Retirement income planning is now more important and relevant than ever to an aging American population. With more than 77 million baby boomers beginning to make the transition from saving for retirement to spending in retirement, new strategies are needed for retirement income planning that help individuals identify, quantify and balance a number of retirement risks so that they can increase the likelihood of meeting their financial retirement goals.
Why? Because the familiar methods and approaches often lead to retirement plans that are doomed for failure.
The abundance of retirement risks includes not only market volatility (both equity and interest rate) but the likelihood, and severity, of illness; longevity, including that of partners; the order of death for a couple; and the variable nature of inflation.
While addressing these risks is complicated enough on its own, there are two added layers of complexity when building retirement income plans: one, the delicate combination of the clients’ risk tolerance and their personal definition of success…whether that means the lifestyle they hope to lead in retirement, or their desire to transfer wealth (for many, success is some combination of both); and two, the fact that for many, they will not be able to achieve everything and will need to make decisions involving risk/reward trade-offs.
However success is defined, here are 10 mistakes to avoid if your clients are to increase their odds of achieving their retirement income goals:
1. Planning to a Specific Life Expectancy. Average life expectancies are deceiving. Mortality is variable, not fixed. Planning to a specific age can be dangerous because by definition, 50% of people will live longer than this estimate. In fact, more than 25% of people will outlive their life expectancy by a period of 8 years or greater. Clearly planning for assets to sustain a plan to a specified age can lead to a situation where assets are exhausted before death. Couples must also discuss the possibility of a spouse living for an additional 20 years without their partner, which can have a significant impact on cash flow (both income and expenses) for the surviving individual.
2. Relying on Average Rates of Return for Assets. Traditionally, asset accumulation planning has relied on an assumed fixed rate of return. Unfortunately, no one can predict future performance of any asset class unless it has a guaranteed rate of return. Market volatility needs to be reflected realistically in the development and testing of an effective retirement plan.
3. Following the Herd. Do not let your clients act according to fads or popular trends. Everyone needs to examine the risk trade-offs they are willing to make and evaluate their objectives and plan accordingly. What are their goals? Lifestyle requirements? Priorities? Willingness to assume risk?
Some clients can afford to take more risk with their financial planning, while others need to be conservative, and planners can help determine what mix of products and strategies works best for their customers. If individuals follow the herd, they are planning based on the needs of others, not their own. It’s important to help clients remember that retirement income planning is not a “one size fits all” solution and following a canned formula could provide less than satisfactory results.
4. Forgetting Uncle Sam. Retirees need to understand that liquidating assets often comes with an expensive price tag from the government. For example, the tax implications will be different for withdrawals from a deferred fund vs. a tax-free fund. The choice of timing when withdrawing assets depends on your client’s total financial picture and should be reviewed with a qualified tax advisor.
Tax advisors can guide prospective retirees in the selection of an efficient order of liquidation based on their specific situation using specialized tools and methodologies to optimize the process. Planners need to be upfront about various tax implications so that retirees will not be surprised when the taxman comes knocking at their door on April 15.