3 Strategies for Preserving Wealth in Retirement
What if the market tanks? What if I get sick? What if I get sued? How can I protect my nest egg?
Those nagging questions can be a huge distraction in an otherwise great lifestyle. You can’t control the market’s ups and downs, illness can and does happen. And anyone can sue anybody for any reason. That’s a bit of an exaggeration, and there are no guarantees, but I’ll share some tools that you may want to investigate to help you sleep better at night.
Build a Strong Backstop (Or: Don’t Swing For The Fences)
At a certain age, your relationship with money changes.
Instead of searching for maximum growth, and enduring the risks associated with growth, your attention turns to risk of loss. This is logical; when you have a longer investment time frame you can afford higher risk. But as your time horizon decreases, so does your ability to recover from investment losses.
Safer assets – certificates of deposit and money market accounts – start looking real attractive from a wealth preservation perspective. But there is a problem here. Returns on these assets are generally low compared to riskier investments. And inflation can cut into your purchasing power. With inflation, even if your total dollars invested does not change, those same dollars can purchase less as time goes on. That’s a loss of a different color. It doesn’t seem like a loss because you have the same amount of dollars, but when you go out and spend those dollars, you get less for your money.
So what’s the antidote?
Paradoxically, the antidote is to have some of your nest egg invested in riskier assets. Modern Portfolio Theory teaches us that over time riskier assets such as stocks will generate returns in excess of the rate of inflation. This is especially true when the portfolio combines asset categories whose returns are not strongly correlated. The question becomes, how much do we invest in safer assets as compared to the riskier assets? No simple answer here. That decision is based on a variety of factors specific to you.
But generally speaking, my (admittedly uninspired) baseball analogy holds. To protect your nest egg you’ll want to build a strong backstop into your portfolio to protect you from investment losses. The backstop will be comprised of low risk assets, assets with low correlation to others in your portfolio and yes, some risky assets, but in a relatively low proportion. And since your allocation to risk assets is less, you will not be swinging for the fences to achieve maximum returns – and potentially striking out
Insure, Insure, Insure
Most of our lives insurance seems like nothing but a nuisance. We consider it an extra expense that for the most part just doesn’t pay off.
But take another look. Insurance does have an important function and can be a good way to protect your assets.
Insurance can be looked at as a known expense that replaces an unknown loss. If you don’t suffer a loss, the insurance company wins, but if you do have a loss you may find that insurance is well worth its price. A number of insurances come to mind which could be helpful for asset protection.
Health and Long Term Care Insurance – One of the largest threats to your nest egg as we get older is the cost of health care and long term care. According to the Wall Street Journal, for a couple turning 65 there is a 70% chance that one of them will need long term care. And over 50% of all people entering a care situation will be broke within a year, according to a Harvard University study.
Life Insurance – Many financial advisors will say that life insurance becomes redundant once you have assets. This is true when looking at life insurance as a vehicle to protect your heirs when you don’t have much wealth. But life insurance can also provide benefits to those with assets.
Here’s an example. Let’s say your estate is liable for estate taxes. Generally when this occurs certain assets in the estate are liquidated to pay the estate taxes. However, when properly structured, life insurance can be used as a method for paying off those estate taxes without the need to liquidate estate assets. For this purpose life insurance is held in an irrevocable life insurance trust and not by an individual or the estate itself, so be sure to consult a professional.
Liability Insurance – Umbrella liability insurance can supplement liability coverages from automobile or homeowners insurance and can protect you in case of claims made in excess of the basic limits. If an insurance claim is higher than the policy limits, you’re potentially on the hook for the balance. Extending the limits with an umbrella policy could provide you with additional protection. But bear in mind that there are policy limits on the umbrella policy as well.
Asset Protection Tools
There are a number of other asset protection strategies that may apply to your situation.
Legal Entities – By creating a legal entity for certain assets, separate and apart from you as an individual, you may be able to protect your personal assets. For example, by holding a rental property in an LLC, or limited liability company (as compared to owning it personally) claims against the property could be limited to the assets inside the LLC. Placing your business in an LLC or corporation could have similar asset protection benefits as compared to owning the business personally. Use of legal entities has important tax consequences, so be sure to consult with both legal and tax counsel.
Exempt Assets – Many states allow certain assets to be protected in the event of lawsuit. Typically certain types of retirement accounts, such as IRA accounts, are exempted (but in some states only to a maximum dollar amount). Another common exempt asset is life insurance. The life insurance policy may have substantial cash value but could be protected due to exemption statute. These rules vary from state to state so consult with an attorney knowledgeable in your state’s laws.
Offshore Asset Protection Trusts – This is a somewhat exotic asset protection tool which involves setting up a trust in a foreign country whose laws are supportive of such an arrangement. There are several countries that are, but basically the foreign country must permit a claim to be heard there, even though the claim did not occur on its soil.
Offshore asset protection trusts can deter lawsuits because any plaintiff would have to bring suit in the foreign country and hire representation there. In addition, the foreign trust law could limit or disallow judgment payments from trusts. But there are risks, including political instability or change of laws in the foreign country, as well as the cost of hiring a foreign lawyer to create and represent the trust.
Keep in mind that offshore trusts don’t work as a tax planning tool; if you’re a US citizen or permanent resident any trust income is taxed in the US regardless of where the trust resides.
None of the information in this article should be considered legal, tax, insurance or investment advice. Please be sure to a fee-only financial advisor, an attorney or licensed insurance representative as applicable for further information.