It’s a dynamic and distinct discipline, yet retirement income planning continues to mystify many financial advisors, who are relying on classic investment advice to solve issues that require new thinking.
As Fran?ois Gadenne, executive director of the Retirement Income Industry Association, frames it: “The difficulty with the retirement income issue is that we’re like the plumber showing up for an electrical job. One job deals with the flow of water, the other the flow of electrons. I think we all know that if you take plumbing tools, especially if they’re wet, to an electrical job, you’re not going to like the results.”
The analogy pinpoints the crux of the challenge facing the retirement income planning community today: How does the forward-thinking advisor prepare clients for retirement when so many of yesterday’s rules no longer apply?
“Retirement income planning is not just accumulation planning in reverse. It requires different tools, techniques and skills,” according to Howard Schneider, president of the consulting firm Practical Perspectives and co-author of the 110-page report,The Continued Evolution of Retirement Income Delivery: An Analysis of Leading Practices in Advisor Support.
Far more than investment management, Schneider says, retirement income planning involves a broader focus, a more pervasive risk and a different mindset. “Investment management is not the be-all, end-all in terms of helping someone prepare for retirement,” he adds. “The reality is that once you’re in retirement, almost every decision you make — whether it’s financial or not — has a financial impact. The state of your health, where you’re going to live, whether you work part-time — all those things have a financial implication in retirement. And it all circles back to this: Do you have enough resources to get it done?”
Disappearing pensions, the threat to Social Security, and the increase in life spans have been talking points in the retirement income planning debate for years. No news there. But the damage inflicted by the recession to investor wealth has served as an ugly reality check that has elevated the conversation to another level, according to Gregory Salsbury, executive vice president of Jackson National Life Distributors and author of Retirementology: Rethinking the American Dream in a New Economy.
“Retirewent,” Salsbury calls it. “Investors have seen the black swan. They have been fundamentally and emotionally changed by what’s unfolded the last two years. Lots has changed: expectations, legacy planning, how much to gift, how much to contribute charitably. Guarantees are no longer nice to have, they are a must-have. An advisor’s best effort is no longer good enough. I don’t want a pretty good chance of having enough retirement income for the rest of my life. I want a guarantee,” says Salsbury. “The best advisors aren’t going to go back to standard asset accumulation and planning strategies. They simply can’t.”
What are the major issues facing advisors in the retirement income planning space today? Here’s our checklist, with expert commentary from some of the industry’s top thinkers.
Given this era of global financial turmoil, to what extent should advisors rethink retirement risk management?
While volatility in the capital markets has always been on the table, it’s something investors haven’t paid much attention to in recent years — until now.
“It’s how you feel when you actually lose a big chunk of your portfolio that folks are having to sit up and confront,” according to Olivia S. Mitchell, a professor of insurance and risk management at the Wharton School at University of Pennsylvania and executive director of its Pension Research Council. “In the current era, people are much more conscious of downside risk.”
Also in play: inflation risk, longevity risk and what Mitchell calls “political” risk. “How can we possibly make good decisions about our retirement nest eggs if we don’t know what we have to pay in taxes 10, 15 and 20 years from now? The whole area of retirement risk management has so many more challenges today,” adds Mitchell.
A self-described inflation hawk, Mitchell is a fan of Treasury Inflation-Protected Securities. She says advisors should also give payout annuities and income insurance a hard look.
To adapt to the new climate, she suggests advisors do two things: 1) Get very clear on how much a client is willing and able to lose and use that as guidance in constructing a portfolio. 2) Make sure the client understands that he or she could live to be 100. “Presumably, it’s not going to get any cheaper,” Mitchell says. “So then you have to think very carefully about how you are going to husband your resources so that you can support yourself at that point.”
What is the difference between the accumulation toolbox and the retirement income toolbox?
One of the key differentiators is that in the accumulation phase, the advisor sells expectations, according to Gadenne. In retirement income, the advisor is tasked with providing reliable outcomes: a floor.
“The first thing you’ve got to ask yourself is: Are you operating at the right context level? Retirement is not an individual client event, it’s a household event,” Gadenne says. “While accumulation-level work can sometimes involve the entire household, this is not necessary nor is it prevalent. For retirement income work, the household is the place to start. This seemingly small semantic difference matters because it is one of the many reflections of the shift in the mentality of the investor from the traditional ‘make me rich’ to ‘pay me a smooth monthly income’ business proposition.”
Other differences: 1) In accumulation, the focus is on assets under management. In retirement income planning, it’s the ratio of annual consumption divided by financial capital. 2) In accumulation, the advisor works primarily with financial assets. Later, that expands to include human and social capital. 3) The objective in accumulation is to expose assets to the upside, depending on the client’s risk profile. Not so in retirement income planning. First, the advisor builds a floor, then exposes to the upside. 4) In accumulation, the advisor practices asset allocation among risky assets. In retirement income, assets are allocated using risk management techniques that include diversification, risk pooling, risk transfer and retirement-focused risk-free assets.
How do you get the client on board?
Advisors need to have unprecedented and straight-talking conversations with clients about everything from prudent spending habits to realistic expectations about what their battered portfolios can buy going forward, according to Salsbury.
“A lot of what is changing is psychological as well as fiscal. We’ve got to become more aware of the biases and barriers which cause us to make bad financial decisions. We have got to include the psychological with the fiscal elements of retirement planning,” he says. “The best financial planning advice in the world is irrelevant if the client won’t follow it.”
In a focus group Salsbury conducted recently, a wife said that she and her husband had completely remodeled their 5,000-square-foot home, spending hundreds of thousands of dollars that they did not get back when the property sold. The husband, squirming, replied: “What’s that got to do with retirement?”
“Americans have divorced their other spending from retirement. It’s connected. That’s what investors have to wake up to,” Salsbury added. “Advisors need to help them get there.”
How do you know if your client is right for an annuity?
Three types of clients are appropriate for annuities, according to Moshe Milevsky, professor at York University in Toronto and executive director of the IFID Centre at the Fields Institute. “Sometimes all three personalities are wrapped into one. Understand which is the personality that’s dominant,” he says. “The type of annuity you’re going to recommend is very different based on what the personality is.” The line-up:
- The client who needs tax-sheltered growth. This person has a substantial income, a high tax bracket, is concerned about the phase-out of tax credits and is worried about paying a 10 to 35 percent tax on income. “This is someone you’re going to steer toward a low-cost, tax-sheltered annuity,” Milevsky says. “It’s all about investment and tax deferral.”
- The client who doesn’t have a pension. This is someone who isn’t necessarily very wealthy and is close to retirement. What you’re after: an annuity with pension-like features such as guaranteed lifetime income for both spouses and downside protection.
- The client who is extremely worried about the stock market. This person is naturally risk-averse and has suffered losses. “Whether they are taxable or not or pensioned or not, they are worried,” says Milevsky. “They are hiding money under the mattress in T-bills and bonds earning nothing. They need to be encouraged to go back to the market with training wheels with some sort of downside protection. That’s where the guarantees of annuities come into play.”
What is a safe withdrawal rate?
The industry standard puts the safe withdrawal rate at 4 to 4.5 percent. New research from Michael Kitces, who did groundbreaking research a few years ago into whether that rate is too conservative, concludes: “What we’ve found is that 4 to 4.5 percent is still a good number when we are in really risky environments. Once we leave the riskiest environments, the withdrawal rate is actually higher: 5 to 5.5 percent.” At this writing, in the third week of September, Kitces considered 4.5 to 5 percent to be a safe withdrawal rate.