Helping clients plan for retirement is one of the major jobs for advisors. Helping in that task are retirement planning calculators, investing theories and vehicles, and Social Security strategies galore.
Advisors and their clients must live in the real world, however, and all those tools must incorporate what we know and are learning about psychology, the markets, regulation and legislation, and demographic trends. To help advisors provide the best retirement planning advice for their clients, we list here some of the most salient issues that you should be considering in your process. Some you may know, others you may not have considered as burning issues, but taken together these five issues provide a snapshot in 2014 of what near-retiree and in-retirement clients are and will be facing. We humbly suggest that you read on to better prepare your practices and your clients for this new reality of retirement.
Issue 1: The Feds and Retirement
While advisors helping their clients plan for retirement must address many issues, the elephant in the room is always the Federal government, including actions by the executive branch, Congress and regulators like the Department of Labor. Here are three initiatives that may affect how advisors help their clients plan.
First is the DOL's proposed regulation that would require retirement plan sponsors to project participants’ actual income in retirement. Second is President Barack Obama's plan unveiled in his State of the Union Address for a “myRA” proposal. Third is legislation introduced in January by Sen. Tom Harkin, D-Iowa, that would create a new type of privately run retirement plan.
While all are steps forward in helping address the retirement savings crisis, advisors and industry officials are giving Obama's myRA accounts mixed reviews.
Executive Action: myRA
Obama directed the Treasury Department to set up myRA, a savings bond that he said “encourages folks to build a nest egg.”
Workers earning less than $191,000 per year could invest in a myRA with no tax penalty for withdrawals. Initial investments could be as low as $25, while subsequent investments could be as little as $5 and would be automatically deducted from workers’ paychecks.
Once a worker accumulates $15,000, or has the same account for 30 years, they would have to roll it over to an IRA.
The accounts would have the same variable interest rate return as the Thrift Savings Plan Government Securities Investment Fund.
Harold Evensky, president and CEO of Evensky & Katz, said that while myRA “may open up savings opportunities for those with incomes at the low end of the ‘middle class,’” it will be “of little interest for many middle-class investors.” Families with incomes of $50,000 to $100,000, “are likely to be in a position where parsing savings down to $5 a pop is not necessary.”
Bottom line, said Evensky, “If [myRA] encourages even a few extra people to save, I think it's a valuable concept, but not one to justify changing the tax advantages of a traditional 401(k).”
Obama caught the ire of retirement planning officials when he asked Congress during his State of the Union speech to help him “fix an upside-down tax code that gives big tax breaks to help the wealthy save, but does little to nothing for middle-class Americans.”
Obama's budget for 2015, which is expected to be released this month, is rumored to propose, once again, to cap higher earners’ retirement contributions.
John Comer, principal with Comer Consulting and an adjunct professor at Minnesota State University Mankato, said that myRA “will allow consumers who cannot find a vehicle for small savings amounts to save,” and the accounts “allow employers to provide a way for their employees to save without the administrative costs and liabilities of a qualified plan.”
But myRA “is not likely to do much for anyone who is already working with an advisor because they are presumably already saving. It does not appear to be a way for people who are already maximizing their savings to save more,” added Comer.
Congressional Legislation: The USA Act
Sen. Harkin's Universal, Secure and Adaptable (USA) Retirement Funds Act, introduced in early January, is comprehensive legislation that Harkin says “tackles the retirement crisis head-on by ensuring that every working person has the opportunity to earn a safe, portable and secure pension.”
The USA funds would create a new type of privately run retirement plan intended to combine the advantages of traditional pensions—including lifetime income benefits and pooled, professional management—with the portability and ease for employers of a 401(k).
DOL Proposes: Showing the Number
Harkin's bill also includes a provision that supports the DOL's upcoming proposal to require sponsors to provide an illustration on participant statements that shows how their account balances translate into a dollar amount that they would receive in retirement. “Converting an account balance into a lifetime income can be a powerful incentive to save,” said Greg Burrows, senior vice president of retirement and investor services at The Principal.
Fred Reish, partner and chairman of the financial services ERISA team at Drinker Biddle & Reath, said DOL's proposal will be a “game changer” for plans. The proposed regulation “will change the way plans are seen,” Reish said. “Now, 401(k) and 403(b) account balances are seen as wealth; DOL is changing that to have them seen as sources of monthly income,” which will ultimately result in “more guaranteed insurance product discussions.” —Melanie Waddell
Issue 2: Paying for Health Care
Fidelity Investments’ annual retiree health care cost survey found that a 65-year-old couple retiring in 2013 could expect to spend $220,000 on health-related expenses in retirement. Although that's down 8% from 2012, it's still a big number for a lot of retirees, many of whom have not factored that expense into their retirement planning.
