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

‘Burn rate’ should be key to retirement savings

People often talk about “saving for retirement.” Few question the need to put aside adequate savings to ensure the successful funding of their retirement plan. The operative word though is “adequate.” How much in the way of savings is “adequate”? Of course, it differs from individual to individual, but you will most likely find that spending is the common variable that shapes the limits of what constitutes adequate savings. With few exceptions, our spending needs in retirement will exceed the amount provided by our inflation adjusted social security benefit. Everything else being equal, the success or failure of any effort to fund retirement is above all dependent on lifestyle and spending habits or ‘burn rate’.

To help you visualize “the power of spending” and its impact on a retirement portfolio, I’ve created four basic retirement funding scenarios. These scenarios assume the same retirement period (beginning 2017 and ending 28 years later), an annual social security benefit of $40K (adjusted for inflation), and a $1M diversified portfolio with a rate of return of 5.5%. The only varying parameter between scenarios is the amount of spending each year with associated tax liability. Each scenario was created using 500 cycles of Monte Carlo probability simulations that modify every parameter except length of retirement to address a range of economic variables and unexpected expenses. The charts include only four (out of 500) projection lines from “best case” to “worst case”.

For the first scenario, our hypothetical client spends $50K/year (before tax), having accumulated $1M at the point that she is ready to retire in 2017. As the chart demonstrates, for the best possible outcome the $50K annual spending client actually grows her nest egg to $1.4M over 28 years (this is the blue line or highest line at year 2045) ― leaving, I should add, a sizable chunk of change for a life beyond 28 years, long term care needs, or for her legacy (be it a favorite charity or her grandchildren). If all economic variables are worse than expected and things don’t quite pan out, she can still expect $250K in assets (see the gray line or lowest line at 2045) after enjoying 28 years in retirement. Not too shabby!

But what if our hypothetical client was in the habit of spending about $75K/year (before tax) instead of $50K? (again, assuming she starts her retirement in 2017 with a $1M portfolio). In this situation, assuming everything goes better than expected the Monte Carlo simulations show a surplus of over $1M after 28 years, BUT in a worst-case scenario the portfolio is depleted after 20 years (around 2037) ― enough to make a financial planner seek ways to protect against the worst-case scenario.

Approaching the Bay Area experience is a hypothetical client who spends $100K/year (before tax). What then? The $1M portfolio would not last her beyond 21 years (2038) even in the best scenario. Unfortunately, there is a higher probability that it will be gone after 15 years (2031). While the worst-case simulation shows that the portfolio could be depleted in as little as 10 or 11 years (2028).

Though there are many other possible spending targets (and also more parameters to consider than those in these scenarios), our final hypothetical client spends $150K/year (before tax) to maintain her lifestyle. In which case, the $1M portfolio would last 9 years tops (2026) and could well be depleted within 5 years (2022).

The story told by the 4 charts is very clear. Saving and spending levels must be aligned for a successful retirement strategy. Clearly, accumulated assets alone are not in and of themselves indicative of success over the long-haul. On the other hand, spending habits and your ability to adhere to a budget are very useful indicators. They can provide a realistic view of your retirement “burn rate” and better align your savings today with future need.

Think of it this way, your approach to spending and your connection to buying are formed throughout your life. It becomes an unshakable habit. For this reason, spending seldom decreases in retirement except with a great deal of stress, anxiety, and depression. To avoid this unhappy outcome, the smartest and healthiest action is to establish a realistic budget for the lifestyle that you seek, then plan your savings around the cost to sustain that lifestyle. The goal of your retirement savings would be to build enough wealth to support your lifestyle.

Though planning for retirement includes more than your burn rate and savings rate they are critical beginnings. What I like best is that these are aspects of retirement planning that we can control.

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

Retirement Income Planning – Spend early or make it last?

