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New math for nest eggs

Today’s 65-plus seniors face some daunting challenges. But they can have a comfortable retirement–if they live within their means now and later.

Ask advisors like James H. Fydroski, CFP, RFG, RFC, to assess the financial standing of today’s seniors relative to other generations and they’ll be quick to tell you the generation of roughly 40 million people who were born before 1946 is, generally speaking, in better shape than the much larger baby boomer population.

For one, says Fydroski, president of Haas Financial Services in Southfield, Mich., today’s seniors “are much better savers than the boomers are.” That’s due in large part to the prevalence of defined benefit retirement plans in seniors’ portfolios. Such arrangements tend to deliver more certainty in building a retirement nest egg than do the defined contribution plans offered most workers today.

What’s more, according to recent estimates, today’s seniors won’t need as big a nest egg as subsequent generations. For example, a significant segment of investment advisors polled by
Scottrade estimates that $500,000 to $1.5 million will be sufficient for the average senior through retirement, but that later generations will need nest eggs in the $2 million to $3 million range.

It’s no wonder then, that in the 2010 MetLife Retirement Readiness Index, 81 percent of 65- to 70-year-olds indicated they feel prepared for retirement, compared to 64 percent of those aged 60 to 64.

But a closer look at how the 65-plus set is faring in tackling key retirement issues–such as transitioning one’s mindset and portfolio from accumulation to distribution mode, finding the right investment path to ensure a later lifetime’s worth of comfortable income, and protecting retirement assets–reveals some significant obstacles on the road to a comfortable non-working life.

“The good news is that they do have Social Security and they do have Medicare. Those are safety nets the younger generations may not have,” observes Lynn Ballou, CFP, managing partner at Ballou Plum Wealth Advisors, LLC, in Lafayette, Calif. “But seniors who continue to hold these visions of a grander lifestyle through their entire retirement and choose to live that way–they will wake up someday with nothing left. People who understand what they have and how to live within their means will find themselves in the best position during retirement.”

An uneasy transition

However ready for retirement they claim to be, today’s seniors still must confront formidable challenge–strategic, logistical and psychological–in transitioning into distribution mode after spending most of their working lives accumulating assets.

Long-held notions about retirement age and career paths are changing fast, says Mark DiGiovanni, CFP, president of Marathon Financial Services near Atlanta. That’s due to not only financial necessity but from a desire by many seniors to keep working well into their 60s and 70s. “What I’m seeing more and more is that [65-plus] clients do much better when they don’t stop working altogether,” he says, “but find something else they really like to do, where the money is secondary, but the income means they’re not pulling as much from retirement accounts. That means the money in there can continue to grow.”

For some seniors, there’s simply no point in retiring at 65, DiGiovanni says. “I tell people, if they feel like retiring is going to hurt them financially or psychologically, don’t do it yet.”

The economic and market upheaval of 2008-09 “caused people to rethink their career paths and the length of their career paths,” Ballou explains. “I’m seeing more people [65 and older] switch to what they would prefer to do [for work], like open a bed-and-breakfast or string guitars.”

While the 65-plus generation may be better than succeeding generations at saving, the recent economic downturn still exposed inadequacies in their retirement nest eggs, DiGiovanni says. “With longer life expectancies, people are going to need 30 times their annual income requirements in their retirement nest egg,” he says. “Most have on the order of 20 times [their income needs]. That means they have to [invest] some [of their money] in equities to generate the income they need. One of the new realities is, if you’re going to enjoy 25 or 30 years of retirement, you have to accept a certain amount of risk in your investments to get the returns you need to fund retirement. A too-conservative investment portfolio will not allow them to ratchet up their income to keep up with inflation.”

The upshot is that many seniors’ portfolios no longer automatically switch to pure distribution mode at age 65; most must remain in accumulation mode, at least to some extent.

Change is the only constant

David A. Littell, co-director of the New York Life Center for Retirement Income and the Joseph E. Boettner Chair in Research at the American College in Bryn Mawr, Pa., says that when it comes to helping seniors plan for their retirement, advisors must anticipate that those plans will inevitably need to be amended. It’s not just that recent economic upheavals have rerouted many seniors’ retirement paths; many have been confronted with other changes as well, such as helping a grown child who has lost a job or taking care of a grandchild.

“In some ways working with seniors can be the most complex because the plan needs to change and there needs to be very regular contact between advisors and seniors just because of that issue,” Littell says. “The products and solutions have to be flexible enough to address people’s changing situations.”
For example, for some seniors, a fixed immediate annuity may not be the best solution because most don’t offer a liquidity option “You have to be careful if you use that product, which I like,” Littell says. “You have to have other funds that are available to address the potential liquidity needs.”

Getting past gun-shyness

The challenge for advisors is getting senior investors who are still smarting from the 2008 market nosedive to accept some measure of risk and to help them find a comfortable balance between growth potential and protection.

“A lot of people [65 and over] are scared now,” Fydroski observes. “They’re reluctant to get back in the market to any extent.”

