After a snowstorm closed most of the mid-Atlantic region of the U.S., I began to think about how people could experience a significant financial storm but never consider how their retirement plan would fare.
So I ask you these questions: Do you know what would happen to your retirement comfort if the stock market (and your portfolio) lost 40 percent? What would happen if you or your spouse went into a long-term care situation for three years that costs $120,000 a year? Or how about if you or your spouse died suddenly, leaving the survivor with a mortgage and a low income?
Bad things happen – sometimes more often than we expect. Having a plan for how to handle those events is more than half of the battle.
Let’s take a look at how to stress-test your retirement plan.
First of all, everyone should have a financial plan. In other words, everyone should construct a financial model of how much they have in assets and how much they spend on a regular basis. They should make some assumptions about rates of return, inflation rates, tax rates, etc. Once you have completed this process, you now know a very important thing about your retirement. You know whether you are going to make it or not. Think about it. Most people have enough money to last them for the next 10 or 20 years, but how about the next 25, 30 or even 40 years? That is where it becomes a little sketchier.
I am a firm believer in financial planning (thus my certified financial planner background). We complete financial plans for every one of our clients. We start one when they first become a client and then each and every year thereafter. People need to know where they are and if they will make it or not. More importantly, as their advisor, we need to know as well.
And let’s face it, if you are going to run out of money in retirement, do you want to know now or when you run out? I’m guessing you’d want to know now. So, after you have your financial plan set up, you only need to imagine some scenarios in order to simulate these financial storms.
To forecast a market downturn, simply take your initial assets and decrease them by 40 percent. I know this would cause a big shock to your plan, but I would really want to know if the plan would still work out. And if it did not, I would begin to think of ways to ensure that I never lost 40 percent. I may be more conservative or I may change my allocation, especially today when the market has done so well for so many years.
How about long-term care, with say a cost of $120,000 per year for three years? For this storm, I would not assume the event happens now, but I would show that additional expense in my plan at age 80, 81 and 82. Remember, also to add in an inflation factor (we typically use 5 percent) because long-term care costs are definitely going up each year.
So how does your plan hold up? Do you or your spouse run out of money due to the cost of a nursing home? If so, what can you do about it? Should you buy a long-term care insurance policy? Do you begin putting money aside in a long-term care fund? Does your life insurance policy have a long-term care rider? If not, can you add one to your current policy?
This type of stress-testing helps you be better prepared for the future, no matter what it holds. Finally, let’s look at the last scenario: the death of a spouse. If you or your spouse died, what would the survivor’s income be? What expenses would they have? Think about mortgages and regular monthly obligations. How will they be paid?
If there is not enough money, you must think about alternatives. Is there a life insurance policy that could pay off all of the debts? Should you choose the survivor benefit plan for your pension when you retire? Should you be making extra payments on your mortgage to get it paid off before retirement or soon thereafter?
Again, being prepared in retirement is the key to making it through the 100-year storms. Even though those storms are only supposed to come every century, they seem to be occurring more often. Make sure you know what to do when the thunder clouds roll in.
Good luck, investors.
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How to Prepare for a Storm in Your Retirement Forecast originally appeared on usnews.com