That doesn't even include nursing home care, which Genworth's 2013 Cost of Care study found could run as much as $75,555 a year for a semi-private room and $83,950 for a private room.
“Most of us would aspire to retire early. We know that Social Security can kick in at 62 if you’re willing to take a 25% haircut in your benefits, but what a lot of people don't think about is that Medicare doesn't kick in until 65,” Larry Sinsimer, senior vice president of practice management for Fidelity, said in an interview. “In the past you had to worry about a pre-existing condition, but under the Affordable Care Act, if you got the platinum coverage, which would be comparable to what people are getting from their employers today, it’ll cost a married couple, aged 62, $2,000 a month,” or $72,000 until the couple qualifies for Medicare coverage. “That's $72,000 after tax,” Sinsimer pointed out, “which really equates to about $125,000 pre-tax that you have to put away just to cover that three-year window because you decided to retire prior to 65.”
Coverage can be especially problematic for couples where there is a significant age gap. “Say we have a woman who's 15 years older than her husband and she's the major breadwinner,” Sinsimer said. “She retires at normal retirement age, but her spouse is 15 years younger, and he's been covered by the company health care. Now she's on Medicare but he's not, so he has to go get health care.” Continuing with the scenario, Sinsimer said, “Now let's make that 15-year-younger person not working but they also have a congenital heart defect. Prior to the Affordable Care Act, that person couldn't get insurance. Where the ACA provides a benefit is not only would it be expensive to get coverage for that heart condition, it would be difficult to get coverage at all.”
High and Getting Higher
Health care is the biggest expense retirees have to account for after food, shelter and clothes, Sinsimer said, and it's rising at three times the rate of overall inflation. “National health spending projections, even after health care reform, expected that health care for retirees would continue to rise about 6.3% per year.”
Regardless of how difficult it is to engage clients in these conversations, it's in advisors’ best interest to do so.
“The great benefit to the advisor of having this conversation is that as people come into retirement, they’re going to shrink the number of advisors they’re using. They’re going to consolidate their assets, so the advisor who can really add the value-add, who can point out some of the things they haven't thought about, that's the advisor who's going to end up winning as clients begin to consolidate where their assets are being held.”
Sinsimer noted that it's common for advisors to have more of a relationship with one part of the couple, and it's not always the husband. “Very often it's the wife who manages the money and may be the major breadwinner, but one or the other has the relationship with the advisor,” he said. It's critical that the advisor have that conversation, perhaps separately at first, then together “so that they get on the same page. If you’re working with only one or the other, then the plan's never going to work.”
For example, it's not uncommon for a couple to have different ideas and not realize it. An advisor may find that “the husband thinks he's going to get a cabin on the Platte River in Idaho, and the wife thinks they’re going to get an apartment next to the grandkids,” Sinsimer said. Instead, Sinsimer argued that it's important that the husband and wife share their personal “vision of retirement,” including when and where they want to retire.
First, Show Clients’ Pre-Retirement Expenses
The “where” in retirement becomes especially important if clients are considering a move of their primary residence. Many doctors aren't accepting new Medicare patients, and compounded with a shortage of primary care doctors already, Sinsimer said, clients might have to add the cost of flying back home for a doctor visit when estimating their health care needs.
It can be hard enough to give clients a realistic view of what they spend currently, much less to anticipate what they’ll need in the future. Sinsimer said most clients will know their incomes and how much went into their 401(k)s, but what they may not know about their spending is “Where did the rest of it go?” He suggested using tax forms and credit card statements to show exactly where clients are spending their money. If they spend $700 a month dining out while they’re working, do they really expect to be happy eating every meal every day at home when they’re retired? —Danielle Andrus
Issue 3: Adult Children Living at Home
Cam Marston tells a funny story using the experience of newborns to illustrate the difference between baby boomers and the succeeding generations. The baby boomers’ parents walked out of the hospital with their newborns and put them on the front seat of their non-seatbelt-equipped cars in a blanket, while attempting to keep their cigarette ashes from falling on the baby. Baby boomers’ children were rolled out to their parents’ car in a wheelchair, placed in the rear seats of their cars in a backward-facing infant car seat made of industrial-grade plastic and secured with complicated belts and titanium hooks. Is it any wonder, he says, that the boomers’ children have a different outlook on life? Is it any surprise that those children have different expectations of what the good life can be, and that their parents will play a deeper, even friend-like, role as they enter adulthood?