During our working years we plan for retirement or financial independence in part by saving maximally and investing in assets that are likely to appreciate.  While we are working and saving for retirement we are in the accumulation phase. As we approach retirement (within about 5 years) we continue accumulating assets and begin the process of distributing those assets to sustain our chosen lifestyle throughout retirement. When we use an income stream from our assets we have entered the distribution phase.

During the accumulation phase we all focus on portfolio returns and tolerate some volatility. We can weather market fluctuations and lack of liquidity since we are not dependent on the portfolio and have our earnings to support our lifestyle. The main objective is to pay required taxes, support our lifestyle, save, and establish a life that encourages us to flourish.

As we approach the time when our assets alone will be used to support our lives, it becomes essential that we address the nuances of how the assets will be deployed – this is termed Retirement Income Planning.

Retirement Income Planning addresses in a pro-active manner how to create a stream of income for our remaining days (using accumulated assets) once our income from work no longer fully supports our lifestyle. Since the retirement time horizon is unknown, we must marry wishes for early retirement or plans for having larger income distributions with having assets last through an unknowable lifespan.

Running out of money is never an option in retirement but leaving money behind is also not acceptable, if it limits your lifestyle. This balance becomes a challenge as lifespans extend and health preservation becomes more successful and expensive. The latest survey shows that couples aged 65 have more than half probability (56%) of at least one spouse living to age 92. Despite these findings many feel they will not live past 80 and yet, if healthy and productive, they might feel very differently once they reach 90. Planning effectively for longevity is essential and must be weighed against the benefits of early spending.

For Retirement Income Planning, we also need to manage tax liability since we want to be sure that assets last as long as possible, particularly tax-deferred assets that are taxed at ordinary tax rates on withdrawal.

A market downturn can more greatly impact a portfolio early in retirement or just before the distribution phase. In retirement, unlike in the accumulation phase, it is much more difficult for the portfolio to recover from a market downturn. A robust retirement income plan must include ways to deliver the needed income regardless of market behavior.

The new reverse mortgages are income distribution tools that retirees can use to access home equity as part of a retirement income plan. For some, they provide at least three advantages early in retirement: reduced tax liability, longer investment time for the portfolio, and enjoyment of their home until retirees are ready to downsize.

For all retirees preserving their purchasing power (not just preserving the dollar amount) is an essential part of an income plan. Failure to include inflation protection is evident when retirees hold little to no significant equity portfolio and the consequences are dire. Though annuity and pensions are useful income distribution tools they fail unless combined with a strategy that protects against inflation. Sustaining purchasing power is even more significant when considering healthcare expenses. Keep in mind that healthcare costs grow due to inflation and also as a percent of annual spending as we age.

Scenarios that use all available tools to address how to best deploy retirement income will provide each retiring person with confidence to spend early and throughout retirement without fear of outlasting their assets.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Should you be a landlord in retirement?

As you would expect, we often think about ways to supplement client retirement income and diversify a client’s finances beyond their market portfolio.

Owning one or more rental properties (commercial real estate) can provide a steady source of income and cash flow during retirement, with the added advantage of building owner equity (owner wealth). Once established, rental properties can also be a great resource to meet both planned and unexpected life events. And since they can be depreciated on your income tax, rental properties can provide a significant tax advantage while the asset actually gains in value. All this said, owning a rental property, let alone more than one, is not for the faint of heart. Without regular attention and constant re-appraisal, they can become a major headache and a huge liability.

The path to becoming a commercial real estate investor (a fancy way of saying “landlord”) often begins, innocently enough, with owning a single family home and then, for whatever reason, deciding to convert it to a rental. In this case, the property may need to be adapted in some fashion to accommodate renters. Others will approach a real estate agent with the deliberate intention of purchasing a rental property, in which case the property may be “turn key,” requiring little, if any, alteration. Whichever way you start out, the following are just some of the things you need to take into account before you commit to becoming a landlord in your golden years.

Commercial real estate requires at least 20%-30% down payment and an ongoing source of cash flow to fund expected and unexpected expenses. This means your equity will be locked in your property and only available through the available cash flow stream.

