Investment Advice for Upper-Middle-Income Retirees

The future looks good, although a healthcare cushion makes sense.

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Upper-middle-income retirees can look forward to financially secure retirements. Most can cover essentials with little worry and have money left for travel and other discretionary items, according to advisory profiles of representative retirees prepared by the Society of Actuaries (SOA). Couples are better-positioned than single retirees, who are more exposed to unexpected healthcare expenses. Here are details of three SOA profiles for upper middle income retirees—a couple, a man, and a woman, all age 70.

There are common SOA assumptions underlying the profiles:

• Retirement age and the age of taking Social Security are both 66.

• Current income includes earned income, Social Security benefits, defined benefit pension income, required minimum distributions, and investment income.

• Financial assets are assumed to be 75 percent tax qualified (401(k)), and 25 percent after-tax savings.

• Social Security benefits are based on a single wage earner, with recognition of spousal benefits.

• Target retirement living expenses are assumed to be 80 percent of preretirement income. Expenses include insurance premiums and uncovered health care costs.

• For those who are already retired, target retirement living expenses are 90 percent of those for preretirees. These may exceed the current income of the retirees, but the analysis provides indications of the amount of additional income or the amount of additional assets that would be needed to support this higher standard of living.

• Essential living expenses are limited to the range of $25,000 to $35,000 for single households and $40,000 to $60,000 for married households.

• Discretionary living expenses are the excess of target expenses over essential expenses, but in no case less than $5,000.

• Defined benefit pension or other earned income is estimated at zero percent, 20 percent and 40 percent of preretirement income, to provide a range of possible situations.

• Emergency funds are recognized at 50 percent of annual essential required income.

• Net after-tax assets assume taxes at 15 percent on taxable distributions and no tax on sale of a residence.

Profile 1: Couple

Current income: $93,000

Financial assets: $410,000

Nonfinancial assets: $690,000

Net after-tax assets: $1,050,000

Essential retirement income needed: $60,000

Discretionary expenditures: $35,000

Additional emergency fund: $30,000

Social Security income: $42,000

Defined benefit pension or earned income: $48,000 or $24,000 or $0

Amount needed currently: $86,000 or $587,000 or $1,001,000

Advisory Summary

• The current income of $93,000 exceeds the targeted income needed.

• The $1,050,000 of net assets is sufficient to cover the net retirement and emergency fund needs and would be adequate even in the absence of income beyond Social Security.

• Social Security income covers essential expenses. It could be appropriate to purchase an income annuity with a portion of the financial assets to cover additional expenses.

• Nonfinancial assets (home equity) can be relied upon for emergency funds.

• The amount of financial assets ($410,000) suggests long term care insurance would be appropriate.

• Appropriate assets to consider in some combination, based on the moderate amount of the financial assets, include:

• Low-risk, simple investments and investment approaches: certificate of deposit, U.S. government bonds, money market fund, fixed deferred annuity, single premium immediate annuity, deferred income annuity (ALDA), home equity loan, under appropriate circumstances.

• Low-risk, more complex investments and investment approaches: TIPS, equity-indexed deferred annuity, deferred income annuity, reverse mortgage, under appropriate circumstances.

• Medium-risk, more complex investments and investment approaches: individual municipal bonds, mutual funds or variable annuities that are invested primarily in bonds, real estate investment trust, single premium immediate variable annuity, mutual fund or variable annuity invested in bonds or with a guarantee.

• Medium-to-high-risk investments and investment approaches: individually purchased corporate bonds, balanced mutual funds or variable annuities, mutual funds or variable annuities that are invested primarily in equities, mutual fund withdrawal program, preferred stock.

[See Lifetime Income is an Elusive Goal.]

Profile 2: Single woman

Current income: $43,000

Financial assets: $160,000

Nonfinancial assets: $320,000

Net after-tax assets: $458,000

Essential retirement income needed: $35,000

Discretionary expenditures: $6,000

Additional emergency fund: $18,000

Social Security income: $23,000

Defined benefit pension or earned income: $21,000 or $10,000 or $0

Amount needed currently: $0 or $150,000 or $297,000

Advisory Summary

• The current income of $43,000 exceeds the targeted income needed.

• The $458,000 of net assets is sufficient to cover the net retirement and emergency fund needs and would be adequate even in the absence of income beyond Social Security.

• Social Security income covers essential expenses and the financial assets are limited; consequently, an annuity income to cover essentials may not be practical.

• Nonfinancial assets (home equity) can be relied upon for emergency funds.

• The amount of financial assets ($160,000) suggests that long-term care insurance may be uneconomic and that Medicaid may need to be relied upon for long-term care expenses after savings are depleted.

• Appropriate assets to consider in some combination, based on the limited amount of the financial assets, include:

• Low-risk, simple investments and investment approaches: certificate of deposit, U.S. government bonds, money market fund, fixed deferred annuity, single premium immediate annuity, deferred income annuity (ALDA), home equity loan, under appropriate circumstances.

• Low-risk, more complex investments and investment approaches: TIPS, equity-indexed deferred annuity, reverse mortgage, under appropriate circumstances.

• Medium risk, more complex investments and investment approaches: mutual fund or variable annuity invested in bonds or with a guarantee.

• Medium-to-high-risk, more complex investments and investment approaches: balanced mutual fund or variable annuity.

Profile 3: Single man

Current income: $54,000

Financial assets: $150,000

Nonfinancial assets: $340,000

Net after-tax assets: $467,000

Essential retirement income needed: $35,000

Discretionary expenditures: $22,000

Additional emergency fund: $18,000

Social Security income: $38,000

Defined benefit pension or earned income: $28,000 or $14,000 or $0

Amount needed currently: $101,000 or $304,000 or $507,000

Advisory Summary

• The current income of $54,000 almost meets the targeted income needed.

• The $467,000 of net assets is sufficient to cover the net retirement and emergency fund needs in most circumstances. The assets would not be adequate in the absence of income beyond Social Security.

• Social Security income covers essential expenses and the financial assets are limited; consequently, an annuity income to cover essentials may not be practical.

• Nonfinancial assets (home equity) can be relied upon for emergency funds.

• The amount of financial assets ($150,000) suggests that long-term care insurance may be uneconomic and that Medicaid may need to be relied upon for long-term care expenses after savings are depleted.

• Appropriate assets to consider, based on the limited amount of the financial assets, include:

• Low-risk, simple investments and investment approaches: certificate of deposit, U.S. government bonds, money market fund, fixed deferred annuity, single premium immediate annuity, deferred income annuity (ALDA), home equity loan, under appropriate circumstances.

• Low-risk, more complex investments and investment approaches: TIPS, equity-indexed deferred annuity, reverse mortgage, under appropriate circumstances.

• Medium-risk, more complex investments and investment approaches: mutual fund or variable annuity invested in bonds or with a guarantee.

• Medium-to-high-risk, more complex investments and investment approaches: balanced mutual fund or variable annuity.

[See What You Need to Know About Annuities.]

Twitter: @PhilMoeller