GPSOLO March 2010
Estate Planning for the Baby Boomers
The baby boomers are the post–World War II generation, people born between 1946 and 1964. Nearly 76 million Americans alive today, or about 25 percent, are baby boomers. The oldest members of this generation are in their early 60s. How are they different from their parents, the generation whose retirement and old age we helped to plan during the last 20 years?
A short course in longevity. In 1930, a few years before the first Social Security law was enacted, average life expectancy at birth was about 59 years. At age 65, average life expectancy was just over 12 years. Thus, when Social Security was enacted, most people were not expected to live long enough to collect it. Those who did live to be 65 were truly “old” when they became eligible for Social Security; they were expected to die at about 77 years of age.
By 2003 the average life expectancy at birth was about 77.5 years; the average life expectancy at age 65 was 18.3 years. According to these statistics, the average American can now expect to live 12.5 years beyond the normal retirement age, and those who live to 65 can expect to spend almost 20 years in retirement. But the concept of 65 as the “normal” retirement age has changed little; in fact, some baby boomers expect to be able to retire earlier.
Challenges in retirement planning for the baby boomers. Many baby boomers have an inaccurate picture of what their golden years will be like. Some common problems that estate planners should expect to address with baby-boomer clients follow.
Boomers will be eager elderhostelers, not front-porch rockers. Expenses of ten to 15 years of activity, independence, and health are estimated to run 75 to 80 percent of expenses of the last years of full-time employment. In other words, a couple who spent $100,000 a year (after taxes) while both worked should expect to spend $75,000 to $80,000 a year for at least ten years after retirement (after taxes). In reality, many baby boomers seem better prepared for the last phase of retirement than the first.
Will the baby boomers be at their desks at 80? An AARP study, published in 2004, estimated that the oldest of the baby boomers will have about $850,000 total wealth per household at age 67. Total wealth includes “retirement wealth,” consisting of pensions and Social Security, and “non-retirement wealth,” consisting of investments and housing. Average annual household income will be $65,000, including incomes of those who still will be working. Note that 5 percent of $850,000 is $42,500, and most of that would be taxable, reducing spendable income to $30,000. And some of the baby boomers’ wealth is invested in housing, which does not produce income. How many of our clients can afford to live on $30,000 a year during the active phase of retirement?
The previous generation’s lifestyle during their working years differed from the baby boomers’ in several important ways. The World War II generation often had a single job, lived in a single city, sometimes even in a single home, for most of their working lives. They had one mortgage, and they paid it off before they retired. The house they owned at 65 often was worth several times what they paid for it. Thus, they could sell their now very valuable house and buy a smaller house or a condo in a retirement community and have substantial funds left over from the sale of the house to provide for living expenses.
Baby boomers, in contrast, are more mobile while working and less mobile in retirement. They not only changed employers, but because technology moved at a much faster pace during their working lives than it did 40 years ago, they changed occupations, cities, sometimes even countries, several times during their working lives. Even those who stayed in the same city for long periods tended to view a house as an investment as well as a dwelling. Therefore, they “traded up” several times during their working lives. Furthermore, they were much less risk-averse than their parents. Each time they moved, they went to a larger house in a more expensive neighborhood with a larger mortgage. At age 65, they still will be making mortgage payments. Although their last house may be worth several times what they paid for their first, they bought their last house relatively recently. Therefore, it is unlikely to be worth substantially more than they paid for it. Because it is still encumbered by a mortgage, their equity in this last home is only a fraction of the home’s value. The most economical post-retirement living arrangement thus may involve staying where they are.
Successful strategies for baby boomers. For the oldest baby boomers, if they did not establish a savings plan when they entered the workforce, it may be too late to plan to retire at 65. For the younger baby boomers, active retirement at their current standard of living will require 75 to 80 percent of their current living expenses. Computer programs are available to estimate the necessary minimum asset value to support their current lifestyle at their projected age of retirement. Baby boomers need to target a retirement age, determine the amount they will need, and establish a savings/ investment plan.
Why shouldn’t 75 be the new 65? Options open to baby boomers include continuing to work and to save, working less or at something new, and becoming a consultant. Younger baby boomers can expect postponement or elimination of age caps on retirement compensation, such as an increase in the minimum age to collect full Social Security, and an increase in (or elimination of) the age of minimum required distributions for qualified deferred compensation plans.
Reverse mortgages are one option to help seniors “stay planted.” These are loans against the equity in a home that need not be paid back until the homeowner ceases using the home as a principal residence. The usual requirements are that the borrower must own the home, be at least 62 years of age, and have no mortgage (or only a small balance that can be paid from proceeds of the reverse mortgage at closing). The amount that can be borrowed usually is capped by the FHA mortgage limit for the area where the house is located (currently between about $81,000 and $161,000). Local lenders may cap the percentage of equity that may be borrowed.
Reverse mortgages include several payout plans: (a) tenure: equal monthly payments as long as the borrower lives and continues to occupy the property as a principal residence; (b) term: equal monthly payments for a fixed term; (c) line of credit: in amounts and at times as the borrower requests, until the contracted-for amount is exhausted; (d) modified tenure: combination of line of credit and monthly payments for as long as the borrower remains in the home; and (e) modified term: combination of line of credit and monthly payments for a fixed term.
The advantages for baby boomers who have a disproportionate amount of their wealth tied up in their principal residence and do not wish to move should be obvious. Some of the disadvantages may include (a) transaction costs that average $6,500; (b) “moral hazard”—does the availability of reverse mortgages encourage older homeowners to remain in homes they cannot afford to maintain?; and (c) inability to pay for medical costs or assisted living after the borrower’s home equity has been spent down for living expenses.