From the May 2008 issue of Wealth Manager Web • Subscribe!

The Hidden Obstacles

As advisors, we're keenly aware of the challenges of retirement planning and portfolio management--longevity, inflation, market uncertainty and sequence of investment returns. But as we confront these issues, it strikes me there is another obstacle, less apparent but just as significant and demanding. Unfortunately, it rarely reveals itself until clients actually enter into retirement. The demon is the inability of some clients to comfortably spend down their assets.

Clients routinely ask us how much money they will have for retirement; rarely do they consider whether they will be willing to actually spend that money once they retire. A widowed client of mine recently passed away in her 90s. At her funeral, her children expressed their sadness that she never took the European trip she fantasized about for so many years. In fact, I recall several conversations with her about fulfilling that dream, but because she feared she would someday run out of money, she couldn't bring herself to get on a plane and go.

If this woman had been on a restrictive budget or of limited means, I would not have made the suggestion, but her husband left her a substantial estate to the extent that she could have spent $400,000 a year and not run out of money until she was 120 years old. Nevertheless, she feared outliving her assets and becoming a financial burden to her children, so she hunkered down in a needlessly frugal lifestyle and denied herself pleasures she could easily have afforded.

Sadly, she is not an isolated case. I regularly meet retirees who are afraid to spend down their assets, even when projections indicate they have enough to last. It is this anxiety that we advisors should be confronting as an integral part of our client retirement planning sessions--well before our clients reach retirement age and are suddenly seized with irrational parsimony.

Not being a psychologist, I won't presume to offer a template for conversations about "retirement angst." I know it's an awkward topic to broach with clients, who understandably are more concerned with not outliving the amount available to them when they retire. Yet, unless we address the issue and construct a strategy that will allow them to spend down their assets without that fear, we fail in our responsibility--regardless of the performance of client retirement portfolios.

Misplaced Emphasis

The literature for retirement planning software programs typically depicts scenarios in which retirement assets diminish to zero just beyond actuarial life expectancies. That makes no sense to me.

Let's assume a retiree's actuarial life expectancy at 65 is 18 years, or to age 83. That means the client has a 50 percent chance of dying before age 83, but also a 50 percent chance of living beyond age 83. Conventional retirement planning strategy is to provide sufficient money to last about three years past the actuarial age--or about age 86. If that retiree makes it to age 83, I guarantee you that no matter how cautious his spending habits have been since age 65, at 83 he now has enormous anxiety about outliving his dwindling assets. He relied on you as his advisor to prevent running out of money, and you relied on actuarial projections to support your investment strategies. But your aging client cares only that he is still alive while most of his investment principal is gone.

Usually, we are much younger than our retiree clients. While we employ statistics and projections in creating and funding retirement plans, we fail to consider the hard realities of what it means to run out of money at an advanced age. For insurance carriers, brokerage houses or financial software manufacturers, retirees represent a single market segment with specific statistical probabilities. But that segment is composed of millions of individuals, most of whom will not die "on schedule."

Regularly, we read about the impact of longevity on financial issues, but somehow we don't apply that knowledge to the psychological problems individual retirees experience as they grow closer to an uncertain date of death.

Buying a Better Story

Another complicating factor is the temptation for retirees to believe the best story--that is, to hire the advisor with the rosiest projections.

Suppose someone about to retire with $2 million in assets asks you for a plan. As an ethical advisor, you explain that most people are uncomfortable spending down their assets, and since you don't know how long this prospective client is going to live, you must create a retirement plan that allows his money to last indefinitely. You also explain that even with such a plan in place, he is still likely to hesitate spending down his assets because the plan's assumptions allow for the possibility of severe market volatility or even a depression. In other words, you will do everything you can to protect him from worrying about outliving his assets.

You create a plan for his $2 million portfolio that provides a $100,000 annual income that he cannot outlive. You explain that even if the markets take a precipitous drop, he will not have to worry about running out of money, because the capital generating his income will always be there.

