CROSSROAD #3: RISK MANAGEMENT
In Eric Scott’s book The Five Crossroads, written to lay out the principles of retirement planning that he has developed over his 30 years of experience as a financial advisor, the third crossroad that pre-retirees Sue and John reach is the “Risk Management” crossroad. In the narrative, the Guide in the book explains that, “Risk management is about building from a position of strength and support so you can plan for the worst while hoping for the best.”
There are several things that could happen to negatively affect your retirement dream. Things like health issues, accidents, market losses, and so on. While you can’t prevent them from happening, there are ways you can potentially reduce the financial impact they’ll have on your retirement. This is like laying your foundation. Just like building a real house, building a strong financial house for retirement begins with the foundation cornerstones. Each cornerstone in this case represents a type of protection from financial setbacks.
The four cornerstones
1. The first cornerstone is emergency savings.
We recommend you have 3-12 months’ income put aside in case of a financial crisis in something liquid like a savings account. It seems simple enough, but this emergency fund can be invaluable in times of need. Without this savings built up, you could potentially find yourself in a debt cycle, paying off one debt only to find yourself stuck again when another crisis appears. Life is unpredictable and having this fund available to you when ‘life’ happens can potentially protect you from a major financial setback.
2. The second cornerstone is life insurance.
Life insurance is an important cornerstone when you’re younger because, should a tragedy befall your family, you want to make sure the mortgage payments and other expenses are covered so your loved ones can maintain their lifestyle. Losing a loved one is hard enough already. With life insurance, you don’t have to worry about debts, monthly income, emergencies or other expenses on top of your other stresses.
But even for retirees, life insurance is still relevant, for the same reasons. You don’t want to leave loose ends for your spouse and family. You want to make sure your financial obligations are covered. You may not have any children at home who need supporting, but you still want to make sure your spouse is well cared for. After all, when you pass away, you leave your spouse with a potential loss of income from Social Security, healthcare, funeral costs, long-term care, etc. Not to mention, your spouse could see a loss or reduction in pension checks.
Life insurance serves to pay off your debts if you have them and also to cover your final expenses, such as funeral costs. Whatever remains afterward serves as an income replacement to help maintain the surviving spouse’s financial lifestyle.
There are many modern features of life insurance which may be more beneficial to you than the life insurance of the past. It can be more than just a monthly expenditure—today life insurance can potentially serve as a retirement account for tax-deferred growth, tax-free income, and even tax-free medical benefits such as healthcare, long-term care and assisted living. On top of all that, you could potentially build up a cash value which could be used for unforeseen financial needs.
3. The third cornerstone is home, auto and umbrella insurance.
This cornerstone is designed to help you reduce the risk you face with your fixed assets. Because if you lose your home or an auto, that affects your money and savings you will have to dip into if you don’t have proper insurance coverage.
You see, risk doesn’t only apply to the stock market like many people think. It’s about any exposure to the chance of loss. It applies to your investments, but equally applies to your home, your vehicles and even your business.
Your home is one of the most valuable assets you will ever own. While a fire is not highly likely according to actuarial tables, data and research, natural disasters and accidents can cause irreparable damage to homes. Insurance for your vehicles can be equally important. Protection from potentially expensive damages – either damage you inflict upon another automobile, or damage another driver inflicts upon your vehicle – just makes good economic sense. Reckless drivers, not to mention poor road conditions due to construction or weather, are all the more reason you need that additional protection from those potential losses. Relying on your own finances to repair or buy a new automobile could take its toll. Accidents can happen, and reckless or not, they can happen to any of us. It’s best to be prepared.
There’s one last insurance that we believe everyone should have – umbrella insurance. This type of insurance can be useful in cases when other insurance won’t cover the full damages. For example, let’s say that you are involved in an accident with a man who makes six figures a year, an accident for which you are found at fault. Now, let’s imagine this accident leaves him unable to work for 10 years. Because this drastically affects his lifestyle, he decides to sue you for the $1,000,000 he would have earned in those years. If he wins in court, your financial house can come crumbling down. After all, where do you think he’ll get that money? It could potentially come from your savings, your investments, your assets, and even a portion of your income. If he wins, he could potentially put a lien on your home and your income that could last the rest of your lives.
An umbrella insurance policy can make up the difference when your liability insurance for your home or auto insurance is maxed out. For instance, the average insurance product offers a liability of around $250,000. In our example, we mentioned $1,000,000. In most cases, umbrella insurance policies offer coverage in million-dollar increments for a relatively affordable price. While your auto liability insurance would cover the first $250,000 in damage, the umbrella policy potentially steps in to pay the rest for pennies on the dollar. That small cost could potentially save you thousands.
4. The fourth cornerstone covers healthcare.
Health insurance is part of it, but there’s so much more to healthcare than just traditional health insurance coverage. Traditional healthcare policies have you covered until you reach age 65, but once you reach that point you have the option of trading in your health insurance for Medicare. Many people also purchase Medicare supplemental policies to offset what Medicare won’t cover.
But even that may not be enough. According to Fidelity, it is estimated that a healthy 65-year-old couple will spend $285,000 on healthcare in retirement. A whopping 42% of that—$119,700—is for copays, coinsurance and deductibles, 39% or $111,150, for premiums for Medicare parts B and D, while the remaining 19% is for prescription medications.
Of course, that estimate doesn’t take long-term care expenses into account at all. This is a huge risk, because according to the Center for Retirement Research at Boston College, it’s estimated that 44% of men and 58% of women will need some form of long-term care at some point in their lives. (Compare that to a study done by the National Academy of Elder Law Attorneys, which discovered that the chance of a house fire or a car accident being financially devastating is less than 1%.)
Long-term care costs can add up quickly. In 2018, the average person needing some form of long-term care spent between $18,720 and $89,292. (That gap is based on whether you need a little healthcare help in your own home, assisted living care or a semi-private room in a nursing home.) Your other option is even worse—spending down all of your assets in order to qualify for Medicaid.
The point is, it’s best to be prepared with a healthcare contingency plan. As you reach retirement age, you’ll be glad to know that today’s long-term-care coverage options are no longer just “use it or lose it.” If you’re lucky and stay healthy, you no longer have to waste insurance premiums on a policy that just disappears, you may be able to leave a death benefit to heirs or some other option.
Questions to Consider
1. Do you have a retirement plan that is specifically tailored to your individual needs?
2. Are you prepared to set up the groundwork for your financial house by properly building the four cornerstones?
Cornerstone 1: Emergency Savings
Cornerstone 2: Life Insurance/Income Replacement
Cornerstone 3: Property Insurance – Home/Auto/Umbrella
Cornerstone 4: Healthcare/ Long-Term-Care Insurance
3. Do you have enough income in your personal savings to cover an emergency or unexpected expense? (We recommend having 3-12 months of income in your emergency savings.)
4. How important is it to you to have proper life insurance coverage as a means of income replacement and paying off your debt(s)?
5. Do you have the proper amount of coverage on your home(s) and/or car(s), with umbrella insurance to cover catastrophic liability / damages?
6. Are you prepared with proper healthcare coverage (health insurance/Medicare) to cover potential medical costs should your health fail as you get older?
7. Are you prepared for the likelihood that you’ll need long-term care at some point in your life?