So, friends and relatives, we must now become much more aware of our economic future as we enter a new age of "everyman for himself" government. For the first time in American (including colonial) history, the 'old folks at home' are now on their own -- and hopefully they chose wisely!
By Robert Powell, MarketWatch
Aug. 4, 2011
BOSTON (MarketWatch) — Now for the hard part. Retirees and those on the cusp of their golden years will need to revisit their financial plan in the wake of President Barack Obama signing the debt-ceiling law.
The new law calls for $1 trillion in spending cuts spread over the next 10 years. And though it’s short on specifics, experts say there’s still plenty older Americans should put on their to-do and to-think-about list. Here’s the list. Work on plan B
If there’s any lesson to be learned from the recent debacle in Washington, D.C., it’s this: Don’t run your personal finances the way the U.S. government does. “Don’t live beyond your means, and don’t increase your debt levels, especially when heading into retirement,” said Greg Rosica, a tax partner in the personal financial services group at Ernst & Young and a contributing author to the Ernst & Young Tax Guide 2011. “Don’t emulate the federal government.”
Get your 401(k) back on track
With millions out of work, many people have been forced to take a break from contributing to their retirement account. But once they start saving again, how can they get back on track? Here are some tips.
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That aside, Rosica is of the mindset that the best thing retirees and would-be retirees could do now is to prepare for whatever specific cuts (and possibly taxes) might come when the committee charged with coming up with the details of the debt deal meet later this year.
For instance, retirees and would-be retirees should review the federal or state programs which they rely upon for services or income and consider the effect of cuts to those programs. It’s a bit nebulous at the moment, but it’s working on a plan B, he said. “If you rely on some specific program for day-to-day living it would be wise to know how you would be affected by spending cuts,” Rosica said.
As part of this exercise, experts suggested that older Americans rethink their retirement model and run some ‘what-if’ scenarios with other sources of income, including financial capital and Social Security.
Kathy Sutton, a director of editorial for Broadridge Investor Communication Solutions, Inc., suggested that people nearing retirement ought to pay special attention to inflation. “One likely scenario for Social Security is that cost-of-living adjustments may be calculated differently, resulting — though there have been no CPI adjustments lately — in lower annual adjustments”
Short-term interest rates to remain low
And investments, as most have already noticed this week, are affected by the new debt-ceiling law. Bob LeClair, an associate professor at Villanova University and a principal with Leimberg Information Services, Inc., predicts that short-term interest rates will remain low for quite some time, and it might be time to move assets around to get a bigger bang for the buck.
Investors have about $2.7 trillion in these short-term funds, essentially earning nothing, or next to it, said LeClair. So, investors — especially those who are living off the interest and dividend income — might want to rebalance their portfolios to generate a bit more income. They might, for instance, consider moving further out on the yield curve, say one to three years, to pick up some additional interest income. And they might consider investing in an index fund. The SPDR S&P 500 ETF SPY +0.60% has a current dividend yield of about 2%. The Vanguard Short-Term Investment-Grade ( VFSTX 0.00% has a current yield of about 3% and the average maturity of the holdings in the fund is three years.
Of course, LeClair warned that moving further out on the yield curve and investing in index funds are not without risks. “You have to be prepared for the volatility that goes with them,” he said. “You can’t have your cake (higher income) and eat it, too — safety of principal.”
Bond funds would be subject to interest rate risk (as rates rise bond prices will fall), while stocks would be subject to market risk (the risk that stocks will decline in value for good and not-so-good reasons).
Others agree that moving out on the yield curve could be risky. “Seniors still need to keep an eye on interest rates, said Mary Frakes, a senior investing editor with Broadridge Investor Communications Solutions. “Even though the immediate threat of a downgrade (to U.S. credit rating) seems to be off the table with, at least, Moody’s Investors Services and Fitch Ratings, we’re still on negative watch for a potential downgrade later if deficit reduction levels aren’t deemed sufficient.”
