Retirement income planning: The next frontier

Retirement income planning is gaining traction with the public and among advisors as a practice specialty. In November 2013, USA Today ran an interview with the director of The American College’s Retirement Income Certified Professional (RICP®) designation, which launched in 2013. It’s been a good first year for the RICP: over 3,000 participants, including this writer, had enrolled in the program by late 2103. Advisors can choose from other professional educational programs aimed at retirement income planning as well. The International Foundation for Retirement Education offers the Certified Retirement Counselor® designation and the Retirement Income Industry Association has developed the Retirement Management Analyst(SM) program.

Given the proliferation of certificates and designations available in the financial advisory business, it’s fair to ask if the world needs more sets of initials to list on business cards. Critics can argue that income planning is just another phase in retirement planning and doesn’t merit specialized study. Advisors already help clients accumulate assets for retirement, so what’s the big deal about shifting from accumulation to distribution?

Proponents of retirement income planning as a separate discipline believe it is a distinct process. For starters, consider the duration of each phase. Retirement planning focuses on accumulating assets by a target date. Although the date is subject to some unpredictability, the client decides when to retire. In contrast, retirement income planning deals with an unknown lifespan. Advisors can include life expectancy statistics and personal factors like the client’s health and family history in their projections, but it’s still a question of providing adequate funds for an unknown period.

What is retirement income planning?

There is no single definition of retirement planning but industry sources largely agree on the main elements. Dave Littell, JD, ChFC^®, CFP^®, is director of the New York Life Center for Retirement Income at The American College in Bryn Mawr, Pa and co-developer of the RICP program. He describes retirement income planning as focusing on an individual’s income needs and their other financial goals in retirement, such as contingency funds, risk management and legacy planning.

Jeff Cimini, head of personal retirement for Bank of America Merrill Lynch in Boston, emphasizes that retirement income planning is a process, not a product. It’s not about achieving a single number, he says, because the process incorporates “all of the things that our clients are faced with when determining how to live their retirement years.” Those issues can include the timing of Social Security benefits, funding health-care expenses and determining how to generate additional income. “It’s a holistic planning process that tries to really understand what our clients are hoping to do in their retirement years and then working with them to make sure that from a financial perspective they achieve what they’re hoping for in their retirement,” he says.

Differences from accumulation planning

Cimini notes that two of the main factors clients and advisors must consider with pre-retirement financial goals is the amount to be saved and how those savings should be managed—the asset allocation decision. The scope of required decisions expands for retirement income planning, however, and the challenge is compounded because of uncertain life expectancies. “When you get to retirement, not only do you have to replace the income that your employer was paying you but you tend to have to make substantive decisions about how you’re going to handle health care, and how you’re going to handle your income. Generally speaking, you have an unknown date that you’re managing that toward,” he says. “That uncertainty has some pretty significant impacts in terms of how you approach the planning process.”

Littell cites additional risks that retirees face that they may not have encountered or considered while working. These include inflation, health-care and long-term-care coverage, frailty and incompetence. Financial risks also change after retirement and sequence-of-returns risk is one of the most critical.

Much of the retirement income planning research has focused on sustainable portfolio withdrawal rates. The goal is to estimate the percentage of a portfolio’s value can clients withdraw annually without depleting their funds too quickly. Research has shown that once clients start taking withdrawals, the portfolio’s returns during retirement’s early years have a major impact on its sustainability. This is the period when retirees are most exposed to sequence-of-returns risk, Littell explains. “If the market is bad for the first few years of retirement, you’re going to run out of money much quicker unless you have some system or some plan for addressing that,” he says. “So, one of the big differences between accumulation and decumulation is that particular risk.”

Even the standard definitions of risk and return need modification for retirement income planning, Littell maintains. The traditional measures of risk use volatility measures such as standard deviation while total return gauges the portfolio’s income yield and capital appreciation or loss. Those definitions don’t work as well for retirement income, he says. “In retirement income planning, the risk is that you’re going to run out of money before the end of your life and the return is the amount that you get to withdraw,” he says. “If I withdraw 10 percent (from the portfolio), I have a higher return in my decumulation phase but I have now increased my risk that I’ll run out of money before the end of life.”