Since we can’t predict how the market will perform—or when, the effects of the sequence of returns makes it difficult to plan for consistent retirement income that will last for a couple’s lifetime. One of the possible solutions to address sequence of returns risk would be to use investments that are less affected by volatility or provide guarantees to cover essential expenses.
Inflation risk. Most clients are aware that purchasing power in retirement will decrease over time as inflation rises—particularly if their income doesn’t also increase to meet rising costs. If history provides us any perspective at all, we should expect health-care costs will increase at a greater rate than other costs during retirement. The real impact comes when you consider that health care becomes a larger proportion of total expenses as people age.
According to the Kaiser Family Foundation and HRET Survey of Employer-Sponsored Health Benefits, from 1999 to 2018, overall inflation rates have eroded purchasing power by 51% and health-care premiums for family coverage have increased 239% over the same time period. Using simple mathematics even at a modest 3% inflation rate, the cost of living will double over a 24-year period of time.
Clients will be counting on you to provide guidance and alternatives that can address all risks. Social Security is one form of guaranteed income that has a cost of living adjustment. The question to ask your clients and yourself is will this be enough to address inflation for all of your client’s fixed expenses during a 30 or more year period? If not, you’ll need to look for other investments that offer guaranteed income with possible increases all throughout the planned distribution phase.
Utilizing The VIP Process
So how can we help clients feel more at ease in dealing with these risks? Make them feel like a VIP by showing them how “VIP” fits into their financial planning process.
In this case, “VIP” stands for Value of Income Planning, and refers to a simple 5-step process that can help clients identify expenses, sources of income, risks and possible solutions to consider when planning for the other side of the mountain.
Step 1—Review Expense Categories: Start by helping your clients identify the three main types of spending in retirement that comprise their overall retirement expenses:
Essential—the “needs” or essential expenses for basic necessities such as food, clothing and shelter, as well as health-care costs, taxes, etc. These are the “must haves” they simply can’t ignore.
Discretionary— the “nice to haves” or “wants” such as travel, club memberships, gifts and entertainment. The fun stuff that was put off because of all the “adult” responsibilities they can now pass on to their children.