From the March 2010 issue of Investment Advisor • Subscribe!

Cover Story: Custom Job

In a challenging time, Norm Mindel thinks he has solved the retirement income puzzle for his clients. How are you doing?

All signs point to 2010 as the year in which many substantive retirement planning reforms will either be cemented or set into motion by Congress and the Obama Administration. This is welcome news to retirement officials and advisors who say many facets of the retirement planning system need urgent attention. Case in point: the retirement income puzzle that continues to be a major challenge for advisors and their clients. One positive step in solving the search for retirement income is a request for information (RFI) issued by the Department of Labor (DOL) and Treasury Department in February which seeks public input on how best to integrate lifetime annuities and other income-generating options into 401(k)s and other employer-sponsored retirement plans. The RFI (comments are due by May 3) is a welcome development because "the real challenge going forward is: how do you create this lifetime income stream?" said Robert Reynolds, president and CEO of Putnam Investments, in an interview. "That's a challenge for the industry, regulators, and politicians because there is no silver bullet product."

There's no doubt that measures being considered on Capitol Hill and among policymakers (see Income Initiatives sidebar) to address the nation's retirement conundrum will help advisors as they strive to find the right income strategy for their clients. But advisors like Norm Mindel know all too well that one product alone won't provide the solution. That's why Mindel, co-founder of Forum Financial Management in Lombard, Illinois, has designed a "bucket" approach to building retirement income portfolios for clients. He details this bucket approach in his new book Wealth Management in the New Economy (John Wiley & Sons, 2010). "I can't solve [the retirement income problem] by a product or an incredible investment opportunity and find [a client] something that's going to produce 6% guaranteed return," Mindel says, adding that he also tells clients that with the low interest-rate environment, they are not going to be able to live off of interest income in the near future. When investors' faith in the market was shaken in 2008-2009, Mindel says that he, like most advisors, "kept most of our clients in [the market], but what we started talking to clients about was dividing their money into different buckets." He uses a four-bucket strategy that he dubs EAGR, which stands for Emergency, Annual Income, Growth, and Risk. He tells his clients to put away one to three years of cash for emergencies, and then he builds a portfolio of mostly bonds--short-term or laddered bonds--for annual income, which accounts "for about seven or eight years of living costs." By using this emergency and annual income strategy, "I've given them a portfolio that for ten years they don't have to worry too much about the stock market. And what I'm trying to frame for the client is if we have another March of 2009, you don't have to worry for a fairly long period of time about getting access to cash," Mindel says.

For growth, Mindel allocates from 50% to 70% of a client's portfolio to equities. As for risk management, Mindel says advisors must talk to their clients about long-term care issues "so they can protect their portfolio." For instance, while income annuities can be "expensive and complicated," he notes, "in cases where the client is uninsurable, [income annuities] may be used as a supplemental source of income to pay for long-term care. Under the new tax code, certain annuities may qualify for tax-free withdrawal if the monies are used for long-term care costs."

About 10% to 20% of Mindel's clients have started to adopt his bucket approach to portfolio construction, which he says can be customized to use two, three, or four buckets. His firm recently sent a letter to all clients urging them to reposition their portfolios as well. "When the market crashed, [clients] were open to repositioning their portfolio, but now that the market has done really well in the last 12 months," they are far less inclined to change any allocations.

Why Buckets May Be Best

Howard Schneider, president of independent consulting firm Practical Perspectives, says that research conducted by his firm along with GDC Research, headed by Dennis Gallant, has found that advisors who follow Mindel's bucket approach to retirement income planning are "the most confident" in the strategies they devise. Retirement income planning is "all about integrating a variety of different products and solutions," Schneider says. "The question advisors ask when they look at new products is how they fit into the integrated and diversified approach that I've set up to solve this solution." Advisors "do not like products that are positioned to them as the be-all end-all solution for retirement income."