To keep 65-plus investors from “going into a shell” and keep them in the market if their nest egg demands it–and it frequently does–Fydroski often recommends, particularly for older seniors, a managed growth portfolio built with enough upside potential to provide solid, steady growth, but with a conservative downside risk-management strategy.

While some advisors might turn to a tool like a single-premium immediate annuity to deliver growth and income in retirement, Bob Oberstein, CPA, RFG, RIA, of Oberstein Wealth Management in Sherman Oaks, Calif., says he prefers not to tie up clients’ money in an annuity contract with high surrender penalties. Rather, he suggests putting the money “in some kind of conservative portfolio that’s going to deliver the cash flow they need,” while preserving unfettered access to the money for health emergencies and the like.

Also part of the post-recession retirement reality for some seniors is the need to take relatively drastic steps to shore up their nest eggs. “I think we’re going to see a lot more press about reverse mortgages,” Ballou says. “The over-65 set is going to be using them a lot more than they thought they would.”

The quest for income certainty

For seniors and boomers alike, the crux of the retirement challenge is building a nest egg that’s large enough–and protected enough–to provide the means to live comfortably through retirement. People in or approaching retirement are losing plenty of sleep over the “income for life” issue.

Sometimes an annuity can be part of the solution. An analysis published recently in the Journal of Financial Planning finds that “an equity portfolio with a fixed annuity component provides a higher chance of maintaining retirement distributions than other alternatives.” The report, authored by Craig Lemoine, CFP, David M. Cordell, Ph.D., CFA, CFP, CLU, and A. William Gustafson, Ph.D., concludes that for clients who want to maintain projected retirement withdrawals to age 100, “100 percent equities with an annuity lock is the preferred approach.”

According to the report, “By specifying the annuity purchase as a future alternative, the financial planner can encourage a higher-equities portfolio, which will likely lead to a larger accumulation in retirement.”

Longevity, inflation and economic realities are dictating a reassessment of distribution and income-generation strategies among seniors, according to Fydroski. “I think there’s a lot of confusion about how much people can reasonably take out from their accounts during retirement,” he says. “The old model that says if your portfolio is earning a rate of return of eight percent to 10 percent, then you can safety take out seven percent to eight percent each year.

But that has given people a false sense of security. New research says if you want [the retirement nest egg] to last 25 or 30 years, a safer number would be to take out four percent to five percent a year. I think that may be a big surprise for people 65 and over. So you have to make them aware of the new calculations, especially if they are in the 65 to 70 [age] range.”

Preserve and protect

Inflation is a huge X factor in the income equation, DiGiovanni says. For 65-plus clients, he often suggests a mix of conservative investments (bonds and bond funds, etc.) for near-term income, plus equities (mutual funds, mainly) for growth potential, with some form of inflation protection built in.

Inflation isn’t the only great unknown, however. “Health-care costs loom as a major risk for retirees, with nursing home care as the real wild card,” according to the Center for Retirement Research at Boston College. A typical couple at age 65 can expect to spend over their remaining lifetime $197,000 with a five percent risk of exceeding $311,000, excluding nursing home care; or $260,000 with a five percent risk of exceeding $570,000, including nursing home care, according to recent CRR findings.

“Affordable medical care is the number one issue and concern on client’s minds with regard to affording retirement,” Ballou observes.

Long-term care insurance is one way to protect a nest egg from that risk, but it’s often prohibitively expensive for 65-plus clients to purchase, Fydroski notes.

Adds Ballou: “Many who can afford [LTCI] are purchasing 10-year-pay policies so that they aren’t hit with huge premium increases in the years when they cannot afford these increases.”

An alternative to straight LTCI is to purchase one of the relatively new breed of hybrid annuity products that have a long-term care coverage component, DiGiovanni says.

The belt must tighten

If purchasing long-term care insurance isn’t viable, then perhaps the best asset-preservation strategy for seniors involves living more within their means.

It’s a matter of opening senior clients’ eyes to their ability to “control their personal inflation rate,” meaning curbing frivolous spending now because they will need that money later, Ballou says. “With clients who are thoughtful about controlling their spending, keeping their cost of living to a two percent or three percent growth rate is very doable.”

Littell agrees that “Americans are terrible at budgeting.” It becomes even more of an issue in retirement because people can’t go out and make more money. “You have to live within your means,” he says.

That sets up an interesting dynamic between advisor and client where the advisor almost becomes the parent. ” ‘They [the advisors] tell me I can’t spend anymore,’ ” says Littell, imagining what a client might say about an advisor. “ That becomes an issue, people staying within a budget. If you are using a systematic withdrawal approach, staying within the discipline of that, well, it’s not that easy.”

Given today’s financial, economic and longevity risks and realities, “Learn to Live Below Your Means” is the mantra the 65-plus set and subsequent generations should be following, Ballou stresses. Those who do follow it “are the ones who are going to walk away from this okay.”