From the October 2007 issue of Boomer Market Advisor • Subscribe!

How to deal with affluent over-spenders

I recently interviewed a number of financial advisors who have affluent, retired clients with one thing in common -- they spend too much money. This is not surprising. Many high-earners get used to a certain standard of living, one they're reluctant to sacrifice once they retire. Often, they have accumulated what they think is a lot of money -- for example, $1.5 million to $3 million -- and believe this is enough to continue their affluent lifestyle. With retirement comes time for more cruises, more golf outings and more trips to visit the grandchildren.

Here is a typical example. A client was making $230,000 a year and, right before retirement, was contributing $20,000 a year to a defined contribution plan. His after-tax income was $150,000 a year, or $12,500 a month. He retired with an accumulation of $2 million. Prudently, he should withdraw no more than 5 percent ($100,000) and adjust it each year according to inflation. After adding Social Security and adjusting for taxes, this person would have $9,300 each month to spend. This equaled 25 percent less in spending power than when he was working. This didn't sit well with the client. He wanted to increase his spending, take a cruise and play more golf. The result was an initial drawdown of principal at a much higher level than the advisor thought sustainable.

This leads to a key question; how should a financial advisor handle the affluent over-spender? I recommend that the client be given relevant information about the need to maintain certain levels of accumulation. For example, health care costs have recently risen at a substantially faster pace than inflation. Inform the client of the projected cost of Medigap policies, Medicare parts B and D and average drug costs in 10 years. Ensure the client understands that if inflation averages just 3 percent each year, the cost of living will be 33 percent higher in 10 years. Tell the client that it is unsafe to assume that he will be comfortable with a lower quality of life at ages 75 or 80. The affluent are likely to be vigorous for a longer time than their less affluent counterparts. Finally, housing options are now available for older clients that are expensive, but desirable. A friend recently put her parents in an assisted living facility that cost $90,000 per year. Imagine the cost of that same facility in 10 years, when demand for those services will be much greater.

If this discussion does not convince them of the need to retain higher assets and spend less, I suggest that you try to set up an intermediate asset goal, such as a goal for 3 years and 5 years after retirement. If assets remain above a certain amount, then spending can continue at current levels. If assets fall below the amount, a reduction in spending will ensue. Affluent clients should also be informed that financial products exist that allow older people to safely withdraw higher amounts than could otherwise be taken, with no risk of the value ending. Examples include immediate annuities and longevity insurance. Consider a client at age 75 who receives $300 a month, after taxes, from a $100,000 CD paying 5.25 percent. Put that money into an immediate annuity and the after tax payout is 2.5 times higher.

The point isn't to sell an immediate annuity. It's to indicate to the affluent over-spender that 1) prudence requires a certain level of accumulation at each age, 2) it is not prudent to expect spending needs later in retirement to decrease (there is a good chance that needs will rise), 3) you will help set up an effective warning system before too much damage is done and 4) you know of methods for safely extracting more income out of accumulations and can help the affluent client combine financial security and the most efficient investment portfolio.

It is hard to control affluent over-spenders, but pointing to likely scenarios and well-thought-through strategies will serve these clients better.

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