Lou Stanasolovich, president and CEO of Legend Financial Advisors in Pittsburgh, says this his firm's retirement income strategy focuses on generating "a steady return for the client over time that we can take money out of regardless of source, and provide that to them in the most tax-advantaged manner possible so that they have this stream of cash." He prefers to say that his clients are getting the "cash that they need, as opposed to income. If we can generate cash for them on a tax-advantaged basis, why give them income?" Diane Pearson, an advisor with Legend, adds that many retirees believe they must have income-producing assets to provide cash flow. But, she says, "if we can build a strategy where we know they are pulling out a set dollar amount, it really doesn't matter if it's income, dividends, appreciation, or capital gains."

The dilemma that advisors face when building retirement income strategies for clients is that it's very customized and individualized--there's no turnkey solution, notes Schneider of Practical Perspectives. "We hear from advisors that you could have [clients with the same wealth], and depending upon goals and other factors like what the client wants to do in retirement, the advisor may take totally different strategies."

Don't Focus on the Individual

While each client's retirement strategy must be customized to fit their needs, Francois Gadenne, chairman and executive director of the Retirement Income Industry Association (RIIA), argues that most advisors use the wrong tools to help clients decipher their retirement income needs, and therefore don't do an adequate job. When talking about retirement income with clients, it's no longer a conversation about an "individual client or individual account, it's a household issue," Gadenne says. "If I'm going to work on your retirement, it's a very different conversation than if we're talking about your investments. ... If I need to talk about your retirement, I need to talk about your spouse, [children], and plenty of other stuff at the household level because retirement is a household event, not an individual event." Retirement is "predicated on the resources of the entire household."

Gadenne says RIIA's retirement management analyst (RMA) curriculum provides advisors with the right "toolbox" to properly serve clients' retirement income needs. Most of the computer modeling software that advisors use tend be client- or account-focused, and is "not optimized for creating household use," he says. He claims that the RMA, launched last October, provides a unique software modeling system that can consider an entire household. Once the right "household" toolbox is in place, Gadenne says it's now up to the advisor to use the right "metric" to measure retirement income. If advisors are bringing only the assets under management (AUM) tool to the table, that's incomplete. "The relevant benchmark for retirement is not just AUM, it's actually consumption in retirement divided by financial capital. That's a very different story. If I invest your money for investment purposes, we don't need to have a discussion about what you're going to spend in retirement. However, if we do retirement income, we better have a very good discussion about what you plan to spend," Gadenne says. "Notice I used the word 'consumption,' not expenses or income. It's your planned annual consumption in retirement, because, ideally, income should equal consumption, but more often than not it doesn't--it's either bigger or smaller. Expenses may equal consumption, but as you get into the details you realize that people think they're going to spend X but they add everything up and say, 'Oh, looks like we have a problem here.' So consumption divided by AUM all of a sudden gives you ratios by which you can start to look at clients very differently."

Gadenne says securing the RMA credential resembles the same process that it took to establish the CFP. RIIA has "identified the body of knowledge and defined the curriculum, and the depth of the curriculum is provided by required readings and suggested readings and optional readings." At the conclusion of RIIA's spring conference, which takes place this month, RIIA plans to teach the first "boot camp" on the RMA designation and give the first exam. "We already have scores of advisors who have signed up and paid in order to get access to the designation material and the exam," Gadenne says. Plus, he says, a large university is now creating a certificate granting program to teach the RMA. "We'll announce that publicly later." (Merrill Lynch is encouraging its brokers to attain the Chartered Retirement Planning Counselor designation: see Merrill Discovers Retirement sidebar, below.)

The Role of Annuities

As noted previously, those advisors who tend to be ahead of the pack when it comes to retirement income are those that integrate a variety of products and solutions. Schneider of Practical Perspectives notes that research done by his firm and GDC Research found that advisors who serve mass affluent clients tend to favor guaranteed products more than other advisors. "Advisors in the bank and insurance channels or the independent B/D channels tend to be more heavily oriented toward using annuities than RIAs who have clients with an average wealth that's much higher," Schneider says. "We know, for example, that advisors who've already moved their practice more heavily to retirement income use more guaranteed solutions." However, that "doesn't mean they use them for every client and it doesn't mean they use them for more than a third of the portfolio on average. So it's not as if they are saying an annuity of some form--VA or fixed--is the right solution, and the only solution."

