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RETIREMENT PLANNING

For most people, saving for retirement is the single largest future capital and income need associated with their financial plan. Education funding, vacations, capital purchases, weddings, etc., all consume financial resources but should not supplant the primary savings goal of accumulating a retirement nest egg. Government entitlement programs and traditional pensions will continue to be scaled back and even eliminated for many individuals, so personal savings must assume an increasing role in generating future retirement income.

It is essential to consider the impact of potential long-term care expenses and medical costs in conjunction with retirement savings. One technique to consider is targeting an amount of net worth to preserve at the end of the plan which can be accessed for unforeseen medical or end-of-life costs. Long-term care insurance, whether addressed through a traditional or an “asset-based” approach can decrease the amount of needed reserves by transferring the risk of generating funds to pay for care to a counterparty, most often an insurance company.

Integrating tax considerations into a retirement savings plan is critical. Along with inflation, taxes pose a serious challenge to successfully accumulating and distributing a retirement nest egg. While current income tax brackets are not now low, tax increases in the future (whether income or consumption) are likely. Governmental regulations allow for income tax breaks either when funds are deposited into a designated retirement savings account or when funds are withdrawn. Only rarely are benefits available on both ends, and governmental agencies work aggressively to close any “loop holes” in regulations that allow for what they consider to be excessive income tax breaks. Developing pools of money that have different tax treatment is a prudent strategy for accumulating a nest egg. Tax-qualified plans, tax- deferred savings vehicles, tax-free investments, assets producing capital gains and other tax-favored approaches should be considered. Please refer to the section on tax-planning for additional information.

Life expectancy is another factor that must be addressed in a comprehensive retirement plan. Family history of longevity along with consideration for life-lengthening medical advances is prudent. A conservative approach is to assume age 100 as life expectancy; however, assuming a longer life requires additional assets be accumulated in order to generate an adequate lifetime income. Laddering portions of the retirement nest egg to produce income during subsequent income phases allows for better portfolio positioning to achieve both growth and distribution of assets within appropriate risk parameters. Life expectancy of prior generations should be considered in terms of potential inheritance as well as for determining general life expectancy.

Given recent capital markets history, it is difficult for many savers to muster the optimism to commit their money towards the types of investments that may best fit the timeframe and risk parameters necessary for long-term investing success. For those with more than ten years remaining before they will begin spending from their next egg, as well as for funds for current retirees that will be accessed more than ten years in the future, long-term market returns matter. Too often retirement nest eggs have too little exposure to asset classes (i.e., stocks) that can provide the returns necessary to accumulate sufficient retirement assets. To be sure, investment risk management is important—a relatively new metric for evaluating a manager’s value is upside vs. downside capture ratios, which measure how that manager’s risk management techniques reduce declines in poor market conditions as compared to a benchmark (as well as gains achieved during positive markets against the same benchmark). Ultimately, portfolios must have returns sufficient of provide an increasing income stream that accounts for inflation as experiences by seniors (not just the US Government version of CPI inflation). Portfolios must also reflect the risk tolerance of the saver. That risk tolerance should be expressed numerically, not simply in the relative terms of conservative, moderate, or aggressive.

Time horizons of less than ten years must necessarily be evaluated differently. Rather than investment returns measured in long-term market averages, the sequence of returns becomes much more relevant in shorter time frames, since a significant decline in portfolio value immediately prior to withdrawals or while funds are being spent from the account could mean failure of the next egg to provide the amount or length of income required.

Finally, when determining the amount necessary to be accumulated in a retirement nest egg, linear analysis fails to adequately illustrate real world experience. Simply assuming a portfolio will average X% annual returns may well illustrate an overly optimistic or pessimistic approach. While it generally makes more sense to be an aggressive saver (put more money into a retirement account) than an aggressive investor (assume high returns will almost always prevail), a modeling approach that provides a statistical probability of achieving the goal given varying market conditions is inherently more valuable than a linear approach. A Monte Carlo analysis uses real world results, modeling multiple possible investment return scenarios and producing a statistical probably of success.

In summary, retirement planning should take into consideration the following:
• Other savings and spending goals with respect to their effect on retirement savings
• Long-term care and medical expense planning
• Final expense planning
• Tax considerations
• Life expectancy
• When appropriate, plan for inheritances
• Laddering the next egg via multiple buckets or pools of money
• Investment positioning/risk management necessary to achieve the goal
• Modeling accumulation and withdrawal using statistical probabilities (Monte Carlo)

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