible for the actual transfer and settling of accounts. Dependent on the time of the year and with the guidance from the Estate attorney, we may want to delay the involvement of the CPA or bring them on immediately.

Once this process begins, it is imperative that we keep the lines of communication open throughout the process as the Estate settles and assets transition. There are time constraints associated with certain filings and activities related to settling the estate which makes it doubly important to work together. But it all begins with having your documents available, titled correctly, and beneficiaries clearly stated. We will focus on reviewing your estate documents during 2021 meetings.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

New tax rules (Secure Act of 2019)

As you know, we believe strongly that managing tax liability is essential to building wealth. The Secure Act of 2019 has made significant changes which we will use to create and action strategies best suited for each of you.
Everyone, near retirement, is aware that there was an extension to the Required Minimum Distribution (i.e., RMD) from age 70.5 to age 72. This is good for many since it gives you more control over your tax liability early in retirement, but it also has made the Roth accounts an even more powerful tool for some.

Sadly, the Secure Act of 2019 has made inherited IRAs a big tax burden for beneficiaries, particularly trust beneficiaries. Because of this, IRA accounts that use a trust as a beneficiary may need to be re-examined to ensure that the language allows beneficiaries to minimize their tax liability.
Let me know if these topics are of interest and we’ll include them at our next financial planning meeting.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Cost effective implementation of Long Term Care insurance

Long Term Care (LTC) decisions form a critical part of all retirement plans. That said, we can’t properly address individual LTC needs until a retirement plan is designed and participants are able to quantify the aspect of Long Term Care they will fund. If LTC insurance is part of their ideal LTC plan then we must identify the best policy and the most cost effective way to pay for it. This article is intended to review LTC and layout how a business can help pay for LTC insurance in a cost effective manner.

(1) Long Term Care – a review
Long-term care (https://longtermcare.acl.gov) is a range of services and supports needed to meet personal care which is not included in healthcare. About 2/3 of the population will need LTC after age 65 (and 1/3 before 65). Of those reaching age 65, 70% will need LTC or assistance with activities important to life. LTC includes everything from social services, physical and emotional support, finances, housing, a myriad of legal decisions, family interaction and social dynamics. LTC should include all assistance with tasks that will allow for productive, engaged and enthusiastic daily life. It should include assistance with routine tasks such as housework, money management, taking medication, shopping, traveling, caring for pets, responding to emergencies (these are known as Instrumental ADLs) and NOT just the “basic” Activities of Daily Living (ADLs, such as assistance with bathing or eating).

Currently, 80% of all LTC needs provided in the home are supported by unpaid family, friends or neighbors. The average support needed in the home is about 20 hours per week. Fortunately, as services develop, we find an increase in community support services. These include adult care services, transportation services, and home care that is round the clock or as needed.

If you require or prefer the use of LTC services provided by an institution or facility you will need to investigate Assisted Living, board and care homes, or Continuing Care retirement communities, not just nursing homes.

(2) What is LTC insurance?
LTC insurance is a contract to pay premiums every year for care you may need in the future. It will pay out an agreed daily amount for your care only if you are unable to do a certain number of Activities of Daily Living (ADLs). These are the basic ADLs (includes bathing, eating and dressing). LTC insurance is not usually available if there are pre-existing conditions. Benefits are provided for a set number of years of care based on a daily dollar amount dependent on local costs and total maximum benefits (these are usually capped at around $350K). But how many years of LTC will be needed is unique to the individual, though we have past indications that males need at least 2 and females 4 years. Three years is the standard, but we know that 20% of those over 65 years will need ADL assistance for longer than 5 years. For these reasons we recommend this insurance purchase be made based on your retirement plan.

Naturally, LTC insurance premiums are less expensive for the young (and healthy) but starting early will cost more over time and is not advisable if your personal cash flow can’t support this expense throughout your life.

(3) Best ways to pay for LTC insurance
How do we pay for LTC insurance if we think it fits within our retirement plan? It should be clear that healthcare or Medicare (except for very short periods of time and only in specific emergency situations) do not cover LTC costs. On the other hand, Medicaid does cover LTC but has very strict requirements to qualify. If you are fortunate to qualify, LTC coverage is provided by the Older American Act (OAA) and Department of Veteran Affairs.

