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By Christine Benz and Jeremy Glaser | 04-12-2017 01:00 PM

As Retirement Nears, Customize Your Plan

Pensions, idiosyncratic risks, your legacy, and healthcare can affect investors' retirement spending rates and asset allocations.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many investors, when considering their retirement plans, think about their age or the risk tolerance when making it, but Christine Benz thinks there's a few other factors that they need to consider.

Christine, thanks for joining me.

Christine Benz: Jeremy, great to be here.

Glaser: Let's talk about why it's important to kind of have this more customized plan. Why do you think it's important not just to use the off-the-shelf advice about retirement portfolios and about spending?

Benz: Yeah, I think, the off-the-shelf advice actually serves accumulators really well. And the basic idea is, if you have a long time horizon, you should have a pretty risky portfolio in order to earn the highest possible return over time. But as you get closer to spending your portfolio, I do think it's really important to take a look at the specifics of your situation, to look at the specifics of the cash flow sources that you'll be bringing into retirement, as well as other goals that you might have for your portfolio beyond retirement. And depending on how you approach those different variables, that could call for a dramatically different asset allocation as well as perhaps a dramatically different spending rate from your investment portfolio.

Glaser: The first factor you've mentioned is pensions. This is something a lot of investors still have. How could that impact how you think about your retirement plan?

Benz: Well, generally speaking, if you're one of the shrinking share of the population who will be bringing a pension into retirement, you would want to make your portfolio that much more aggressive because chances are your spending demands on that portfolio would be that much less. So, in our Retirement Readiness Bootcamp, for example, we walk through some examples of people with pensions, some without pensions and what you could see is that the person without a pension will be spending more aggressively from the portfolio, so should need to batten down the hatches with a greater share of the portfolio.

On the other hand, the person who has a pension, or perhaps a pension and Social Security are supplying most of their in-retirement income needs, that person would have much less of a need for a sizable cash and bond stake. Of course, risk tolerance is a little bit in the mix here, too. For example, if you are someone with a pension and Social Security supplying most of your income needs in retirement, but you know that you freak out when the equity portion of your portfolio goes down, you of course want to invest a little bit more conservatively with your portfolio than the person with a very high risk tolerance.

Glaser: You think another factor is to consider idiosyncratic risks in your financial life. Maybe you own asset classes outside of stocks and bonds, like a rental property. How would you factor things like that into your plan?

Benz: Yeah. It's valuable to take stock of how many idiosyncratic risks are baked into your plan. Jeremy, you mentioned a couple of the ones that can arise. People do sometimes come into retirement with some sort of rental properties that are supplying them with income, maybe they own shares of businesses, perhaps private businesses. And it seems to me that the more of these nonportfolio investments that you have, the more idiosyncratic risks that you have, the more conservatively you ought to invest your actual investment portfolio.

So, for an example, let's think about someone who is getting some of their desired retirement cash flows from, say, rental income from some properties that they might own. I think it's wise to plan for perhaps periodic disruptions in that income flow and so, you might want to have a little bit more invested in conservative securities even though you are getting some of your income today from those rental properties.

Glaser: How you think about your legacy and legacy planning is an important factor, too.

Benz: Absolutely. And from a practical standpoint, a lot of retirees think of their homes in which they live as the asset that they will pass on to their children or grandchildren. And in that case, there probably shouldn't be big implications for how they manage their portfolios. But for retirees for whom leaving a chunk of their investment portfolios is a priority, it means a couple of things. First of all, you need to wall off that portion of your portfolio that you'd like to leave to heirs from your spendable portfolio. So, there are implications there for your spending rate from that portfolio. And then, I think, you'd also want to think about how to position the portion of assets that you will leave to your heirs. Generally speaking, if these are assets that you will pass to your heirs after you are gone, you'd want to position that portion of your portfolio more aggressively.

Here is an area, Jeremy where I would say it's really valuable to get some help from an estate-planning specialist. They can help you look at the totality of your assets and figure out, well, these are the best assets to leave to your children and grandchildren. You may have, for example, highly appreciated assets within your taxable accounts. Those can be great assets to earmark for heirs, because your heirs will receive a step-up in the cost basis upon your death. So, get some help on this front if leaving a bequest is a big motivation for you in retirement.

Glaser: One of the big questions heading into retirement is what healthcare spending is going to look like and long-term care spending in particular. That's an important factor to consider as well if you have long-term care insurance or not.

Benz: Absolutely. In fact, I sometimes touch on long-term care when I'm out and about speaking and the discussion can quickly get away from whatever I was initially talking about to be all long-term care. People are very concerned about the possibility of needing long-term care and depleting their assets in the process. So, it's important to have a strategy of some kind of for long-term care, whether you are insuring against your long-term care risk or self-funding long-term care. And if you've opted for the latter, so if you haven't chosen to insure long-term care, it is valuable to again segregate those assets from your spendable portfolio. There will be implications for your spending rate. And then also think about having the longest time horizon for your long-term care assets.

Especially, if you're a young retiree who is self-funding long-term care, it's a good bet that you won't need to tap those assets for perhaps another 20, 25 years. So, you'd want to position them aggressively for the maximum possible growth from that portion of your portfolio. If on the other hand, you're an older retiree, say, you're in your 80s and you are intending to self-fund long-term care expenses if they should arise, it seems to me that you'd want to start shifting a portion of that portfolio into more conservative assets because the potential need for long-term becomes a little more realistic and maybe a little bit more short-term than would be the case if you are a retiree just starting out.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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