Real estate can be a great addition to an investment strategy, but rarely prudent as a sole investment. Unlike your portfolio, which will have fixed expenses, be liquid and globally diversified, your real estate will be impacted by local conditions with unexpected expenses and periods of poor liquidity. Expenses that are predictable include mortgage, taxes, landlord-specific insurance policies (both property and liability). Less predictable expenses are maintenance and repair costs as well as tenant related expenses. For those in control of their family cash flow, it is this difference that makes rentals a good consideration as a secondary investment and as part of their financial plan.

Like all investments it takes time and due diligence to generate a stable positive cash flow from rental properties – luck alone will not suffice. The price you set for rent is all important as are the expenses you incur. You need to be sure to cover your operating expenses which can include mortgage, property tax, insurance, maintenance, bookkeeping and accounting fees, utilities and if you use a management company you must also include their fee. In addition, the rent must provide you with a reasonable return based on cash flow, not just property appreciation, since you can’t sell the property to pay for ongoing expenses. The property must remain competitive with the local rental market and your cash flow able to cover expenses that may not be deductible in the year they are spent (a roof is an example of an expense that is depreciated and not deductible).

In addition to the financial considerations cited above, you will have legal obligations that are based on local laws and regulations pertaining to rental housing. A broken water pipe, furnace or refrigerator? Round-the-clock availability for emergencies is your responsibility. You can, of course, assign or pay for someone to take care of such things, but the legal responsibility will still be yours (always have sufficient liability and property replacement insurance). You are likely to be held liable for tenant or visitor injuries if due to unsafe conditions, especially in the common areas. Safety and habitability is paramount. On a regular basis, you must make sure structural elements are safe, the electrical, potable and wastewater infrastructure is sound, that trash containers are provided, that any known or potential toxins (such as mold or asbestos) are properly managed, that rodents or other vermin are kept clear off the premises.

However you come by your rental property, you will have to choose whether you should be your own property manager (directly overseeing and paying for maintenance yourself) or to take a more arms-length approach by contracting with a property management firm. Some clients hand these tasks to a family member who wishes to work part-time while others hand it over to a professional. A property manager can help those who wish to limit their day-to-day responsibilities, especially if you aren’t the handy sort or aren’t physically up to the task, but then you will have to cover the additional expense. Property managers, in simple terms, are hired to find tenants, maintain the property, create budgets, and collect rents. You will want to hire someone who knows about advertising, marketing, tenant relationships, collecting rent, maintenance, plus local and state laws in the location that you have the property. As the property owner, you can be held liable for the acts of your manager. It’s prudent, therefore, to hold the rental property in an entity that can provide some legal protection. Costs for contracting a property manager will usually run about 8% of rental income for management and about the same for engaging new tenants—this can eliminate your profit but if properly priced will provide you with a sustainable model well into retirement.

Finding reliable tenants is always a challenge, even if you employ a property manager. Tenants need to be able to pay their monthly rent, keep the property in good condition, and follow policies in the lease or rental agreement. You’ll find it easier to find good tenants if you select a property in an area experiencing low vacancies and high demand. Unfortunately, this means the property will also cost you more.

You should be prepared to have to deal with (or have someone deal with) evictions, wear and tear on your investment, unauthorized sub-lets, termination without proper notice, smoking, illicit drugs, pet odor and damage, parking and waste management issues, advertising, noise (including sometimes difficult neighbor relations), and other eventualities. Or, you can get lucky and find perfect long-term tenants! Realistically, as you age these tasks may become too stressful, eventually requiring you to hire a property management company or engage a (younger) interested and motivated loved one to take on this role. Either way, you must put this in writing as part of your purchase plan—including when you want this to happen, who this person should be, and finally, when the property should be sold.