The most common way to pay for basic LTC needs is through insurance or out of the personal or family budget. Other ways include a reverse mortgage, annuities, other assets, and income from a dedicated source (such as rental income).

LTC insurance premium costs are based on your age, your location, your wishes for level and amount of care. The premiums are not usually a burden on a yearly basis but they take a toll over time. These premiums must remain in effect for life. Additionally, policy premiums today can increase by more than inflation (over the last year we’ve seen 18% to 90%[!] increases in premiums for existing policies).

Long Term Care Purchasing Options

There are at least 2 ways to pay for a new LTC insurance policy – as an individual or as a business. The advantage of an individual LTC insurance policy is that it is based on your needs and can be tailored to you. The advantage of a business LTC insurance plan is that it can be paid by the business and therefore tax deductible. If you are the business owner it can also be tailored to your wishes (see the chart below assembled by Aikapa).

LTC insurance premiums are supposed to be deductible but we find that most of our clients with high AGI (Adjusted Gross Income) and low medical expenses are not able to deduct their premiums on their annual IRS tax filings (Schedule A has a 10% AGI floor). In addition, the deduction is also limited to age specific maximums (see table below) regardless of actual cost for the purchased LTC insurance policy. To help you understand the implications I’ll outline at LTC insurance for three separate age scenarios (ages 55, 61, and 71):

Currently a basic 3-year policy with $150 benefit per day would have an annual premium of around $2,100 at age 55, $2,900 at age 61, and $6,900 at age 71 (quotes may differ given different assumptions and are likely to be lower for males and couples but may be higher or not available based on health history).

Long Term Care Deductible Limits

To help understand how tax deductions actually work if buying this insurance individually, I’ll use the three LTC examples outlined above: To allow for this comparison, I’ve assumed that the cost of the above three policies are the only tax deductible medical expense. This is important because the deductibility is dependent on exceeding a 10% floor based on AGI. Anyone with an AGI (i.e. number at the bottom of the first page of your 1040 IRS filing) of more than $60K would not be able to deduct their LTC premium under any of these scenarios unless there were other deductible medical expenses. Most of our clients that purchase an individual policy are not able to deduct premiums. In retirement deductible medical expenses rise and then some of these premiums are tax-deductible.

On the other hand, the same insurance policy purchased by a business provides tax deduction of LTC insurance premiums up to age limits and may even cover the entire premium (see below for details).

Sole Proprietors, Partnerships, S Corporations, and LLCs can provide owners and spouses with LTC premium tax-deductions that are only limited by age specific maximums (see above table – which shows that at a business can pay up to $1,530 for an owner’s (aged 51-60) LTC premium tax-free). If we look at the same three examples AND purchase the policy using one of these firms the tax deduction in 2017 for the 55 year old would be $1,530 (less than the cost for a base policy of $2,100), the 61 year old would have their premium fully paid tax-free (since their premium of $2,900 is less than the maximum limit of $4,090 for her age group), and the 71 year-old would pay no tax on $5,110 (though premium total was $6,900).

C Corporation and non-profits may cover LTC insurance premiums  for owners or members tax-free (without age limits mentioned above).

Using the same three examples AND having the C Corporation or the nonprofit pay for the premiums, then the entire LTC insurance premium for all age groups would be tax-free.

In summary, Long Term Care planning involves much more than just buying a LTC insurance policy. It encompasses consideration of a myriad of integrated services and support that should be aligned with your wishes both early and later in life. LTC insurance is one way to cover basic ADLs. Before making a purchase of LTC insurance you must have calculated what you wish to cover yourself and what will be paid for by insurance benefits. It is more cost effective if LTC insurance is provided by an employer (with no cost to you) and even better if you are the employer. As the employer you can design a policy that best fits your plan and offers tax-free premiums.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Two common estate planning failures

(1) Failing to plan for incapacity:

Only 33% of Americans have executed a medical directive (as found by the American Bar Association). AARP (American Association for Retired Persons) reports that 45% of Americans over the age of 50 have a durable power of attorney.

