3 Largest Risks of Retirement Transition

I often speak to community groups about retirement planning, and more often than not, listeners are surprised when I talk of a phase I call “transition.”  We have been trained to be savers and the traditional retirement savings paradigm reminds us to accumulate to a point of critical mass, and then develop a distribution plan.  For those folks that work with our practice, it is transition planning that they are embracing—the idea that the 10 years pre retirement and 10 years post retirement are exposed to a unique set of risks, and therefore require a unique set of planning strategies.

The three largest risks a transitioning retiree is exposed to are longevity, behavior, and timing.  The statistics on the current age wave are staggering.  There is a 50% chance that one person in a 65 year old couple will live to age 92, and a 25% chance they will live to 97.  In 2004, Hallmark reported selling 85,000 100-year-old birthday cards.  With all of the advances in medicine and biotechnology, I believe that we will continue to live longer, and as life expectancy grows, so does the need for a larger nest egg for a longer retirement.

Clients often challenge me with the idea of behavioral risk, by stating that they were surely exposed to behavioral risk their entire investing experience.  I would argue back that this behavioral risk is heightened as your get closer to needing to use your assets to supplement income.  As the markets climb and fall, it can be difficult to stomach the volatility.  Part of putting together the right transition plan is to assume an investment strategy that can ride out the volatility more smoothly. 

Investment markets do not care when you decide you want to retire.  The economy moves in cycles from expansion to recession.  If the timing of your planned retirement happens to fall during the next recession, you need some sort of infrastructure in your plan to guard against this kind of timing. 

These three risks are often ignored until just before the move toward retirement.  The time to start building a protection infrastructure around your retirement nest egg is much earlier.  These challenges are real and must be faced head on.  Attention to retirement  transition planning is important.

Reflecting on College Funding Paradigm

Last week we offered our first client workshop centered on college savings plans and understanding the financial aid application process.  We had a good turnout, and a big thank you for all who attended.
As the FAFSA (the required form to apply for federal financial aid) deadline approaches, I thought I would take a moment to review the aid programs that are available, as well as discuss a quick overview of the tax-advantaged savings methods.  I think it is important to realize that many of the aid programs are created for those who need it the most.  Middle class families are expected to be able to contribute a significant portion toward the cost of tuition when it comes to these programs.

Aid Programs

Pell Grant—the Pell Grant is entirely needs-based.  It is free money, meaning that it does not to be paid back in the form of a loan.  It is only available to undergraduates.

Stafford Loan—the Stafford comes in two varieties:  the Subsidized Stafford loan is entirely needs-based and the interest does not start accruing until schooling is complete.  With the Unsubsidized Stafford, loan interest begins accruing at grant.  It must be repaid in 10 years, and payment begins within 60 days of final disbursement.

PLUS Loan—the PLUS loan is a loan entirely dependent on the parent’s credit score.  These tend to be at higher interest rates.

Federal Supplemental Education Opportunity Grant—the FSEOG is only available to those families with a low expected family contribution.  It is only paid out if the funds are available (whereas the Pell is not limited in the funds that are paid out).

Work Study—work study provides on or off campus employment to pay for the cost of tuition.

Perkins Loan—Perkins loans are available to families with exceptionally low expected family contributions.  The school acts as the lender with very low interest rates.  These loans are awarded on a limited basis

Savings Programs

Prepaid Tuition—This program allows you to pay for college tuition at today’s cost.  The advantage is that you are able to lock in today’s cost of tuition for future attendance.  The disadvantages are that your return on investment is caps at the tuition inflation rate (which is not a bad return as compared to recent years); if the child receives a scholarship, then only your principal investment is re-paid; and the school or school system you pre-pay may not have a program that is strong that matches up to your child’s interest.

529 Plan—This account allows saving of after-tax assets in a tax-sheltered account.  Assets can be withdrawn tax-free if they are for qualified educational expenses.  The contributor retains control of the asset if the child decides not to go to college, and can re-assign the account to another beneficiary.

Coverdell Educational Savings Account—The tax benefits of the Coverdell ESA are similar to the 529 plan, however annual contribution totals for these accounts are much lower, and donors are phased out of contributing with modified AGI of $190k-$220k (MFJ) and $95k-$110k (other filing statuses).  Coverdell ESA funds can also be used for private elementary and secondary school.

Custodial Accounts—Funds that are established under the fiduciary control of an adult, but taxed at the rate of the child.  Unfortunately, these accounts are considered an asset of the child—a significant negative difference when applying for federal financial aid.  These accounts can sometimes be subject to “kiddie” tax—pulling them back into the parent’s taxable rate.  These funds become the full property of the child at the age of majority.

Planning for education funding is a very important goal-based part of being fiscally fit.  If you plan to help your child by contributing toward the cost of their education, but have not ear-marked funds to do so, this can have a severe affect on your other financial planning goals—specifically retirement savings.  A popular funding tool for college expenses has become the Roth IRA; because you can access these funds prior to 59 ½ if they are for qualified educational expenses.  The problem with doing this is that you are eating into funds that you may have previously designated as retirement assets.  Just as with other financial goals, the rules for college savings are start early and stay fit.