With ongoing volatility across global markets and an uncertain future in terms of taxes, regulations and government safety nets such as social security; diversification is key in managing the risk associated with your retirement savings. That’s why these four risk diversification strategies across products and services make a lot of sense for the changing world we live in.
Strategy #1 – Mitigate Tax Impacts
Who knows what tax rates and policies are going to be 15, 20 or 30 years from now. So, choosing products that mitigate tax risks becomes key in your retirement planning. For example, a tax-advantaged retirement product that mitigates future tax risks type available to most is the Roth IRA. You pay taxes on contributions, but once you reach age 59½, you qualify for tax-free withdrawals of both contributions and any accumulated earnings. In addition, you’re never required to take distributions, making a Roth IRA an effective option for both retirement and estate planning purposes.
Even regular retirement account products like a 401K provide a useful mechanism to mitigate tax impacts since all contributions and earnings into a qualified retirement account grow tax free, though you do pay taxes on the distributions.
Strategy #2 – Annuity Income
Annuities have been said to offer investors “an income that they cannot outlive.” In its most basic sense, an annuity is a contract between you (an investor) and an insurance company in which the insurance company makes a series of regularly spaced payments to you in return for a premium or premiums you have paid. It is a great concept; however, today there are numerous types of annuities to choose from and you need to be careful about the options you pick. Particularly if you want the annuity payments to last you through retirement.
There are basically two types of annuities. These are fixed and variable. Primarily the difference between the two types is in the risk tolerance. The money in a fixed annuity account typically accrues on an annual basis, and the funds grow tax deferred until they are withdrawn. Most insurance companies offer a minimum guaranteed interest rate on the fixed annuities they offer.
Fixed annuities can provide a guaranteed income amount over a specific period of time. The insurance company that provides the annuity actually takes on the profit or loss on the annuity and cannot decline the guaranteed payment.
Since they are low risk and provide a guaranteed minimum amount of income, fixed annuities are a popular option for retirees. However, it’s important to note that there can be withdrawal penalties if you take the money out of the annuity prior to a specified time. Further, if inflation were to spike, fixed income annuity holders may get much lower expected (in real terms) than expected.
Variable annuities, at their core, have a similar framework to that of fixed annuities. In other words, deposits are made that grow tax deferred. And, if death occurs prior to income being paid out, survivors receive the death benefit proceeds.
The difference between fixed and variable annuities is in the way that the cash in the “investment” side of the account grows. Whereas fixed annuities are invested in low risk, lower return vehicles, variable annuities provide more access to equities, such as mutual or index funds. Therefore, although there is typically a small guaranteed amount of return, there is more risk with variable annuities in that the investment account can move up and down with the market.
On the upside, these investments can help the account meet or beat inflation. However, as with other equity investments, there is the very real risk that the account value may fall. In addition, variable annuities are known for the higher fees charged to investors, including account maintenance fees and surrender charges if you need to access your funds prior to a certain specified time.
Other than the cost and fees associated with an annuity, the most important decision to make when choosing an annuity is which payout option to go with. Because there are a number of choices, you need to understand what each one means, and how it could affect your retirement income both now and in the future.
Strategy #3 – Long-term care insurance
The median national monthly rate for a nursing home is $3,185. That’s over $38,000 per year. But this is just an average. The cost can run well into six figures per year in some areas of the country and for specialized care needs. Many are under the misconception that programs such as Medicare or Medicaid will pay for long-term care services. However, this is only partially true. In order to qualify for Medicaid long-term care coverage, one must be at the poverty level. The qualification amount differs from state to state. But on average, a single individual must have financial assets of no more than $20,000. This rules the vast majority of seniors out.
One way people can protect their retirement savings from excessive medical costs is through the purchase of a long-term care insurance policy. Long-term care insurance protects assets, avoids dependency on government programs, and allows the insured to retain the freedom of choice in terms of where they receive care. Long-term care insurance plans can cover care in a facility as well as care at the recipient’s home. This not only allows financial independence by having some or all of the costs paid for by the insurance, but also physical independence in that the recipient can remain in the comfort of their own home.
Premiums for long-term care policies will be treated as a medical expense and will be deductible to the extent that they, along with other non reimbursable medical expenses, exceed 7.5 percent of the insured’s adjusted gross income. Once insured under a long-term care insurance policy, the care recipient is covered for a certain pre-set dollar amount of care expenses, for a certain period of time. Some policies even offer a lifetime coverage option, meaning that care costs will be insured for as long as the recipient needs it.
There are many ways to design a plan, making long-term care insurance affordable for most people. In fact, the policy premium could even be viewed as an investment that protects hard-earned savings dollars, especially in retirement.
Strategy #4 – Think Globally
Most US based investors have the majority of their investment in US based assets and companies. But limiting yourself to a particular region or limiting yourself to a country, no matter how large it is, is always a mistake, especially when you look at currency risk. Investing globally is extremely important, not because we’re necessarily betting on their economies. But, what we’re betting on is their consumers realizing that they want to grow and move into the middle class. And, we as investors want to participate in that. I think that one of the big challenges that we’re facing today on the economic side, besides the volatility and the high unemployment and the uncertainty is the fact that interest rates—I mean real interest rates, after inflation, the real rate of return on your money, are at historical lows. So, I would look globally, and I would say that there are many great companies outside of the U.S. that are paying relatively high dividends. You build a portfolio that way, you get some income.
The above strategies should be considered against what you want/need from your retirement income and implemented in a step-by-step and fully informed basis. Ideally, in conjunction with a certified financial planner.