During retirement some will love the ability to work part-time at managing their properties (even if only in a limited manner) whereas others will find it too complicated for their ideal retirement life. Invariably a well-managed property can generate ongoing income and create owner equity that will be a godsend in retirement or as an alternative to your market portfolio. Unfortunately for some, the process can become too complicated and stressful. So much so, that they avoid the tough decisions and derail their entire retirement plan. Being a landlord is very much an individual decision.

The bottom line is that rental property cash flow can generate a stable income during retirement, and can provide needed equity to fund contingency plans (such as disability, long-term care, health care needs, legacy) but profiting requires planning and annual review. It is a business that needs your ongoing attention or it will become a major liability. Even with the help of a property management firm, you may wonder in what way you can really consider yourself “retired” owning and managing rental properties.

Like any other financial investment, do your homework, and moreover, make sure it fits with your long-term financial goals and vision for a rewarding life.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Medicare—Surprising facts and critical changes

The goal in retirement (or financial independence after age 65) is to be able to support our lifestyle using accumulated assets, Social Security and Medicare. It has become evident that Social Security and Medicare had to change to continue to sustain future retirees. The loss of the Social Security ‘file and suspend’ strategy for anyone who is not 66 by the end of April, 2016 has received a lot of media attention. Yet, major changes in Medicare have garnered much less publicity although no less important to retirement planning.

From our retirement planning vantage point, we believe the new Medicare changes will add a significant wrinkle to what is a already a very fine balance between distributions from portfolios, income tax liability, and funding our client’s ideal retirement lifestyle.

This short educational article outlines a few surprising (even shocking) facts that everyone should know about Medicare. For more details (particularly those approaching 63 or are two years from switching to Medicare from employer plans), I recommend that you read, in detail, the annually released official US Government Medicare Handbook. The 2016 version of this booklet is available at https://www.Medicare.gov/pubs/pdf/10050.pdf