And though interest rates may stay low for the immediate future, a downgrade of the U.S. credit rating or the Federal Reserve Bank eventually starting to raise interest rates would likely adversely affect bond portfolios. “Many seniors may not realize that bond prices fall as interest rates rise,” said Frakes. “There would be an upside, though, since rising rates would actually benefit senior savers who have maintained a solid cash position but have suffered from low rates.”
Cuts to Medicare, Medicaid providers
Medicare and Medicaid advocates are predicting that cuts to providers will adversely affect family physicians, hospitals and elderly patients. And that means retirees and would-be retirees need to plan ahead for the likely changes to Medicare and Medicaid.
There’s certainly going to be some uncertainty relating to Medicare, if the soon-to-be appointed committee doesn’t come up with recommendations that are passed by Dec. 23, 2011, automatic cuts will kick in beginning 2013, said Jim Walsh, vice president of editorial for Broadridge Investor Communication Solutions. “While Medicare beneficiaries won’t directly see a reduction in benefits were this to happen, it’s not hard to imagine some of the potential problems seniors may experience if there are further reductions in payments to providers. And of course, with ‘everything on the table’ as the committee looks for an additional $1.5 trillion in savings, it seems to me that all entitlement spending, including Social Security, faces some uncertainty.”
Read Powell’s column “Get ready for Social Security, Medicare meltdowns” for more advice on how to plan for possible changes to Medicare and Social Security.
Others, meanwhile, suggest that it might be high time to consider such products as long-term care insurance to insure against the risk of high out-of-pocket expenses in retirement. “There will be pressure to reduce health-care costs over the coming decade,” said LeClair. “More expenses will be pushed onto individuals.”
Given that, LeClair suggested that buying long-term care insurance might prove a wise and prudent decision. “The problem, however, is that it’s expensive and some retirees and near retirees may not be able to afford it or qualify for it,” he said.
Read Powell’s column “Retirement products: rising costs, fewer providers” to learn more about the current state of the long-term care insurance business.
Taxes to rise
Las Vegas might not have odds on this one just yet, but it is a good bet that state and local taxes will rise as the federal government doles less and less to states. “I call it ‘trickly-down austerity,’” said LeClair. “Local communities will have no alternative but to raise property taxes and other fees to make up the difference.”
LeClair’s advice: Retirees and those nearing retirement may want to think about relocating to communities and/or states that have lower tax rates if they can afford to do so.”
For his part, Mark Luscombe, a principal analyst with CCH, a Wolters Kluwer business, said there is no immediate impact on retirees from the debt-ceiling law. Or at least there’s not from a tax point of view. No tax provisions were included in the legislation, Luscombe said. “The legislation did call for a joint Congressional committee to address tax reform by the end of the year and for Congress to approve that legislation to avoid across-the-board spending cuts. Even if that tax legislation were enacted, it is expected that the provisions would for the most part not be effective until 2013.”
Others, however, are predicting if not tax increases, some sort of tax reform. “In my opinion, I also think significant tax reform — not necessarily an overall increase — is a given in the next two years,” said Walsh.
With some provisions such as the Alternative Minimum Tax patch expiring, and current rates and other major provisions expiring at the end of 2012, something is going to happen, said Walsh. “It may not make a major difference to the average senior, but higher-income seniors could really be affected,” he said. “Throw in potential changes or expiration of current estate tax rules and higher-income seniors are going to have a lot to digest and deal with.”
Get ready to work longer
Given that retirees will likely pay more for health care in the future, that federal, state and local taxes will rise, that interest rates will remain low, and that there’s a potential for cuts in Social Security benefits, odds are high folks will either work longer or postpone retirement indefinitely.
“Part-time work may also become more common,” said LeClair. “Early retirement will fade and more people will work at least until they qualify for full Social Security benefits. Some may consider working until age 70 to maximize Social Security payments.”
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Read the MarketWatch Retirement Adviser special report on how to maximize your Social Security benefits while working.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. Learn more about Retirement Weekly here. Follow his tweets here.
Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.]
