A very nice couple came to our office a week or so ago; let’s call them John and Sally. They are self-proclaimed “faithful” Cutter Family Finance readers who are looking for help. John and Sally are from Franklin, but have summered in Falmouth for 30-plus years. They are planning to retire here in the next few years. John and Sally wanted to talk to Susan and me about developing their retirement system as they move from the accumulation to the distribution stages of their lives. They are ages 55 and 56, respectively, married with three grown children, have amassed about $1.5 million in assets and are extremely conservative. John and Sally have more than two-thirds of their portfolio (about a million bucks) in a five-year CD, paying them interest just south of 2 percent. The rest of their portfolio is in a splattering of stock and bond mutual funds with a buy-and-hold type of strategy.
Hmm. Our question was: “Why?”
John explained that they feel this is a very safe and secure strategy that will allow their portfolio to keep up with inflation.
Ahh, inflation. Investopedia defines inflation as “…the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.”
John told me that he has read the inflation rate is around 2 percent. I asked John if he thinks inflation is the same for everyone. I asked him if he would still be comfortable with his strategy if the cost of goods and services important to people entering the distribution phase of their lives is rising significantly more than what Uncle Sam determines to be our inflation rate? John asked for an example of such a cost. The following is what we discussed.
The 2017 Retirement Health Care Costs Data Report from HealthView Services paints a scary picture for our retirees. The report concludes that the total projected lifetime healthcare premiums (Medicare Parts B and D, supplemental insurance, and dental insurance) for a healthy 65-year-old couple retiring this year are expected to be $321,994 in today’s dollars ($485,246 in future dollars). Adding deductibles, copays, hearing, vision, and dental, that number grows to $404,253 in today’s dollars ($607,662 in future dollars).
You see, when we think of retirement planning, we usually assume that we will need money for our retirement home, or a new RV to finally travel around the country, or a golf membership to fill our free days. We don’t envision that nearly half a million bucks will be spent on healthcare costs.
Unfortunately, as I explained to John and Sally, we need to wrap our heads around that fact, because it will likely only get worse. HealthView Services’ report also shows retiree healthcare expenses will rise at an average annual rate of 5.47 percent for the foreseeable future—almost triple the 1.9 percent US inflation rate from 2012-2016 and more than double annual projected Social Security cost-of-living adjustments. As this report details, the compounding impact of healthcare inflation means that healthcare costs will be one of the most significant expenses in retirement.
And it is not just the seniors who need to pay attention. The report even breaks out different age brackets to project future healthcare costs. It determined that for a 55-year-old couple, their future total costs would be just north of a million bucks, and for your 45-year-old couple—get this—$1,730,774!
You are probably just as surprised to hear these numbers as John and Sally were when I told them. So, use the time you have to your advantage as you build your wealth and prepare. For example, a 55-year-old, such as John, who has already saved enough to replace about 85 percent of his pre-retirement income, could increase his 401(k) contributions by as little as $17 per paycheck to address his retirement health premiums, assuming his company match is 50 percent. Of course, John and Sally’s investment strategy plays an important role here.
Their current combination of CDs and a splattering of outdated buy-and-hold mutual funds will not get them to their goal, since there is no inflation hedge. Susan and I explained that while certain investments might seem to give a decent return, when you build inflation into their current investment model, it actually shows a loss of purchasing power over time. So we suggested a more appropriate strategy, using inflation-hedged downside risk models, which will give them a higher probability of success.
I explained to John and Sally that how they invest their money can matter just as much as how much they put away. I also explained that it is important to put thought into the tax implications of different retirement vehicles and to consider how funds will be distributed years down the road. Lastly, I suggested that John and Sally maximize Health Savings Accounts (HSAs). (An HSA allows for a tax deduction on any contributions and tax-free growth on distributions for medical expenses.)
Look, no matter what demographic you find yourself banded to, healthcare costs are very scary. I get it, but they are also manageable, especially if you plan correctly.
John and Sally came to understand that a 1.9 percent rate of inflation is not entirely accurate, considering what is actually inflationary to them. They now understand that the investment strategy they believed to be inflation-hedged would not be enough. They decided to make the necessary adjustments to their retirement system to give them the highest probability of success. Have you?
Folks, it’s as important as ever for you to be vigilant and stay alert, because you deserve more.