  • Medicare Alphabet Soup (A, B, C, D) are not all free – The 2.9% current premium paid to Medicare on your earnings while employed only provides for free Medicare Part A coverage. Part A only covers hospital insurance, not comprehensive health insurance. Medicare Part A participation, however, does provide access to the other Parts that, when taken together, can constitute a comprehensive health insurance plan able to meet specific needs. Part B is basic medical insurance. When combined with Part A it is termed “Original Medicare.” A and B combined isn’t enough to cover everything you’ll need. Part D is a premium paid for drug insurance. It is incredibly complex as specific drugs fall in and out of favor within each plan. On the other hand, Part C is an integrated health plan that usually includes Part A, B, and D. It is often called “Medicare Advantage.” Finally, you may encounter Medigap coverage (which has its own alphabet soup) to cover areas missed by Medicare A, B, C or D.
  • Basic Costs: Average costs are difficult to estimate and are often not as low as many expect. Part B would seem very well priced at less than $1,500 per year and yet in the real world we seldom find these ideal rates. Instead, we find health insurance through Medicare averages around $4K-6K per person per year. Moreover, rates are expected to rise significantly in 2018 because of surcharges.
  • Enrollment in Medicare is not all automatic and requires strict attention to timelines. Timelines appear long (for example, 7 months for the initial enrollment) but to avoid penalties and loss of coverage you will need to act early in the timelines (most wait until their birthday month and may find that they have a gap in insurance coverage even though they make the enrollment timeline). To avoid penalties, initial enrollment into Medicare is 3 months before your birthday month and extends to three months after. If you have approved coverage (for example, from an employer health plan) and need to transition to Medicare you will have a “Special Enrollment Period” with its own timelines that must be initiated prior to leaving your employer approved health coverage (excluding COBRA).
  • There are hefty penalties that stay with you for life if you miss an enrollment timeline – Penalties for missing enrollment timelines into Part B are currently an additional 10% of your normal premium cost for every 12 months delayed. Part D penalties are 1% per month delayed. These penalties continue throughout your enrolled life, meaning that you’ll pay more for the same coverage. For example, if you enroll 3 years later than required, the premium you pay for the same Medicare Part B coverage is 30% higher. If you also missed enrolling in Part D, the premium is 36% higher.
  • Once you enroll in Medicare you can no longer make H.S.A. contributions. Once you begin collecting Social Security you are required to enroll in Medicare Part A, which eliminates your ability to participate in certain plan features. For example, it disallows the annual tax-free H.S.A. contributions.
  • There is free personalized health insurance counseling. You should use it to design the best plan for yourself and to fully understand what you need to do each year to make the most of the health care plan you chose (given your expected annual health care needs). In addition, work closely with your Wealth Manager to ensure that you distribute your wealth in the least costly manner given your lifestyle and available assets.
  • Not all health insurance plans are available in all locations. When planning your Medicare health plan, use the community you are planning to retire into to get the most accurate list of health plans available. There is also a 5-Star rating website, provided by Medicare, to help you choose the best available plan in your area.
  • Since 2007 Medicare has been MEANS tested (i.e., dependent on income). Additional income-based premiums can come as a surprise, but what is perhaps more shocking are the new income limits that will begin in 2018. For the moment, surcharges to Medicare premiums begin at $85K and $170K MAGI (Modified Adjusted Gross Income for those filing as single or married filing jointly). Currently, the surcharges top out at $390/month or $4,700/year for Part B for those with MAGI greater than $214K and $428K (single versus married filings). Separate surcharges apply for other Parts. But take note—starting in 2018, the surcharges will apply to a lower MAGI. The largest surcharges will be for those with MAGI over $160K and $320K. An additional surprise is that the earnings that will be used to calculate your Medicare Premium surcharge (also known as the annual “Income Related Monthly Adjustment Amounts” or IRMAA) will be based on your income tax filing from two years earlier. For example, if you enroll in Medicare in 2018 they will use your 2016 taxes to estimate your IRMAA (there is a process to appeal surcharges).
  • The income included in determining additional premiums is based on your adjusted income PLUS any tax-free income (such as Muni bond interest) – MAGI (in these scenarios) includes all ordinary income (work earnings, pre-tax withdrawals, pensions, etc.), plus 50% of Social Security collected, plus tax exempt interest. It doesn’t include H.S.A. or Roth distributions or loan proceeds. Annual distribution will now need to be tightly connected to your MAGI.
  • A “cost of living” gift from the ‘Hold Harmless’ rule – For some, the “Hold Harmless” rule provides additional premium savings. This benefits those who have their Medicare Part B deducted directly from their social security. This rule prohibits increases in Medicare Part B premiums when there is no similar increase in Social Security benefits. The ‘Hold Harmless’ rule evaporates for anyone not deducting their premiums from Social Security, or if they pay additional premium surcharges (because of income limits), or if it is their first year in Medicare (plus a few other exceptions).

These changes to Medicare (and likely new changes in the future) will make it essential that your accumulated wealth be deployed in a manner that will allow you to have the necessary cash flow for your chosen lifestyle while maximizing the various MEANS adjusted benefits.

It has always been our recommendation that clients have more than just pre-tax savings, Social Security, and a pension to support their retirement distribution. Going forward, Roth and H.S.A. savings will unquestionably become even more powerful adjunct retirement planning tools since they are tax free and not part of Medicare MAGI Means testing.

Know the facts about Medicare. An educated consumer is better equipped to make sound choices leading up to retirement and much more likely to secure the retirement lifestyle they have in mind.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

The skateboard champion and other stories

As a way to put money away and save on taxes we often think of retirement accounts for the self-employed that include a simplified employee pension plan (SEP), an individual 401K-profit sharing plan (401K-PSP), or Defined Benefit (DB) plan. DB plans are the least used and yet the most powerful at reducing tax liability and quickly increasing your tax-deferred savings. To illustrate how DB plans can be used, I want to share with you how creative individuals were able to leverage their DB plan to save maximally and retire early.