Marston is one of the most insightful observers of the differences between generations and what those differences mean for advisors. In a presentation at the TD Ameritrade annual conference in late January, his musings on those differences highlighted one of the biggest retirement planning issues for boomers: Their children are not leaving the house. Perhaps better put, the Gen Y and millennial generations have a much different relationship with their parents than did the boomers, so they’re comfortable with living at home throughout what Marston calls their “adult-olescence.”
The problem with that sociological trend—a 2013 Pew Research study found that 22 million millennial children are living with their parents, the greatest number since 1949—is that those young adults are soaking up a significant amount of the financial resources of their near-retirement or already-retired parents. They also are not aware of how their comfortable living arrangements are affecting their parents.
A Securian Financial study of 700 millennials living with their parents released in September 2013 found that 19% have no idea what kind of impact, if any, their living at home has on their parents’ finances; more than 90% have no deadline for moving out; only 10% pay rent and 82% “pay” for their room and board by “helping with household chores.”
Those numbers have a big impact on those parents’ retirement planning. The employment situation for young people isn't helping either. The January 2014 unemployment rate for teenagers (ages 16 to 19) stood at 20.7% and was at 11.9% for those aged 20 to 24. At a time when pre-retirees are traditionally spending less—their mortgages and college bills may be behind them, for instance—and their incomes are traditionally at their highest levels, this unexpected and unplanned-for expense of hosting their young adult children can put a strain on their retirement planning finances.
As with most planning challenges, however, there's also an opportunity for the informed advisor. Getting involved with clients’ children at this critical time for them—teaching them budgeting skills and perhaps even providing career advice—can not only help your clients address this financial problem but can also build bridges with that next generation who could be your next generation of clients. You might also point out that when it comes to employment, it's still the case that the higher the education level attained, the lower the unemployment rate: The unemployment rate for all workers with at least a bachelor's degree was only 3.2% in January 2014, compared to the overall jobless rate of 6.6% —James J. Green
Issue 4: Retirees Spending Too Much
In a presentation at the Think Retirement Income Symposium last year, advisor Harold Evensky displayed a photograph he had recently taken on a luxury cruise: a passel of walkers, wheelchairs and oxygen tanks parked beneath a cruise ship stairway. Evensky's point: Advisors’ assumptions that people spend less as they age is misguided. “People continue spending until they die,” he argued. While the assumption is that people grow sicker as they age, and thus spend less in retirement, the fact is that “people are living longer and are healthier for longer,” he said in an interview last year.
Traditionally, researchers have suggested that an income replacement rate of somewhere between 70% and 80% of pre-retirement income is necessary to maintain a similar lifestyle in retirement, but pinpointing that amount requires an accurate picture of a retiree's actual expenses. Bureau of Labor Statistics’ data suggests that spending on health care increases by 25% during the first decade after age 65—even while overall spending drops. A study published in November 2013 by David Blanchett, head of retirement research for Morningstar Investment Management, reviewed the wealth of research on the topic, both in the United States and abroad, and concluded that his own research indicates that expenses “actually decrease in real terms for retirees throughout retirement and then increase toward the end.” Blanchett concluded that “the real change in annual spending through retirement is clearly negative.”
A November 2013 Fidelity Investments report that heavily relies on the Bureau of Labor Statistics’ “Consumer Expenditure Survey” noted that for planning purposes, “many people experience above-average expenses” in retirement, “particularly if they live longer than today's average life expectancy or incur long-term care costs.” There's also solid evidence that a wealthier person tends to live longer and be healthier in old age than their less-wealthy counterparts. Wealthier people tend to keep more of their income in retirement than their poorer counterparts due to their lower taxes in retirement.
Then there's the psychological expectations of retirees. “Most people see their standard of living increase throughout their working lives and look to at least maintain that in retirement,” the Fidelity report said, quoting Steve Feinschreiber, a senior VP for Fidelity Strategic Advisers.
Wealthier retirees can control more of their expenses since, as Steve Devaney, director of financial solutions at Fidelity Strategic Advisers, argued, “Higher-income earners use less of their income for essential expenses and more of their income for savings and discretionary purchases.”
Using data from the annual U.S. Bureau of Labor Statistics’ “Consumer Expenditure Survey” and from the biennial “Health and Retirement Study” survey conducted by the Survey Research Center at the University of Michigan, Morningstar's Blanchett made these conclusions on retiree spending for the average U.S. retirees:
Spending drops modestly (14%) immediately after retirement, partly due to the cessation of work-related expenses and changes in food expenditures.