Legal documents to plan for incapacity include a power of attorney, a medical directive and a trust. Even though it is a good first step, a comprehensive estate plan requires these documents and more.

Media mogul Sumner Redstone had an estate estimated to be over $42B, but late in his life a series of conflicts began over his competence and the control of his estate. According to the granddaughter, “the aunt and other family members succeeded in reversing decades of my grandfather’s careful estate planning and poised themselves to seize control of Viacom and CBS.”

Naturally, we all have some expectation of what our life’s work will amount to. The legal system has documents that can be used to support our wishes if we are unable to make decisions, but who decides when we are not able to make them? As difficult and challenging as it is, we might want to consider what indicators we wish to use to trigger assistance. Otherwise, you could find yourself making a good many mistakes before anyone deploys these legal estate documents.

In one case, the California Court of Appeals ruled: “Appellant produced evidence of forgetfulness, erratic, unstable and emotional behavior, and of suspicion, probably delusional at times, on the part of the testatrix. This is of no avail unless it were shown, as it was not, that it had direct influence on the testamentary act.” In essence, the court is saying that the individual displaying these disturbing signs is still capable of making their own financial decisions. After all, we are all entitled to make poor decisions.

In a perfect world we would never have to deal with diminishing faculties or the thought that, at some point, someone else will have to make decisions for us. The truth is, most of us struggle with the timing and triggers that have to do with relinquishing our ability to self-direct or make our own decisions.

Estate planning begins with the basic documents, but effectively planning for incapacity entails much more.

(2) Dying without a will:

Dying without a will doesn’t impact the deceased, but signing a will does make it easier on those left behind. And yet, people who ought to know a whole lot better continue to die intestate (without a will). Famous examples include Abraham Lincoln. Lincoln was a successful and skilled attorney and yet he left an estate of $110,297 without a will. In more recent times, the entertainer, Prince, died without a will, leaving an estate of $300M. Though Prince’s sister and five half-siblings appear now to be the instate heirs, this would have turned out differently if not for DNA testing. Carlin Q claimed to be the “love child” of Prince and would have inherited the entire estate (!) had DNA testing not proven that he was not a biological offspring of Prince.

It is shocking that over 64% of Americans do not have a will. Yet a will is simple to create. Dying without a will means the estate will be handled by attorneys in front of a probate court. Dying intestate results in delays, higher fees and possible litigation. It surprises many that intestacy can create other messy dispositions based upon the order of death or age of those inheriting assets.

In many states, each child and the surviving spouse will inherit an equal percentage. If a trust is not established, a minor child may be entitled to receive inherited assets by age 18. Ex-spouses may have control of the inheritance until the child reaches adulthood.
In some states, if a married couple with no descendants (children) and no wills are injured in the same accident and one spouse dies prior to the other even by a few minutes the outcome will be that only one spouse’s descendants will inherit the couple’s joint estate and the other spouse’s family will receive no assets. In California, Alaska, Kentucky, Texas, and Wisconsin the state requires that the spouse must outlive the other by more than 120 hours, not just a few minutes, for the assets to pass to the ‘surviving spouse’ and skip the first-to-die family.

Some famous examples include musician, songwriter and poet,  Kurt Cobain, who left a detailed suicide note but didn’t sign a will. As it happened, his wife and daughter were his only heirs and the estate was split in half. Martin Luther King Jr. died without a will leaving his children in a long fight over the estate.

So how does the state decide who manages the assets for under-age children when there is no will? Current state statutes set an order of appointment with the surviving spouse normally being the first person, followed by the closest BLOOD family members. This is determined by relationship, not competence. Think about it. Do you really want anyone to manage the estate for your loved ones just because they are your closest blood relative?

Prince’s estate is an example of how much of his legacy will be wasted as six different heirs without knowledge or competence in the music field are now fighting over how to handle his vast music empire and unreleased songs. Of course, he is gone so at least he doesn’t have to worry about it, BUT his fans will be affected.