  • The Skateboard Champion – A 30-year-old skateboarder plans ahead and saves $130K per year from winnings and endorsements. He will have saved $2.6M by the time he turns 50 (without considering any market growth).
  • The Lobster Fisherman – A 61-year-old fisherman from Maine pays himself $35K in payroll from his C Corporation and saves $60K per year for the last five years before retiring. His reward: an estimated $300K in accumulated additional savings for his retirement.
  • The Clothing Store Sales Rep – At 57 years of age the rep contributes $150K per year for herself and $12K for her young assistant until retirement at age 65. She accumulates another $1.2M not including growth.
  • The Lobbyist from Virginia – Beginning at age 48, the lobbyist contributes $145K/year for 7 years saving just over $1M by age 55.
  • The University Professor & Guest Speaker – Starting at age 54, the Prof contributes $42K per year from guest speaking engagements. He does this for 12 years and adds $502K in savings (excluding growth) to his already substantial university benefit plans.

DB plans provide the highest contribution amounts particularly when combined with a 401K. To take full advantage of this type of plan, a business must have sufficient profit and cash flow. DB plans, like a 401k, must be established in the same year and have specific requirements including annual tax filings. DB plans are not limited by the fixed maximum contribution found in SEP or 401K plans but instead are based on age, payroll and future benefit. This year, the maximum annual future benefit is up to $210K (this can amount to substantially more than a $210K contribution in any one year).

If you have a side business or are starting your own full time business consider the DB plan. Even though these are powerful, the best type of retirement savings plan for you is dependent on your business’ current and projected cash flow. As you can tell from the stories above, a well-designed DB Plan is not just for those over 50 or those with large earnings. It can be a very smart way to defer taxes today and provide for your lifestyle in the future.

Defined Benefit plans are not appropriate for everyone but I’ve seen them work for so many different people in unexpected situations that I thought I’d share some success stories with you.

Identifying Your “Retirement Paradise”

For most of our clients their ideal retirement location or “Retirement Paradise” is in the Bay Area (or other high cost areas), near family and friends and a stimulating environment, but high taxes and the cost of living cause many to re-evaluate.
For those choosing to remain in the Bay Area, the purchase of a smaller home (downsizing) is often used as a way to reduce expenses or to make their home better suited for independent at-home aging.  To remain in the Bay Area (or other high cost areas) retirement saving goals must be very aggressive and fully funded to support the same lifestyle during retirement.

Some consider moving to lower cost US states and even overseas. The idea of downsizing away from California (or your home state), as a way to reduce expenses and bolster available retirement funds may not be as easy as selecting the lowest tax or lowest cost location.  Keeping in mind that retirement is not one uniform event, but a series of phases, let’s cover a few of the financial implications.

Relocating may indeed reduce some costs, but there are ramifications that are often overlooked.  For example, moving away from higher cost areas can reduce income taxes, but this may not offset the increased cost of travel, other taxes (such as real estate), services, and costs associated with changes to lifestyle.

We suggest that you give the town, state or country that you intend to relocate to a try for extended periods of time and at various seasons of the year with an eye toward evaluating how you will spend your retirement and what costs will be incurred. How does it feel to revisit the same place over several years? Can you see yourself developing the supporting network you’ll need as you grow older? How will your budget be changed?

Don’t underestimate the value of a community that can provide stimulating events that you would be interested in attending (the opera, symphony, music, college courses).  What about your family and friends? Will you want to be close to them while you age? What healthcare do you need and how does your future community support it?  Some areas have low taxes, but do they provide the services that you’ll need as you age?

If you enjoy particular hobbies, you’ll probably want to check out the ease of access to your interests, but don’t neglect other priorities such as transportation and communication. As you age, travel becomes more difficult, especially if you develop special needs. Give thought to public transit and convenience to major airports or rail lines. In our experience, clients will deliberately choose a populated community to move to (later in retirement) with well developed public transit.  Access to quality internet is also your lifeline to friends and family and to future independence.

