Many advisors find that non-retired clients have a tendency to focus on accumulating money through vehicles like 401(k)s, mutual funds and IRAs. For an advisor, it’s easy to be reactive to the demands of clients asking for help with the accumulation side of the equation.
It’s understandable why a client may bring this perspective to the table. After all, most of us get our first lesson in retirement planning from our parents, many of whom adopted a simple accumulation strategy to augment the regular pension and social security payments they knew would be there for their golden years. There’s an opportunity to help clients understand that, in an evolving financial landscape, this strategy may leave them exposed to challenges their parents never had to worry about.
It’s increasingly less likely that today’s pre-retiree has a traditional pension. Today only 17 percent of Fortune 100 companies offer traditional defined benefit pension plans. In 1985 this number was 89 percent.6 Other important changes in the retirement equation include longer average life spans and increased medical and long-term care costs. Add to that the murky future of programs like social security and Medicare.
The fact is, we’re increasingly on our own in a way our parents may never have been when it comes to ensuring we don’t run out of income, whether that’s during retirement or the result of an unexpected income disruption that could happen at any time.
Tools like life insurance and annuities may be used to create a holistic Income Replacement solution for clients. Advisors can help clients understand three ways that income can be disrupted, and plot a strategy for each:
1. Premature Death
Many consumers do not properly address a critical part of their income replacement plan by failing to properly answer the age-old question: “How much life insurance do I need?” A common mistake is to settle on what seems like a large lump sum and hope for the best. It’s important that they understand just how far that money will go.
If there is no plan to replace the income a family member may generate over the remainder of their working career, the surviving partner will eventually have to figure out how to generate new income or be prepared to reduce the family’s standard of living. For example: If a client earning $100,000 a year has a $300,000 life insurance policy, after just three years the family’s financial picture may change significantly.
Advisors should ask their clients: If you or your partner’s income stops, how will it affect plans for the survivor’s retirement, putting kids through school, maintaining the family’s standard of living, etc? Answers to these questions should drive a great conversation about income replacement and how an optimized life insurance policy can defend against income disruption.
2. Outliving one’s income
People without the guaranteed income of a pension who simply focus on an accumulation strategy may be leaving themselves at risk of outliving their income. This is a problem not easily remedied for someone who realizes this too late. If you are 95, going back to work is usually not an option.
The estimated number of people age 100 and over is projected to increase 400 percent globally by the year 2030, according to the United Nations Department of Economic and Social Affairs.4 It’s critical that clients accept the reality that with medical advances they are likely to live considerably longer than their parents without the income safeguards many of them enjoyed.
Annuities are one way to help ensure that income is not outlived. In addition to income, an annuity can also offer downside protection in a volatile market as well as tax advantages, however, withdrawals will be taxed as ordinary income.
3. Life’s what-if scenarios
What if you face unexpected medical bills? What if you need long-term care for fifteen years? What if the stock market crashes and takes too long to recover? It’s no fun talking about unpleasant scenarios, but advisors need to help clients understand how life’s what-if scenarios can shock a budget and devastate income.
A recent survey by Nationwide Financial found that nine in ten soon-to-be-retired Americans are “terrified” about what health care costs may do to their retirement plan.5 Three in four survey respondents simply guessed at how much they needed to plan on spending on healthcare in retirement. On average, respondents estimated they would spend $5,621 each year on health care. This represents a drastic underestimation based on a 2010 Fidelity study that estimates annual out-of-pocket health care expenses for a 65-year-old couple retiring today and living for 20 years to range from $12,500 to $21,500.1
Commonly, retirees start retirement in good health, with low healthcare costs. But many of them will face the risk of dramatic increases in these costs when our health eventually declines.
According to the Employee Benefit Research Institute, 30 to 40 percent of those reaching age 65 will use nursing home care at some point.2 Many Americans mistakenly believe that Medicare covers long term care; unfortunately it does not. In 2008, the annual cost of a nursing home was about $71,000 for a semiprivate room, but nursing home costs are expected to reach $265,000 per year by 2030.2 According to LIMRA, less than two percent of Americans currently own long-term care insurance.3
Doing the math in planning for long-term care and health care cost can be scary. A long-term care rider on a life insurance policy is a great way to start addressing this challenge. In addition to income guarantees, many annuities and life insurance policies may help provide the liquidity necessary for access to funds for emergency use during life’s what-if scenarios.
Advisors have an opportunity to help clients look beyond the simple accumulation strategy that may have worked for their parents and begin to see income as an “asset class” that should be considered for many portfolios. Instead of just “investment performance,” clients should consider “income performance.” This is critical because, while investments are volatile, income should not be.
As an industry, we must help clients understand this isn’t their parents’ retirement, and guide them in creating a comprehensive income replacement strategy. In the long run, they will thank us for it.
1Fidelity Consulting Services, 2010. Based on a hypothetical couple retiring in 2010, 65 years or older with average (82 male, 85 female) and longer (92 male, 94 female) life expectancies. Estimates are calculated for “average” Retirees, but may be more or less depending on actual health status, area, and longevity.
2 Fronstin, Paul. “Savings Needed Insurance to Fund Health and Health Care Expenses in Retirement: Findings from a Simulation Model | EBRI.” Employee Benefit Research Institute | EBRI. May 2008
3 Insurance Barometer Study, LIMRA and the LIFE Foundation 2012
4 United Nations Department of Economic and Social Affairs, Population Division. World Population Prospects. Publication Date: September 2011
5 Health Care Costs in Retirement, Nationwide Financial Consumer Poll, 2012
6 Towers Watson Insider, Vol. 20, Number 6, 2010