Michael Finke, dean of the American College of Financial Services and director of Texas Tech University’s department of personal financial planning, has some lessons for financial advisors working with clients on their retirement plans that might surprise them.
Although many people fear they will run out of money in retirement, the reality is that a large number of them don't spend as much as they should if they want to enjoy their golden years, according to Finke.
“People aren’t spending enough in retirement,” said Finke, who spoke at this week's CFA Institute Wealth Management conference in Minneapolis, a presentation that was also webcast. “They’re missing out on how they could have lived in retirement." He suggested that advisors develop strategies “that allow retirees to get the most out” of retirement.
According to a Texas Tech Retirement Planning and Living Survey retirees scrimp on spending in retirement because they don’t know how much they can spend and still live comfortably (40%) and they worry they won’t be able to live a desirable lifestyle (43%). Only 11% cared about leaving a large bequest.
Slightly more than half were uncomfortable if the balance in their investment portfolios fell during retirement. About three-quarters said certainty about their income was more important than the performance of their portfolio.
The result that their median spending is about 45% of their gross income. Overall spending in retirement declines over time, according to Finke. In the first year retirees tend to spend as much as they did the year before retirement, but as they age they spend less. Retirees are less active as they get older and many also worry about health care costs, said Finke.
Those worries may be missplaced. In most cases the rise in health care expenditures is relatively modest -- 14% of annual spending for those over age of 65 versus 10% pre-retirement, said Finke. As retirees age and reach their 80s or 90s, however, health care spending rises and the increase can be exponential. “It is that tail risk that will jeopardize a retirement income plan,” said Finke.
And more retirees are living longer.
According to the latest Society of Actuaries Mortality Table there’s a 40% chance that one person in a married couple, both aged 65, will live past 95, said Finke, adding that this “tail risk” is even more pronounced for wealthy couples. “Wealthier folks are living longer.”
If advisors use a 30-year time horizon post-retirement and a 4% rule for annual withdrawals there’s a rising risk that those clients who live past will run out of money, according to Finke.
Using Monte Carlo simulations Finke showed that 13% of retirees aged 95 or above would be out of money if they started with a little over $1 million in assets and began annual 4% withdrawals between ages 65 and 69. The median would be left with about $355,000 in legacy assets.
He warns against long-term care insurance with short-term elimination periods as a hedge against that tail risk and favors instead deferred annuity contracts known as QLACs A $125,000 AQLAC will pay almost $70,000 a year for the rest of retirees life started at age 85, and is about one-third the price of building a bond ladder, said Finke. But if the retiree dies before age 85, there likely will be no money for heirs. A conventional QLAC does not have a death benefit.