Pre-retirement checklist is an essential planning tool

Checklists are essential risk management tools in many different fields, including retirement planning.
Before pilots take off in an airplane, they go through their preflight checklist. Since managing retirement income accounts is also risky business, consider developing a pre-retirement checklist. The checklist should identify the most serious financial threats your clients may encounter in retirement and whether they are prepared to handle them. Here are six essential items you should have on your list:
Live on 4%. Can your clients live off a 4% distribution? Because of the volatility in financial markets, there are times when retirees need to scale back their distributions to 4%. These cycles can last much longer than investors realize. As a result, clients must be capable of living on a 4% distribution for extended periods of time. If not, then they are ill-prepared to enter retirement.
Eliminate leverage. Have your clients paid off all their major debts? If clients are carrying significant debt into retirement, they can experience a serious cash flow crisis during a falling market. To fund the debt payments, they may be forced to liquidate assets at the worst time, which can further deplete their asset base. If we have learned anything from the current down market, it is that excessive debt can threaten the financial security of even the largest institutions. Clients should heed that warning. The less debt they carry, the higher the probability that their portfolios will survive a 30-year retirement if necessary.
Create cash flow. Do your clients have sufficient cash flow to meet their basic living expenses? By basic living expenses, I mean the bills that have to be paid each year, such as utilities, health care, real estate taxes, food, clothing and transportation. For example, if your client tells you that he or she must have at least $50,000 a year to pay the basic bills, consider generating $50,000 of cash flow from interest and dividends.
If you have cash flow, you are providing your clients with the staying power to survive tough markets. We are eight years into a stock market that has produced no capital gains. Cash flow can be a portfolio saver.
Create liquidity. Do your clients have at least one year’s worth of distributions in highly liquid assets? During negative market cycles or financial panics, it may be difficult to sell what you otherwise thought were readily marketable securities. By having at least one year’s worth of liquidity, clients have time to approach asset sales in a more orderly format. If you combine the cash flow with the one-year pool of liquid assets, you have a great deal of flexibility to deal with market volatility.
Plan for long term care. Do your clients have a plan for paying potential LTC costs? Long term care poses the single biggest financial risk for most retired investors. In today’s dollars, long term care can easily run $80,000 a year. For a married couple, this is a potential liability of $160,000 per year. Many investors simply do not have the assets to self insure those costs. Therefore, clients should consider LTC insurance to cover the percentage of the liability that their asset base cannot support.
Combat inflation. Do your clients have a plan for combating inflation? While financial-market volatility can create short-term threats to a client’s security, inflation poses the biggest long-term threat. At a 3% inflation rate, your client’s income stream will need to double every 23 years to maintain purchasing power.
Many investors are relying on increasing stock market values to offset inflation. But history tells us that there have been plenty of cycles when stocks failed to provide an inflation hedge, because they were either declining in value or stagnating. Therefore, investors should also consider alternative sources of inflation protection, such as Treasury inflation protected securities, inflation-indexed immediate annuities and stocks with growing dividend payments. If equity values don’t appreciate as expected, these inflation fighters should serve as a handy Plan B.
A pre-retirement checklist should make you a better risk manager and help your clients live a more secure retirement.