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We planners and advisors face a psychological as well as a financial challenge in preparing clients for retirement.

Americans are obsessed with “winning the race,” chasing accumulation and net worth, not “finishing the race.” That is, many people do not focus on embarking on a lifetime plan that is consistent with their risk tolerance, aligned with goals and sustainable (if maybe not designed to make us multi-millionaires). Following are some personal observations on this psychological conundrum, gleaned from client experience, plus some ways I have used logical arguments to start to overcome it.

Americans have more personal responsibility for their retirement than ever before. 401(k)s have replaced defined benefit plans as the primary vehicle for retirement investing. Personal responsibility now requires the ability to be a disciplined, rational investor in difficult times, and many investors cannot do this.

This flawed approach to retirement stems from years of learning about accumulationand very little about distribution. A common situation that results from this is clients growing assets in their working years and then pursuing a “spend down” strategy at retirement with little thought given to how long that income might last.

It?s true that, in these times of more reasonable equity market growth, expectations of market return have lessened somewhat. However, many people still feel they can safely withdraw up to 6% or 7% from their retirement portfolio, when 3% or 4% is a much more realistic number.

In fact, one could argue that the greatest threat to investor return is investor behavior. The average equity investor earned a 2.6% annual return from 1984 through 2003, vs. 12.2% for the S&P 500 and 3.2% for inflation, according to a 2003 DALBAR study on quantitative analysis of investor behavior. This indicates that personal responsibility comes with a price.

Today?s focus should be on “finishing” the race. This requires a change in mindset.

First, everyone needs a dose of reality. As noted above, studies have shown that 3% to 4% is an achievable rate of annual withdrawal from a retirement portfolio while still preserving assets.

Second, everyone needs to realize that blending certain guaranteed income products (such as immediate annuities) into a retirement income strategy can potentially increase long-term sustainability. Currently, many people carry around a lot of historical misinformation with regard to annuities and retirement distribution strategies. The single largest hurdle is unwillingness to give up control of principal by annuitizing.

Incidentally, this is not only an issue for clients but also sometimes for advisors. Many advisors believe they can manage investments well enough to avoid the need for annuitization.

Finally, getting clients to grasp the concept of planning for future income is one of the major challenges that financial professionals must tackle. To do this, advisors must convince clients that accumulation is a means to an end, not an end in itself, and a broader lifetime view is needed for retirement planning. This is going to take time and education. I can tell you that I have been reasonably successful transitioning clients to an income focus by delivering a logical argument backed by solid analysis. But the discussion must be a personal analysis.

One example is Hank and Betty (see chart). These recent retirees have a $450,000 retirement portfolio, $40,000 of estimated annual essential expenses and $18,000 in annual Social Security income. A $22,000 annual withdrawal from their portfolio seems a very small amount but is actually a 4.9% withdrawal rate, which would put them at a strong risk of depleting their assets within their projected lifetimes. We suggested a different approach: Purchase a $250,000 single premium immediate annuity, which provides $18,000 in guaranteed annual income for the rest of their lives. Supplemented by Social Security, they now can meet their annual essential expenses with just a $4,000 withdrawal from savings, substantially decreasing their worries of running out of money.

In sum, breaking down the many components of a retirement plan and creating a viable strategy is not a simple task but a necessary one. No single strategy will work if a client needs more than a 3.5% withdrawal rate.

Solutions must involve the following components: 1) educating clients and managing expectations; 2) using immediate annuities where appropriate to fund basic living costs; and 3) managing the balance of the portfolio using an allocation strategy consistent with the clients? risk tolerance and with enough liquidity for emergencies.

Retirees and near-retirees face a complex environment, and financial advisors need to be the retirement income experts who assist them. As a consultative resource for clients, one who helps create a holistic financial plan, the advisor will gain trust and grow clientele.

is a Certified Financial Planner with Genworth Financials Terra Securities, Schaumburg, Ill., where he supervises Terra Financial Planning Groups client assets. His e-mail address is norm.mindel@genworth.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 3, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.