Putnam's Reynolds says that to make annuities more appealing, "the next round of retirement reform legislation" should include an optional, national insurance charter along with a new regulatory body (like the FDIC) that could approve or disapprove qualified lifetime income options, annuities, or non-annuities. The new entity could be called the Lifetime Income Security Agency (LISA), Reynolds suggests, and it would "be empowered to not only vet income solutions, but to administer a national insurance pool funded by the industry itself, just like the FDIC, to ensure that qualified lifetime income solutions actually deliver on their promises to plan participants." (For another retirement issue being debated in Washington, read The Problems With Pensions sidebar, above).

Indeed, while many advisors remain wary of annuities, since the market meltdown, advisors have become more receptive to "all types of annuities," notes Bruce Ferris, VP at Prudential Annuities. Ferris says he's actually seen a "sea change" in the number of advisors who've become receptive to hearing about the benefits--and costs--of guaranteed products. Tom Buckingham, senior VP, life and annuity product development at Phoenix Investments, says that considering the low interest-rate environment, clients need more exposure to the equity markets, but they also need protection on the downside. "Given what's happened over the last 15 months, people are shy," he says, "about putting money into the equity market....I think people need exposure because their assets have declined and a lot of people have probably not set aside enough money" with which to retire. The best products to offer equity exposure with downside protection, Buckingham argues, are VAs with guaranteed minimum withdrawal benefits (GMWB) or guaranteed minimum income benefits. Buckingham says Phoenix and several other companies have extended some of those GMWBs to mutual funds and managed accounts.

Phil Michalowski, director of annuity product development at The Hartford, says that the trouble with guaranteed products is that "they are based on equity guarantees, and what we've all seen is the cost of those guarantees have become extremely high," while over the past year "the benefits [have been] scaled back." Michalowski says that The Hartford's recent launch of its Personal Retirement Manager is designed to address the high cost of guaranteed products and provide more flexibility for advisors and their clients. With the Personal Retirement Manager, "we took a very basic variable annuity chassis with approximately 60 subaccount options, and instead of taking an income guarantee and wrapping it around the entire annuity product, we are using a payout annuity structure," he says. "So what we've created is a fund within the product that's a payout annuity structure. That allows each advisor and customer to create a solution that fits their needs. If you think of the lifetime GMWB product, it's a one-size fits all." With the Personal Retirement Manager, a client can "allocate the dollars to income that [they] need, and when they've generated the amount of income that they need, then the rest of [the money] can remain invested in the subaccounts at a very low cost."

Making Products Understandable

Kristi Mitchem, head of U.S. defined contribution at BlackRock, says that as retirement service providers understand more about retirement plan participants, they understand how essential it is to make product designs easier for them to grasp. "That's essentially what we're doing with our concept to utilize annuities within a target date fund" through BlackRock's SponsorMatch product, she says. SponsorMatch, which has been available since 2008, "is about matching these lifetime benefits that were once provided by the sponsor inside the 401(k) plan. So it's a lifecycle fund, but instead of rebalancing between equities and fixed income, it rebalances between equities and deferred fixed annuities," she explains. "So we take a lot of the guesswork out of the game for the advisor and the consultant because as a fiduciary asset manager, we are determining how much to annuitize, when to annuitize, the price at which we annuitize--all of these very difficult decisions are actually done inside the fund."

Mitchem says "a lot of the noise" about the losses incurred by target date funds during one quarter in 2008 "is premature...because these are long-term products." A lot of the pressure, she says, "has come off of target date funds as the market has recovered." What's interesting about SponsorMatch, she continues, "and income products in general, is it really takes a lot of the heat off of the glidepath because they do provide for guarantees in retirement."

Reynolds says Putnam is working with its sister company, Great-West Life, and other providers, to develop insured products, and also working with Putnam's asset allocation group "on ways to structure a portfolio using relative return products and absolute return products, which give you returns at much lower volatility and a combination to create a lifetime income stream." To Putnam, he says, the relative return and absolute return strategies have "particular play and are great tools, it's the next step down the path from aged-based or lifestyle funds."


Washington Bureau Chief Melanie Waddell can be reached at mwaddell@investmentadvisor.com.

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