The Bigger Picture is part of Investment Advisor's year-long 35th anniversary celebration in which we look at the environment in which advisors operate, and will operate, by delivering insights from some non-traditional sources.
Advisors who write financial plans for clients, and those who work with clients on their financial plans, take an individual's life expectancy into account. But how seriously are you factoring clients’ extended life spans into your retirement planning?
According to actuaries like Ron Gebhardtsbauer, clinical associate professor of actuarial science at Penn State University's Smeal College of Business, not nearly as much as you should. He believes that neither financial advisors nor their clients have come to terms with increased longevity and the risks it poses to financial plans and retirement planning in all its aspects.
“Consider that about 30% of couples aged 65 today will have at least one of them alive in 30 years, at the age of 95,” he pointed out. At least one of about 8% of couples aged 65 will live another 35 years, reaching the age of 100.
Think of how inflation could erode that couple's purchasing power over 30 or 35 years. Think of how defined benefit plans benefit only a small percentage of clients, then mix in the fall in the housing market during the Great Recession, and equity markets, which have suffered two colossal declines in the first 10 years of the 21st century. What's required, actuaries say, is a sweeping change in advisor mind-sets.
Part of that change must come from societal shifts, said Anna Rappaport, chair of the Society of Actuaries’ Committee on Post-Retirement Needs and Risk.
The obvious and increasing pressures of the aging population on Social Security and Medicare aside, our retirement planning needs to recognize that the retirement age has to be raised as people are living longer, she said, and take into account the fact that so many people will be working in some capacity even after they retire.
Beyond what government may or may not do, the onus nevertheless falls to individuals and their advisors to plan for a long life. Rappaport feels that even the most carefully written financial plans aren't being built to cope with increased longevity, because even among those individuals or couples who do make a reasonably good estimate of their remaining lifetimes, only a smattering plan adequately for the consequences of outliving average life expectancy.
“People are reading the age numbers and seeing that we’re living longer and longer, but unless they experience first-hand someone living to a very high age, they don't really get the full implications of that,” Rappaport said. “Most peoples’ financial plans haven't been thought out to more than five years after they retire. That has to change; the planning horizon has to be extended.”
Stages of Retirement; The ‘Life Portfolio’
For that to happen, Rappaport believes that both financial advisors and their clients must stop viewing retirement as monolithic.
There is too much of a focus on income generation in retirement, she said. Though advisors do gain an understanding of what their clients want to do in retirement in order to plan finances accordingly, they’re unwittingly viewing retirement as a “block” instead of something much more segmented that moves in phases and changes as clients age.
It isn't just about planning for changes in housing (moving from a private home to a nursing facility, for example) or calculating the cost of long-term health care, which many financial advisors and clients have addressed. For Rappaport, an extended planning horizon should include the more esoteric and hard to quantify “life portfolio.”
“I’d define a life portfolio as those activities a person might have in retirement,” she said. “Maybe someone has a part-time job, maybe they take care of a grandchild. Maybe in the years immediately following their retirement, they play tennis every day or volunteer for a half dozen things. All of these are items that give meaning to a life. Because they’re important in defining who someone is and what they do, they’re important for financial planning in retirement.”
Just as clients should be saving and planning for adequate income in retirement, Rappaport said advisors should encourage their clients to start developing life portfolios as early as possible. How these interests and activities will pan out in the future will become clearer not only in the five years or so before retirement, she said, but throughout a person's working life, “I believe it's important to have a life portfolio that helps them know who they are because ultimately, being passionate about things is very important.”
The Key Role of Annuities
The qualitative and quantitative aspects of longevity are a key area of focus for the Society of Actuaries via its “LIVING to 100” effort, which includes a triennial international research symposium that brings together thought leaders from around the world to share ideas on aging (an issue that impacts many countries around the globe), increases in survival rates and the resulting increase in aging populations, together with the implications for social, financial, retirement and health care systems.
As an actuary, Gebhardtsbauer—who prior to teaching at Penn State served as senior benefits advisor to the chairman of the U.S. Senate Committee on Finance—also believes that advisors must do a more thorough job of encouraging their clients to purchase annuities. While annuities have received a great deal of negative press, especially among fee-only advisors, he suggested the products have improved and advisors shouldn't ignore them anymore.
Clients should purchase annuities before they reach retirement, since “having chosen an annuity and the chance to be golden the rest of your life” is a huge positive, Gebhardtsbauer said.
Gebhardtsbauer views annuities as crucial in managing longevity risk because they provide a steady income stream, but he cautioned that a whole lot of income may not be so necessary in clients’ advanced ages.
“A big part of the problem today is that everyone believes they are going to need so much more than they actually will when they’re living into those very old ages,” he said. “People want to make more and more money now because they think that's going to be important later on, and they’re much more focused on accumulation than they should be.”
With the increased probability that people will live into their 90s if not beyond, “it's good to have an annuity that will go as long as you live and you don't have to worry about the stock market crashing,” Gebhardtsbauer said.
Purchasing annuities is not an absolute guarantee for longevity risk, of course, but it is one key strategy to reduce the risk of outliving your financial resources.