A viatical settlement is the sale of a life insurance policy by the policy owner before the policy matures. Such a sale, at a price discounted from the face amount of the policy but usually in excess of the premiums paid or current cash surrender value, provides the seller an immediate cash settlement. Similar to reverse mortgages, viatical settlements involve insured individuals with a life expectancy of less than five years. In countries with high health care costs (such as the United States), this is a practical way to pay extremely high health insurance premiums and other senior care expenses that severely ill people face. Some people are also familiar with life settlements, which are similar transactions but involve insureds with longer life expectancies (two to fifteen years). - From Wikipedia and other sources 5/2007Faulty Assumptions Threaten Boomer Retirement Plans
(PRWEB) April 28, 2006 -- The majority of individuals spend surprisingly little time planning for retirement. In fact, 30% of individuals in one survey indicated that they would prefer to visit the dentist's office than plan for retirement. Making matters worse, much of the planning they do accomplish is often based on overly optimistic assumptions. “We find that many individuals are using simplistic and flawed assumptions when estimating the adequacy of their retirement savings” says Peter Passalacqua, a Certified Financial Planner with Frontier Financial Planning in Somerville, New Jersey. “For instance, many people will apply an assumed rate of return to their retirement nest egg to determine available income. If the resulting income level seems adequate, the individual is satisfied.” Passalacqua explains. “Regardless of the interest rate being applied, this thinking ignores two critical factors which influence the adequacy of a retiree’s income. One is inflation, and the other is investment risk”.
The effect of inflation is easily understood with a simple spreadsheet analysis. Assume on the first day of retirement, a retiree invested a $100,000 nest egg at a guaranteed fixed interest rate of 5%. Assume also that the resulting $5000 per year, when combined with Social Security and pension income, is just enough to cover this individual’s living expenses in year 1 of retirement. How long will the money last? Without considering inflation, the money could be expected to last forever, since the investor is only spending interest income. Increasing the $5000 annual living expense by 4% per year, however, results in a much different picture. Under this scenario, the investment account will be depleted in 20 years.
Adding risk to the forecast can really muddy the water. Let’s say that, after considering the effects of inflation, our retiree decides that he needs a higher rate of return on his investments, and is therefore willing to take on some investment risk. As a result, the investor puts his money in an investment account with 60% stocks, 25% bonds, and 15% cash. Based on historical performance of similar investments, he believes he will receive an average rate of return on this portfolio of 9%. The problem is that the actual rate of return will be subject to significant fluctuations from year to year. As a result, the simple projections we used to determine the longevity of the guaranteed portfolio will not provide the same level of certainty once investment risk is introduced.
“Portfolio risk has a huge and underappreciated impact on retirement planning” says Passalacqua. “You may expect your portfolio to average, say, 9% over 25 years, but the timing of good years and bad years can dramatically influence your investment results. Although we feel comfortable projecting average long term returns based on historical performance, no one can predict which years will be good and which will be bad. This is the biggest challenge a planner must overcome in determining the adequacy of an individual’s retirement savings.”
Many financial planning firms uses statistical modeling tools such as Monte Carlo simulations to estimate how long investment accounts can be expected to last given various withdrawal rates and inflation assumptions. “With tools such as Monte Carlo, we can provide our clients with statistical probabilities that they will achieve a particular goal, given their savings rates and investment choices” Passalacqua explains. “Some of our clients are surprised to find that the retirement assets they had projected to provide retirement income for life may have only a 60% chance of lasting until they are 85 years old. Many others are surprised to find that their ultra-conservative portfolios of bonds and CD’s have less chance of surviving retirement than a more aggressive portfolio which includes some stocks and growth investments”.
Many baby boomers are undoubtedly looking forward with great anticipation to their upcoming retirement. These future retirees would be well advised to double check their retirement planning assumptions to make sure they have adequately accounted for inflation and investment risk. It may take a little effort, but the stakes are high. It may be that a little extra last minute savings effort is needed to ensure that the golden years will truly be golden. Then again, the local Wal Mart store is always looking for part time help.
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