Finally, the wishes of the deceased may not be respected without a will. NFL player Steve McNair purchased a million dollar home for his mother to live in, but he retained title to the home. On his death, his wife demanded that the mother pay rent and when she couldn’t, she had to move out! It would have been so simple for McNair to provide a written will stating that his mother could keep the home when he was gone.

Estate planning is a significant part of your overall financial picture. We’ve reserved the month of June to review beneficiaries on your accounts and to encourage you to review your wishes for your estate plan. Our priority in estate planning is to ensure that you are comfortable with the basic estate planning documents (DPOA, will and trust) that will protect you and your family to a very large degree in the event of your incapacity or death.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Death and sepulcher – facing the inevitable

Benjamin Franklin famously wrote, “in this world nothing can be said to be certain, except death and taxes.” In all the years that I’ve worked with clients to create a financial path for their long-term wishes in life and after they are gone, I’ve covered a huge spectrum of topics. Until now, I’ve never asked clients about their “right of sepulcher” (the right of sepulcher means the right to choose and control the burial, cremation, or other final disposition of a deceased person). I recognize that, for some, this topic may seem a tad morbid. The cautionary tales of contentious and messy celebrity funerals that follow (suggested by Amy F. Altman, an associate at Meltzer, Lippe, Goldstein and Breitstone) may provide you with some perspective and may help you consider how you and your loved ones feel about your right of sepulcher.

  • Litigation surrounding the 2007 death of actor, model and TV personality Anna Nicole Smith made headline news for weeks as her mother and the guardian of her infant daughter battled for the right of sepulcher. Ultimately, the daughter’s guardian prevailed and Anna was buried in the Bahamas next to her late (and recently deceased) son.
  • Boston Red Sox Hall of Famer Ted Williams’ death in 2002 resulted in a spectacular rift between his children over the disposition of his remains. His eldest daughter argued that Williams’ will clearly stipulated cremation, BUT his son had been given power of attorney and his father’s health proxy and he wanted his father cryogenically preserved. Eventually, the son won out, largely because the daughter could not afford the cost of litigation.
  • Legendary actor Mickey Rooney died in 2014. His estranged wife wanted him buried in a shared plot purchased before they had separated. Rooney’s conservator (court appointed guardian) had other ideas and a costly tug-of-war ensued. In the end, his wife capitulated, recognizing that burial in a Hollywood cemetery befitting Rooney’s status was appropriate.

These cases, regardless of age, underscore the importance and value of discussing with loved ones your preferences for disposition. The laws regarding rights of sepulcher vary widely by state. If permitted under state law, completing a “disposition of remains form” together with advanced directives seems an appropriate start. This will create clarity with respect to the sensitive issues surrounding burial.

As with all legal documents you need to first understand what it is that you really want, which can take a long time to fully grasp and may require delicate discussions with loved ones and personal introspection. Leaving aside what I consider the more important question regarding life support for now, you can first deal with the question, do you want to be cremated, or perhaps cryogenically preserved? Do you want to be an organ donor? Would you like your funeral to take place at home or at a funeral parlor? Do you want a formal service or commemorative event? Though you’ll be gone, these are all options that may well prove to be important (and costly if mishandled) to those you leave behind.

At times, I think that there is so much to do while we are alive that taking time to consider what will happen after we’re gone seems inconsequential and entirely unimportant, but this may not be the case for loved ones. Let me offer an example.

Recently, a client shared that over the course of a dinner conversation with his parents they casually revealed their preference to be cremated. This came as an enormous shock. “Never in a million years,” he said, “would I have predicted that this was my parents actual wish.” This is a man who has made every effort to ensure he is in touch with the real wishes of his aging parents. “I would have got it wrong,” he said, adding “a split second’s worth of conversation set me straight.” He felt like a huge weight was lifted from his shoulders.

