Where do we begin? That’s one of the first questions I’m asked when I sit down with a new client. Specifically, clients want to know how to manage the complexities of investment options and insurance needs and how to create a financial plan that will serve them well into retirement.
Most people are surprised when I tell them that before they can dream about the potential upside of their financial plans, they need to identify and control their exposure to catastrophic risk. Managing risk is the first and most important step in developing a sound financial plan. After all, what good does it do to plan for the best if a relatively likely event can ruin everything?
Catastrophic risk — for our purposes — is the possibility of a future event or series of events that will lead to unacceptable financial hardship. It’s important to realize that the types of risk you will face and the severity of the threats they pose often vary significantly over the course of a lifetime.
Federal employees’ risk profiles often differ significantly from their private-sector counterparts. For example, private-sector retirees with no guaranteed pension benefits are usually more susceptible to investment risk than federal annuitants, who have their Civil Service Retirement System or Federal Employees Retirement System benefits. In my experience, however, it’s common for federal employees and their families to assume that their employer-sponsored benefits are all they need and to overlook certain types of risk in planning for the future.
While it is true that federally sponsored retirement programs, such as the Thrift Savings Plan, are some of the best available, many people focus only on the financial prize they expect to have earned at retirement. They continue to invest in these programs but fail to accurately identify the sources of risk in their lives and to effectively neutralize or reduce that risk.
For example, it’s important to research and understand your investment options. Most people realize that they have different needs throughout their lives depending on their age, family obligations, health and years to retirement. Yet choosing an investment strategy only for its upside potential while ignoring the risk posed by its likely fluctuation in value is a common financial planning mistake.
The most common risk oversights I see in my practice:
- Death. The financial implications of the unexpected death of a bread-winner tend to be the most severe in midcareer. During this period, workers are usually saving for future events, including retirement, have higher spending obligations and a long life expectancy. During this time, even the maximum available Federal Employees’ Group Life Insurance coverage might not be adequate to provide dependent survivors with the resources they’ll need. You can mitigate this risk by purchasing additional life insurance through the private sector from reputable brokers. However, as catastrophic as a death is, the need for life insurance often disappears or, at least, declines substantially as retirement approaches.
- Disability. The risk of loss of income caused by disability is usually greatest early in a career when the number of years of income to be lost is the greatest. Like the death risk, the risk of income loss from disability usually declines as retirement approaches. But, unlike the death risk, the risk posed by disability
tends to re-emerge after retirement and increase substantially with age. Rather than loss of income, this late-life disability risk is associated with the high cost of long-term care — care not often covered by medical insurance. This risk can be managed with long-term care insurance that is available from the Federal Long-Term Care Insurance Program (www.ltcfeds.com) or on the private market from reputable insurance brokers. - Liability. Most federal employees carry property and casualty insurance to cover the loss of their highvalue tangible assets such as personal and real property. However, while it’s essential to cover the loss of your home and property, it’s important to also prepare for a large, unexpected personal liability claim. A serious auto crash or other accident could result in damage liability in the hundreds of thousands or millions of dollars. Liability insurance is relatively inexpensive for the protection it provides. Make sure that you have at least $1 million in total protection.
- Investment. For many federal workers, even those with substantial annuities, personal savings are the key to adequate retirement income. Unfortunately, many federal investors fail to manage their retirement savings portfolios in a way that avoids unacceptable risk, the most common being the risk of exhausting
the portfolio prematurely. This risk is managed by either selecting and implementing the right investment strategy, or purchasing a guaranteed immediate annuity, or both.
Risk is managed in one of two ways: through careful planning and selective behavior, as in choosing and implementing an appropriate investment strategy, or through the use of insurance. It’s important to identify the risks that could most affect you and your family. For instance an employee living on the Florida coast will have different personal property risks than an employee living in Arizona. Evaluate where you are in your work career, your family obligations, and how a catastrophic event could change your life for years to come.
Admittedly, risk management doesn’t come with the same dreams as what you’ll do when you retire. But, I can assure you that the planning you do today will prevent a potential future nightmare.
Written by Mike Miles
For the Federal Times
Publication September 18, 2006