Much time is spent helping clients create strategies to save for retirement so they are able to comfortably retire on their terms. But saving is just the beginning. Equally important to accumulating assets is having a retirement income strategy that will endure through retirement.
Financial professionals can help clients build a solid retirement income strategy that may be protected against several risks including the impact of inflation, longevity, the rate of consumption, and market volatility. Take these risks into consideration and discuss how they can potentially impact a client’s portfolio to help them feel prepared and more secure when their last day of work arrives.
When helping clients build a retirement income strategy, ensure that inflation doesn’t erode savings faster than expected.
(Related: 3 Common RMD Errors Advisors Must Avoid)
According to a recent Allianz Life inflation study, nearly one third of Americans claimed they were either “panicked” or “very worried” about inflation, yet 64% of them did not have a financial plan to address the rising cost of living in retirement. This is where financial professionals can truly make a difference. Discuss what inflation increases may mean for clients and their retirement income – especially as retirements potentially last longer.
Consider this, the U.S. Census Bureau projects that clients retiring today at age 65 could expect to live at least another 20 years based on life expectancy tables. Even with a modest inflation rate of 2.5%, costs would double over the course of a period of 28 years. Those planning an early retirement will need to pay even closer attention to inflation risk as their retirement may last longer.
On average, the Census Bureau also estimates that by the year 2020 women will live to be 81.9 and men will live to be 77.1.
Compare that to 1935, when life expectancy was just over 59 for men and slightly above 63 for women, and it’s clear that managing longer lives creates an increased need for income protection in retirement, especially as assets are drawn down. Social Security, which was a large part of retirement income in the past, may not be enough to effectively address inflation in the future and may be a smaller portion of a retiree’s overall income. To make up the difference, other income options may need to be explored.
With longevity also comes higher health care costs and medical expenses.
It is estimated by the U.S. Bureau of Labor Statistics that retirees who are 65 and older can expect to spend 12.2% of their income on health care expenses (as compared to 4.6% for 25-to 34-year-olds). Also consider the fact that Social Security cost-of-living (COLA) increases may not cover the rising costs of healthcare like Medicare.
Case in point: The average annual COLA increase over the last 30 years was only 2.6% which did not make up for the average annual Medicare Part B premium increase which was 6.2% during the same timeframe, according to data from the Social Security Administration and the Centers for Medicare and Medicaid Services. As health care costs continue to take up a greater portion of expenses, retirement income that used to go towards other expenses can be at risk, especially as clients live longer.
3. Rate of Consumption
Retirement often means moving to a lifestyle where every day is the weekend. While most of us look forward to this, many people find that because of this they actually spend more in retirement than originally thought. If clients are too conservative with their assumptions, their standard of living in retirement may not be what they hoped for.
Financial professionals can help clients manage these expectations. Our study found nearly four out of 10 respondents felt either “panicked” or “very worried” they might not be able to afford the lifestyle they want in retirement due to an increased cost of living and claimed their plan to address this was to “be more frugal with money.”
While it may be an expense management tactic, clients should understand that frugality may not be a viable long-term solution as they want to spend their money on experiences, travel, and may run into unexpected expenses like supporting a family member. Building a flexible retirement income strategy can also help manage the rate they spend their assets.
4. Market Volatility
A final risk to discuss with clients when creating a retirement income strategy is market volatility.
When retirement is several years away, volatility isn’t a major factor because there may be time to recover. But when income begins, volatility can be a game-changer on how long retirement savings can last. Encourage clients to protect a portion of their income from market downturns by giving them options to protect their nest egg.
When asked, respondents in the Inflation study expressed interest in a solution that gave them the chance to have income that increased throughout retirement. The vast majority (73%) of respondents even preferred the idea of a financial product that starts with a slightly lower income rate, but offers the possibility for income increases over time compared to one that has a higher, but fixed, rate. Knowing this, take these solutions into consideration when discussing a client’s overall retirement income portfolio.
Clients may take more time planning the first half of their retirement – the accumulation of assets; but could need even more help planning the second half of their retirement – an income strategy. Explore solutions that can help clients manage risks that could impact their retirement income so they can be more prepared to address the effects of inflation, provide an income that can’t be outlived, and have protection against market downturns. With an appropriate strategy, their retirement story can have a more secure ending.
--- Read Allianz Life Hires Debra Repya As Senior Director of Advanced Markets on ThinkAdvisor.