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Stress-Testing Retirement Plans

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When everything is going right with your clients’ retirement plans, it’s easy to overlook the potential exposures. But as the bear market and housing slump have reminded us, life is full of surprises.

Dan Richards, owner of consulting firm Strategic Imperatives in Toronto, Canada, says that advisors need to stress-test three parts of clients’ retirement plans:

1) How much they’ll spend in retirement,

2) How much they’ll save for retirement, and

3) The risk they’ll take in investing to achieve their goals.

Stress-testing — also known as scenario analysis — starts with a base case developed on reasonable assumptions for the key variables. Each subsequent scenario modifies a variable — higher inflation, lower portfolio returns, etc. — to determine how the modification affects the client’s retirement plan. Richards details the steps on his blog at

Stress Test One: Spending

Once you’ve created a base case (perhaps with a high spending and low spending scenario) you can stress test for the impact of higher than expected inflation (a growing concern among some economists due to the record levels of spending by governments around the world) and the effect of unanticipated expenses such as an extended stay in a long term care facility or nursing home.

Stress Test Two: Saving

Many clients have already increased savings levels and made the decision to defer retirement. A recent survey indicated 60 percent of investors are concerned about someone in their house being laid off – you can stress test the impact of clients losing their jobs or earning less part time income after retiring than expected.

Stress Test Three: Risk Taking

Given what’s happened to markets, many investors would prefer to avoid risk entirely, so you could start by stress testing a retirement plan for the impact of the 2 percent return currently available on guaranteed investment contracts. For most Canadian investors without guaranteed company pension plans, a 2 percent return means they’re almost certain to run out of money in their 80s. You can do further stress tests at 4 percent, 6 percent and 8 percent returns — looking at the greater volatility and risk that comes with each of those higher return levels and helping clients understand the tradeoffs between risk and return.

“One of the critical things that you achieve by going through the kind of scenario planning that I’ve described is that you are able to communicate to clients that they do have options, they do have choices,” says Richards. “For example, if you (the client) choose to, we can scale back on how much you spend at retirement or you can choose to work longer. There are things you can do. I think that’s a critical message that advisors need to communicate to clients. That they aren’t just powerless victims in the current environment.”

Kathy Fish, CFP and owner of Fish and Associates in Memphis, Tenn., an affiliate of NFP Securities, Inc., regularly performs a version of stress-testing with her clients. The reviews consider asset allocations, investment returns, and spending patterns. She works with analytic software from BetaVest to help illustrate scenario outcomes and says that the conversations have been worth the effort.

“I have had to have difficult conversations with almost every client that’s taking income,” she says. “Maybe they were taking a 4 percent withdrawal overall off the portfolio and now that’s moved up to 6 percent because of how the market’s performed. Everybody was open to the conversations, because this whole meltdown was unlike anything any of us had seen in our lifetimes. You have to have these conversations with your client if you are doing the right thing, as far as I’m concerned.”