Inflation-adjusted spending continues dropping slowly after retirement as retirees age into their late 70s.
Housing and housing-related expense is by far the largest spending category for all age groups.
Health care expenses rise with age, but remain substantially lower than housing expenses.
Increases in health care spending are not sufficient to change the downward trend in total inflation-adjusted spending, at least not until late in retirement.
Moreover, Blanchett said that the size of the typical spending drop upon retirement “is inversely related to household wealth.” However, he also provided some insight into actual retiree spending: “Not all retirees exhibit a spending drop: About 53% of households exhibit a drop in spending at retirement, another 35% report a negligible change in spending at retirement, while 12% reported an increase in spending at retirement.” Finally, expenses in retirement must also take into account the 25% to 28% of people who involuntarily retire, usually due to health conditions.—James J. Green
Issue 5: Off-Target Target-Date Funds
Assets flowing into target-date funds at the end of 2013 totaled $13 billion, according to Morningstar, up from $2.3 billion in the third quarter. That's in spite of average total returns coming in at just over 5% for the fourth quarter—half the return of the S&P 500—and about 16% for the year—again, half of what the S&P returned in 2013.
So what do investors see in target-date funds? Assuming most advisors don't choose TDFs for individual clients, are they appropriate for plan sponsors to include for participants?
Catherine Gordon, principal in Vanguard's Investment Strategy Group, said that for some plan participants, the attraction is a combination of investors’ confidence in investing and how they want to spend their time.
“Someone might feel perfectly comfortable and say, ‘I can build my own portfolio, but there are other things I want to do,’” she said. “There's an appeal there, as opposed to someone who might say, ‘I really don't have a lot of confidence in my ability to build my portfolio,’ and target-date funds are a reasonably straightforward concept to communicate.”
However, Ron Surz, CEO and president of PPCA and president of Target Date Solutions, said that at least some of the flow of assets into target-date funds aren't from investors choosing them at all.
“The vast majority of the assets, from what I’ve read, are there because the plan sponsor, and actually the plan advisor, has chosen target-date funds” as the qualified default investment alternative (QDIA) for automatically enrolled participants, he said in an interview.
By choosing TDFs as a QDIA, sponsors could be “removing a layer of fiduciary insulation” because when the fund is chosen for the employee, it's no longer participant-directed. Gordon, however, disagreed. “Employers who select target-date funds as a default are given safe harbor under the Pension Protection Act. I’m not sure I would agree necessarily that it removes a layer of protection because the fiduciary responsibility comes at the plan level, not at the individual fund level,” she said.
Surz sees advisors often make two assumptions about defaults that are wrong. “They have this misperception that first of all, any QDIA will do because it's qualified so it's a safe harbor; and second, that you can't go wrong with the big three: Fidelity, T. Rowe and Vanguard. ERISA attorneys tell me that both of those perceptions are wrong,” he said.
Surz said that “throwing a dart at the QDIA dart board is not a fulfillment of fiduciary responsibility,” and even though TDF providers may have products that can replace pay and manage longevity risk, not all participants have the same objectives for a fund. “If you’re going to replace pay for a work force of 20,000 people, the best you can do is try to structure a portfolio for the average employee, but among 20,000 people, there are going to be some people that are not at all like the average employee.”
The idea behind TDFs is not a bad one, Surz admitted. “The general idea is good in that it can—but it doesn't—provide important benefits for plan participants: broad diversification and risk control. The cons are, in my opinion, the industry has a long way to go to provide the best it can in those two areas.”
Diversification is improving in TDFs, Surz said, although he thinks they’re still too U.S.-centric, but the big problem is the risk allocation in funds for investors nearing their target date.
“If you look at the risk at the target date today versus where it was in 2008 for funds near retirement, it's the same. Nothing has changed. Diversification is getting a little bit better, fees are getting a little better, but the risk controls are still as lousy as they were when we had this catastrophe,” Surz said.
Surz thinks TDFs should have zero allocation to risky assets by the time they reach their target date. The funds he manages are entirely allocated to 90-day Treasury bills and two-year TIPS at the target date. To people who say retirees can't live on T-bills and TIPS, he says, “‘You’re absolutely right. All I’m trying to do is get them safely to their target date with their assets intact.’”
The Department of Labor has said that it expects to release in March more details about a rule requiring more disclosure on the investments in TDFs, and the SEC is considering a rule this year as well. —Danielle Andrus