The person to whom you give the right of sepulcher may gain much by having even a short conversation about your wishes, regardless of your age.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Understanding Longevity Risk and Your Retirement

The oldest person alive today is Emma Morano of Vercelli, Italy who turned 117 this November. She was born in 1899! Queen Victoria was still on the throne of England and William McKinley was president of the United States. If you’d asked Emma in 1917 if she could imagine living long enough to see 2017, would she have imagined such a long life? Most Americans do not live as long as Emma, but in general we are living longer and healthier lives. The number of centenarians is on the rise. Longevity – long life – can have obvious perks, but also poses a conundrum in terms of finances. To help us plan for longevity we use “longevity risk” to measure the likelihood that you’ll run out of wealth before you’ll run out of life. In our planning we like to ensure that we mindfully set longevity at the right level for each person.

Few, if any of us, have advance knowledge of precisely when our time will come, so questions like this often boil down to statistics. You’ll sometimes hear that the average life expectancy for females is age 83 and age 81 for males, BUT are these appropriate target-end dates for your retirement plan? The truly important challenge is coming up with the best end-dates for retirement that will allow you to enjoy your wealth early while leaving enough assets to comfortably support you later in life.

In retirement planning, the variation in life expectancy can range quite dramatically and yet we find that client expectations generally fall into two categories, (1) those who want to make absolutely sure they don’t outlive their wealth, and (2) those who have a definite expiration date in mind, say 80 years of age, and believe that planning for life beyond that age is simply not relevant or realistic. The latter are often operating on some assumption based on, for example, both parents dying in their late 70s or not long after retirement.

At the risk of sounding morbid, but with the goal of having your retirement plan more fully represent your expected end of life target date, I want you to consider three facts that most often cause people to underestimate their longevity (in turn, this may help you understand why we sometimes encourage you to increase your target-end date):

Life expectancies that are often quoted may not be relevant since they are often calculated at birth. Life expectancy on reaching age 60 or 65 should be much higher than those quoted at birth since some will die before they reach this age. In fact, life expectancy for a 65-year-old, non-smoker is much higher. As an example, a 65-year-old female of average health has a 50% chance of reaching age 88 (see the table below) but once she reaches age 88 she has a much higher chance of reaching age 95.

longetvity_table

  1. Life expectancy is often calculated using mortality rates from a fixed year instead of projected to future expected mortality rates. Social Security Administration (SSA)’s period life tables are based on real mortalities in any given year. Though valuable, since they are real, they underestimate the observed trend for increased survival. As mentioned above, we perceive our survival based on our own anecdotal experiences. The question to ask ourselves, is this correct or is this an underestimation?
  2. Finally, we find that the population on which longevity risk calculations are based may not be appropriate. If we work with an aggregate US population life expectancy (as does the SSA period life tables) we must include a correction for socioeconomic and other factors that are known to impact mortality rates and could underestimate our lifespans. To-date there is evidence to indicate a positive link between income, education, long-term planning, and health. Yes, someone who plans and prepares appears (statistically) to live longer.

In case it is still not clear – let me explain. When planning retirement projections, the length of retirement greatly impacts planning choices (planning for 20 versus 45 years may require different strategies given the same wealth). Considering your specific longevity risk necessitates that we prepare for the contingencies that apply to you. There may be good reasons to target a lower longevity, but for most we will likely need to include, at the very least, a reasonable adjustment for expected increased longevity. This often means distribution of existing assets and thinking about end-of-life questions (a topic most prefer not to address too closely). If you are expecting a longer life, consider accumulating a pool of longevity assets (like some are doing to cover for potential Long-Term Care contingency) or purchasing a longevity annuity (this asset would only be used if you live past a certain age and, therefore, accumulate what are called mortality credits that can provide a good income late in life, but would be lost if you wind up passing sooner).

Obviously, estimations are just that, estimations. Still, a thoughtful scientific approach ought to be the foundation for retirement projections, never speculation or conjecture. Like Emma, some of us will be blessed with a long life, even inadvertently. One way or the other, I want all of us to feel that we’ve had a life well spent, and that will depend largely on how well we’ve planned for possible contingencies in your life.

This educational piece was drawn from my work with clients, www.longevityillustrator.org, the Social Security Administration period life tables, and a recent academic publication by Wade D. Pfau, Ph.D., published in The Journal of Financial Planning, November 2016, vol 29, issue 11, pp 40.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com