The prospect says, "Thanks; I'll get back to you." But he leaves somewhat disillusioned. He was hoping to take out $160,000 a year. He goes to another advisor who reassures him that there's no reason why he can't comfortably take out $160,000 a year without eroding his asset base. So the client thinks, "Hey, this sounds better. This guy must be a better advisor; he can get me more money."

Of course his assumption is wrong but that doesn't do you any good. You've lost his business.

I'm not implying that the second advisor is necessarily unethical. He may be inexperienced, overly optimistic or extremely aggressive. Or, like many advisors, he may simply base his recommendations on actuarial data without considering the psychological impact of someone outliving their money because of his inaccurate projections. In any case, that is 15 or 20 years away, and who knows whether the retiree will live that long or whether the advisor will still be actively practicing. Moreover, with a potential client sitting in front of him, dangling substantial assets to manage, there is an ever-present temptation to tell the retiree what he so desperately wants to hear: That he can spend another $50,000 or $60,000 a year without dissipating his assets.

Advisory Obligation

For years, I wrestled with the issue of reassuring my clients that they could relax a bit and enjoy their retirement without fear of running out of money. But that fear of spending down was always present, inhibiting them from taking a deep breath and doing things they had dreamed about during their working years.

I have always believed that it is as imperative to discuss the psychological barriers of spending down assets as it is to try to assure lifetime income so retirees can spend down without fear of becoming penniless. Obviously, these talks must be approached with a great deal of empathy and a side-order of sensitivity because they encourage people to think about their mortality.

As advisors, we must also be certain of our knowledge and recommendations, because we have to be right. Successful people in their 40s or 50s who lose their jobs may suffer great angst and even temporary hardship, but a professional can find an alternative position; a talented person can even embark on a new career. The income can usually be replaced. That's not the case when someone in their 80s runs out of money. They cannot replace it.

Therefore, we must not only aim for sustainable portfolio performance, but we must also strive to provide the emotional underpinning that helps clients to confidently make rational expenditures. Balancing these objectives cannot only help lessen spend-down fears; it can simplify asset allocation and facilitate more aggressive investment strategies.

I have two retired clients who are longtime friends. They are professionals who worked together for several decades in the defense industry. They do virtually everything together and the same way, including their retirement portfolio investment strategies.

They became clients about 12 years ago. For the first 10 years, they were so nervous about outliving their assets, they insisted on meeting every month to review their portfolios. Their portfolios were doing fine, but they were living with unnecessary frugality and resisted any suggestion to spend down their money. If the markets experienced any volatility between our meetings, they would call me for reassurance. In short, they were a real challenge!

When I tried to discuss strategies that might allow them to be more comfortable spending down their assets, they would have none of it. But in our monthly meetings, they continually asked me what we could do to ensure their income. I told them their only other option was to reallocate their assets into more Treasuries or AAA corporate bonds. While the income would be reasonably certain, the clients acknowledged the lack of inflation protection, and also worried about liquidity and value fluctuations.

One day, they called to say they had read an article by Moshe Milevsky, finance professor at York University in Toronto. Milevsky advocated the same strategies I had been trying to discuss with them for years. Evidently, seeing it in print--or perhaps it was the good professor's academic credentials--broke down their resistance to change. They shifted virtually all their retirement assets into a model that allowed them to begin nibbling into their assets without discomfort. Shortly afterwards, the now comfortable twosome embarked on a month-long overseas tour--first class no less--something they would never have considered previously.

In addition, they have stopped coming in for monthly meetings. We now get together twice a year, and I rarely hear from them in the interim. They are spending down their assets. Even the recent market turmoil did not upset them or prevent them from planning another lengthy trip.

Obviously, for many retirees, there is never enough money to relax. This is a needless tragedy for people who have planned and saved assiduously for their later years. The variety of products and strategies that exist today should help us reassure retirees that they will not outlive their assets. Of course, much of the value in these products lies in our willingness to hold honest, candid conversations with clients about the psychology of spending down.

Thomas C. Scott, CFP, CFS, is President and CEO of Scott Wealth Management Group, Irvine, Calif. (www.scottwealth.com). He is a Registered Principal with and offers securities through Linsco/Private Ledger (LPL), member FINRA/SIPC.

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