Some states do not tax retiree income and some states provide extensive retiree services. Look to see which location provides benefits that you will need. Often states that do not tax an individual’s income have higher sales and property taxes, so you must do the numbers. Be mindful of Medigap policy costs and Medicare Part D (drug coverage) in your potential retirement paradise. Premiums can be lower in areas that have a lower cost of living or more retirees. The prohibitively high cost for healthcare and lack of services in some counties will likely surprise you.

It may seem a little pre-mature, but you should give some thought and consideration during the process of making your first retirement move to the possibility of a later move in life to be near loved ones or to an assisted-living facility. As we age, the process of moving becomes more challenging – though early in retirement it can be very exciting. You’ll find this stress can be reduced or avoided with some early planning and coordination.

A few words now about moving to a foreign country for some or all of your retirement years.  It is likely that you can find countries with a lower cost of living than the US and where you can maintain or enlarge your lifestyle, but you’d be well advised to examine this option over several extended trips.  If you are planning to remain abroad through only part of your retirement, you will need to determine how to fund your eventual return, or else how you will handle all retirement phases if you intend to remain permanently out-of-country.

All US “persons” (that’s the legal term for anyone deemed subject to US taxation authority) must file taxes annually. Typically the US has a treaty with other countries so that your earnings will not be double taxed, but most retirees do not work so double taxation is not a large concern. There are rules on what is or is not taxable to you as a resident of the foreign country and what is payable to the IRS. Consider that you will have to pay taxes on all pre-tax accounts, social security, pensions even while living overseas but you will likely avoid state tax. As a US person, you will have annual administrative financial filings (known as FBAR) while not residing in the US.  Healthcare is often an issue later in retirement (Medicare does NOT cover foreign health care costs) unless you verify that the services and specialties needed as you age are easily available in your new home.  Finally, currency differences will provide you with more purchasing power while the dollar is high. However, when the dollar drops, there may be a need to return to the US or find some other way to make up the shortfall.  These contingencies need to be planned for early so that you’ll have a framework regarding your choices later in retirement.

When planning for your retirement paradise, bear in mind the most important principle—to think beyond today and prepare as best you can for contingencies throughout all phases in retirement. As always, we’re here to listen and to help outline the implications of your choices for the various stages of retirement. Working together, we can examine financially realistic options so that you can make the best choices today while preparing for the realities of your “Retirement Paradise”.

Retirement Portfolio Distribution – vital considerations

Not sure when and how to start dipping into your hard-earned retirement funds? It’s a BIG consideration with BIG implications. How might you withdraw your money without worry that you’ll outlive your portfolio?

You could use a generic retirement distribution model that targets a 4% withdrawal from your portfolio (if portfolio is allocated at 60/40 equities/bonds). This generic model focuses on not outliving your assets and often leaves much to be desired in terms of maximizing how you distribute your portfolio efficiently. This is where a retirement distribution plan is absolutely vital since it will outline the amount that you need to meet your specific needs each year, the impact on taxes and on your ability to not outlive your portfolio (particularly important 5-10 years to retirement).

Many studies demonstrate that creating a portfolio withdrawal plan that more closely fits your needs in early retirement while providing for your wishes later in retirement leads to a successful retirement. Of course, retirement planning first requires that you’ve accumulated enough assets to support your lifestyle for the length of your potential retirement. It should also allow for unexpected obstacles and other goals.

You may find after discussions that your retirement of choice might be much different than a standard generic model. In some cases, it is in your best interests to keep working even part-time into your “retirement.” This is becoming more and more the case (so don’t feel alone if it comes to that) even if you have enough assets to support full retirement.

A recent study by T. Rowe Price revealed that 22% of recent retirees have rejoined the workforce at least part-time and of these 18% are earning as much as they were earning prior to retirement. Of course others have chosen to adjust their budgets to extend the life of their portfolio and are living on 67% of pre-retirement incomes rather than returning to employment. The study found that retirees are covering their early retirement expenses from the following sources: 18% from pension plans, 42% from social security and 17% from tax-advantaged accounts.

