How to guard against retirement threats

Christine Benz: Hi, I'm Christine Benz for Morningstar. As retirement approaches, even the best-laid plans can go awry. Joining me to discuss some threats that can derail a retirement is Tim Steffen. He's director of financial planning for Baird.

Tim, thank you so much for being here.

Tim Steffen: Thanks, Christine.

Benz: It's always great to have you here. You wrote a piece for Baird clients about some of the external threats that can affect people's retirement plans as retirement draws close, and one of the biggies that you talked about is job loss. I know I have got people in my life who have lost their jobs in their 50s or even their 60s, and that really has turned everything upside down. So, let's talk about job loss later in life, some things that you can do if this happens to you to make sure that your plan stays at least somewhat on track.

Steffen: So, one of the things--the immediate thought is, well I have lost my job, maybe now is my time to take that early retirement. You want to do some budgeting to make sure you can afford to live on that reduced income. By losing your job earlier, leaving the workforce earlier than you planned, you are saving less, you are spending sooner, you've got less to put toward paying down debt. Maybe your plan had been to have debt all paid off by the time you retire. Now you've got to rework that plan. So, rethink about your budgeting a little bit, figure out what are my new income level and my new spending level going to be. The other thing is maybe if you are married, maybe that spouse might have to change his or her plan a little bit, too, and perhaps work a little longer, something to kind of help support that family budget.

Benz: And there might be implications for both partners' retirement plans. You might both have to work longer if one person is out of the workforce for a year or two.

Steffen: Absolutely. What we tell people is to be realistic about that. If you have been out of the workforce for a couple of years, you are probably not going to be able to go back in at the same type of position, at the same pay level you were at before. So, accept that that may have to change a little bit, you may take something that's maybe not exactly what you were doing before at the same pay level. That can, again, impact your budget. So just go in eyes wide open and understand that things have changed, and you are going to maybe have to adapt to that.

Benz: And there are implication for the portfolio plan as well. This is why we always tell people to have an emergency fund set aside. How big should the emergency fund be? I know that's something people wrestle with.

Steffen: It's always a challenge. What I would say is as big as you can handle, as big as you can afford it to be. But you don't want to put all your money into--typically an emergency fund is mostly cash. You don’t want to put all your portfolio in cash obviously because you need some growth. So, you want to have enough set aside to at least cover a few months worth of expenses. Sometimes that emergency fund can also be not literally cash, but maybe access to cash somewhere else, like maybe a line of credit, a home equity loan you could tap into if you needed to. So, emergency funds don't necessarily have to be physical cash that's available to you but just access to some liquidity is the main thing.

Benz: And would you say, generally speaking, the higher earner you are and the more specialized your career, the bigger cash cushion you want to set aside?

Steffen: Well, certainly, because as you moved up in your career, probably your needs, your lifestyle is such that it would be a tougher adjustment to have to dial that back real far. So, the bigger your lifestyle is now the more you are going to have to prepare for if something were to change.

Benz: Let's discuss another one--death of a spouse as retirement approaches. How does this change life for someone as retirement approaches, and what steps could you take to get your plan back on track?

Steffen: Well there is obviously the emotional side of it, that can be very difficult to overcome. So from that standpoint it's always important to have that good network of support, whether its other family, friends, maybe others who have been through a similar type, situation support groups whatever it might be. It's important to build that network to help rebuild that emotional side of things.

Benz: Right.

Steffen: From a financial standpoint, one of the things we always encourage is make sure you've got enough protection in the form of, like, life insurance, for example. Now obviously, life insurance is something you can't buy after death. You don't want to buy it when you are in retirement, its usually very expensive. So that's part of planning ahead. Build that life insurance portfolio up ahead of time.

Benz: Well, here's a question though, how long should you hang on to life insurance? I mean, I think some people think, well, I am retired, my kids are out of the house, or I'm getting close to retirement. What do I need life insurance for?

Steffen: Well, life insurance is there to either protect an income stream or to provide some other source of funding during retirement. So, if you have a--if a big part of your retirement plan is an income source coming from one of the spouses, if that income source goes away you need to replace that. So, if your retirement plan is dependent on that spouse's income source you want to be able to replace that.

Benz: OK. And pensions are another thing that people should think about under the heading of a death of a spouse, making sure that you are making--if you are someone who is eligible for a pension, making sure that you are making good decisions about the type of payments that you are receiving from that pension.

Steffen: So many pension benefits will come in the form of an annuity where you can take a single life where it's just during your lifetime, at your death it goes away, or some sort of joint benefit meaning after your death your survivor gets some percentage--could be 100%, it could be 75%, 50%, could be any number of options. If you are going to take a pension then make sure you are, if something happens to you, your survivor is protected. Sometimes they do that using these joint annuities. Other strategies we have seen is somebody takes the larger single-life pension, but puts some of that money toward insurance policy. Now again, you are in retirement, its going to be an expensive policy. But in the event that pensionee dies, the survivor would get a life insurance benefit then, and that could replace that income that was lost from the pension. Which that kind of gives you the best of both worlds--you get the larger pension during your life plus you've still got some protection at the back end if that pensionee were to pass away.

Benz: Exactly, OK. Let's talk about divorce--a financial killer really at any age. But I recently saw some data that actually pointed to the incidence of divorce--I think it was called gray divorce--the incidence of divorce later in life is increasing.

Steffen: Absolutely. We are definitely seeing it more, I have seen it personally and I have seen it just with clients and that as well. So, there is no doubt. The short answer on divorce is it's a financial hardship no matter what. It's hard to recover from something like that. You are basically taking all the assets and splitting them in half and doubling the expenses. So, it's a challenge. So you need to, again, be prepared for something like that. Accept the fact that your lifestyle is probably going to have to change a little bit. You may have to rely on maybe other family members for a bit to get you back on your feet. The big one we see people struggle with is the house. Everybody wants to stay in that house, but the reality is you may not be able to afford it after a divorce when it's half the income now.

Benz: So, the unifying theme among all of these sad life events is to try to be preemptive, try to get some advice, because an advisor can help you troubleshoot the what ifs that could affect the viability of your retirement plan.

Steffen: This all goes back to having a financial plan done. You don't wait until the emergency happens to figure out how to respond to it. You prepare ahead of time. So, somebody who works with a good financial advisor, just putting together a good plan is going to look at some of those scenarios and say, what happens if one of you were to pass away early. What happens if you decide, either voluntarily or involuntarily, to leave the workforce early. What if there is a divorce, that's going to be tricky one obviously, but having a financial plan in place that accounts for those scenarios can help make the transition into those a lot easier.

Benz: OK, Tim sobering topic, good advice. Thank you for being here.

Steffen: Thank you.

Benz: Thanks for watching. I am Christine Benz from Morningstar.com.