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How should near-retirees deploy their net worth?

A reader asked for some guidance recently regarding a common situation facing workers who are in their 60s and quickly approaching their retirement date. “Karen” and her husband, “Bob,” are both still working and wanted some advice about steps they should take to use their retirement savings wisely.

Here’s Karen’s question: 

“How should we deploy our net worth as we approach retirement? In particular, what percentage of savings should be in an emergency fund vs. long-term savings, and should we have a buffer between these two resources? It seems that most retirement advisers want all of our assets in the market. While I realize growth is important, I’d like a balance between safety/low growth (that is not bonds) and more volatile/higher growth potential.”

Karen and her husband are smart to be thinking about these issues well before they retire, so they can start positioning their assets now for their retirement in the not-too-distant future. Many people put off thinking about this right up to the day they retire. This leaves them vulnerable to events beyond their control that can seriously disrupt their retirement plans, such as a significant stock market crash.

As you’ll see, the potential strategies the couple can use have a lot of moving parts, and the answers aren’t simple, one-size-fits-all. In fact, we’ll use this article and two more to fully address Karen’s questions. Let’s get started.

Here are more details on Karen’s situation:

  • She and her husband are both 63 and plan to retire in their late 60s, possibly as late as 70.
  • Karen has experienced the classic sandwich generation situation: She worked full time for 15 years right out of college, then spent 16 years outside the workforce raising her children and caring for aging parents. She has been back in the workforce for the past 10 years, working full time. Bob has worked full time all his life.
  • Both Karen and Bob have rollover IRAs from previous employers that are invested in funds balanced between stocks and bonds. They don’t have any traditional pensions from previous employers.
  • Karen has been contributing to a retirement plan at her current job that’s invested with TIAA-CREF. Bob has an IRA funded from self-employment earnings.
  • They have significant home equity, with about $70,000 remaining on their mortgage.

Karen and Bob’s circumstances are common for married couples approaching their retirement years, and many readers might gain some insights from their situation. Here are some smart steps they can take to deploy their net worth in the next several years.

Shift your thinking as you approach retirement

During most of their working years, Karen and Bob needed to focus only on saving enough money for retirement and allocating their assets among different types of investments, such as stocks and bonds, in a way that reflects their tolerance for investment risk. 

It gets more complicated, however, as they approach and enter retirement. They’ll want to shift their thinking to developing reliable sources of retirement income and addressing common financial risks in retirement.

One thing they’ll need to think about is deploying their financial resources to address both the short-term and long-term financial goals shown below. Their strategies for these goals will help them decide how to deploy their net worth.

Short-term goals:

  • Maintain an adequate emergency fund.
  • Buy medical insurance to supplement Medicare.

Long-term goals:

First, we’ll look at the short-term goals, and in a follow-up article we’ll explore the long-term goals.

Maintain an adequate emergency fund

While people are still working, common guidelines call for holding an emergency fund equal to three to six months of income. That’s to cover the possibility that your income may be disrupted due to unexpected job losses from layoffs or disability. However, retirees no longer need to worry about these events.

Instead, Karen and Bob will want to focus on building an emergency fund that can cover unforeseen medical expenses and other emergencies, such as expensive car or home repairs. The “right” amount is somewhat subjective, but the basic idea is to have enough ready savings on hand so that they won’t need to sell long-term investments to pay for the emergency. 

Suggestions for an adequate amount range from $10,000 to $20,000 or more, depending on their specific circumstances regarding their house, car and medical insurance.

For instance, if they purchase medical insurance to supplement Medicare when they reach age 65, they’ve reduced their exposure to substantial out-of-pocket medical expenses and might be able to finance deductibles and co-payments from their monthly cash flow (see below).

They’ll want to keep their emergency fund in accounts they can quickly access and that aren’t subject to investment fluctuations, such as bank savings accounts and money market funds.

Buy medical insurance to supplement Medicare

Karen and Bob will be eligible for Medicare when they reach age 65. When they do, they’ll want to purchase supplemental insurance to cover Medicare’s substantial deductibles and co-payments, and to provide coverage for prescription drugs. 

If they don’t buy this supplemental coverage, they run the risk of incurring thousands of dollars of out-of-pocket medical expenses that might require them to withdraw money from savings that are invested for the long term to generate retirement income. Insurance is a useful tool to turn a potentially unexpected, large expense into a predictable expense through monthly premiums.

Karen and Bob have two possible methods to supplement Medicare:

  1. They can buy what’s known as Medigap insurance, plus a separate Part D policy to cover prescription drugs. The advantage of this solution is that it gives them maximum flexibility to choose medical providers.
  2. They can elect a Medicare Advantage (MA) plan, which generally supplements Medicare and provides prescription drug coverage. MA plans typically restrict you to providers in the MA network, similar to an HMO or PPO.

Karen should investigate if her current employer offers either type of plan for its retirees -- it might offer favorable plans using group pricing. Karen and Bob will want to consider these choices carefully as they approach age 65 because the choices they make at 65 can restrict their flexibility to make changes in the future. They should begin their explorations in the months to come rather than wait until a few months before their 65th birthday.

Again, having adequate medical insurance reduces the potential burden on emergency reserves because Karen and Bob might be able to use their monthly cash flow to fund out-of-pocket expenses that Medicare and supplemental insurance don’t cover.

Clearly, you have a lot to consider when developing strategies for a retirement that can last 20 to 30 years, or more. That’s why it’s a good idea to start investigating strategies in the years leading up to retirement. 

Next, we’ll explore strategies that can help Karen and Bob meet their long-term goals.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.