The latest methods for funding retirement are much more specific to your individual situation than a flat 4% withdrawal. When working together (5-6 years to retirement) we’ll formulate your distribution plan through retirement. This would include how your portfolio will be allowed to recover from any potential market decline and how it provides for your wishes during the 30-40 years in retirement. As retirement approaches (or whenever you make the request) we will outline the latest successful approaches to asset distribution for your situation – we want to be sure that you don’t unnecessarily skimp through early retirement or outlive your portfolio later in life.

A formal retirement distribution plan should include a review of alternative income streams, a financial breakdown of at least the first 3 years of retirement, an overall budget for those years, including expected distribution and social security. This is when the value of having different cash flow streams becomes obvious. Taxable accounts, tax free, pension/social security, annuities, and tax-deferred are the usual assets considered in all retirement distribution plans.

By setting the finances for the first years in retirement, you can plan for the potential of a market downturn and also the possibility of allocating more during the first 10 years of retirement if you so wish. Most often, families want to spend their first 10 years traveling or hosting family events as a way of enjoying their most active phase of retirement.

The most obvious danger of ad-hoc or unplanned withdrawals from a portfolio is that the account balance dwindles faster than any return can support. By funding non-budget needs, the portfolio may no longer be able to fund the necessary budget items that are important in that client’s lifetime. To succeed, this requires open communication with our clients, their trust in our work, and their discipline to rein-in non-budget expenses.

Retirement can last 30-40 years and can exhaust any portfolio without a distribution plan. Outside of retirement, your other goals may or may not need a separate distribution plan (we do one for college plans and home purchase too). Speak to your advisor if you are in any way uncertain about how or when to tap into any of your portfolio savings.

Retirement – Vocation, Vacation or A bit of both?

You’ve heard it said: “idle hands make for idle minds.” The idea of an absolutely “work free” retirement may appeal to some, especially if you are passionate about a particular hobby or sport, but others may well find that an “endless vacation” loses its charm after some months or years. Don’t underestimate the benefits of continuing to work through your retirement. Continued employment keeps the mind engaged, provides a sense of personal identity, can aid in physical & mental fitness and, of course, can contribute positively to your finances.

Since I work primarily with self-employed individuals I hear first-hand just how many clients would actually prefer their retirement to include some form of meaningful part-time employment. For most, this work ought to be stimulating, engaging, productive and affirming with or without financial rewards.

What would you want in retirement? How do you determine what you prefer? What are some options?

Explore what would inspire you with colleagues, friends and family. This conversation can be with a group of similarly motivated and stimulating colleagues (or friends/friends) and help identify your ideal retirement. You might also examine your “motivators,” both existential and economic. Are you someone that thrives on intellectual stimulation, competition, growth and learning, is your identity tightly linked to the work you do? These are “motivators” for finding a vocation in retirement. On the other hand, do you work solely for economic reasons, are you primarily concerned with the rising cost of living, maintaining a given lifestyle, managing debt, or leaving more to your heirs? Vocation may be right for you if you are motivated by existential rather than economic reasons.

You can also use existing social entrepreneurship organizations (such as encore.org) that tap the altruistic resources of retired individuals. Even providing grants for mature adults to develop their ideas while connecting participants with others that share a similar calling.

You might consider that according to AARP nearly 90% of those over age 65 want to remain in their residence throughout retirement. Providing aging-in-place support to elderly in all facets, including bookkeeping, gardening, tutoring, transportation for outings and errands are all viable opportunities. Balance: This is your retirement. Find the combination that best suits you – be it as a vocation, a vacation or a bit of both.

There are unique considerations to working after your formal retirement. To make the most of your in-retirement earnings, you should work carefully with a financial advisor so that social security and taxes can be properly coordinated.