Top 5 Issues Reshaping Retirement Planning in 2014

It can be hard enough to give clients a realistic view of what they spend currently, much less to anticipate what they’ll need in the future. Sinsimer said most clients will know their incomes and how much went into their 401(k)s, but what they may not know about their spending is “Where did the rest of it go?” He suggested using tax forms and credit card statements to show exactly where clients are spending their money. If they spend $700 a month dining out while they’re working, do they really expect to be happy eating every meal every day at home when they’re retired? —Danielle Andrus

Issue 3: Adult Children Living at Home

Cam Marston tells a funny story using the experience of newborns to illustrate the difference between baby boomers and the succeeding generations. The baby boomers’ parents walked out of the hospital with their newborns and put them on the front seat of their non-seatbelt-equipped cars in a blanket, while attempting to keep their cigarette ashes from falling on the baby. Baby boomers’ children were rolled out to their parents’ car in a wheelchair, placed in the rear seats of their cars in a backward-facing infant car seat made of industrial-grade plastic and secured with complicated belts and titanium hooks. Is it any wonder, he says, that the boomers’ children have a different outlook on life? Is it any surprise that those children have different expectations of what the good life can be, and that their parents will play a deeper, even friend-like, role as they enter adulthood?

Marston is one of the most insightful observers of the differences between generations and what those differences mean for advisors. In a presentation at the TD Ameritrade annual conference in late January, his musings on those differences highlighted one of the biggest retirement planning issues for boomers: Their children are not leaving the house. Perhaps better put, the Gen Y and millennial generations have a much different relationship with their parents than did the boomers, so they’re comfortable with living at home throughout what Marston calls their “adult-olescence.”

The problem with that sociological trend—a 2013 Pew Research study found that 22 million millennial children are living with their parents, the greatest number since 1949—is that those young adults are soaking up a significant amount of the financial resources of their near-retirement or already-retired parents. They also are not aware of how their comfortable living arrangements are affecting their parents.

A Securian Financial study of 700 millennials living with their parents released in September 2013 found that 19% have no idea what kind of impact, if any, their living at home has on their parents’ finances; more than 90% have no deadline for moving out; only 10% pay rent and 82% “pay” for their room and board by “helping with household chores.”

Those numbers have a big impact on those parents’ retirement planning. The employment situation for young people isn’t helping either. The January 2014 unemployment rate for teenagers (ages 16 to 19) stood at 20.7% and was at 11.9% for those aged 20 to 24. At a time when pre-retirees are traditionally spending less—their mortgages and college bills may be behind them, for instance—and their incomes are traditionally at their highest levels, this unexpected and unplanned-for expense of hosting their young adult children can put a strain on their retirement planning finances.

As with most planning challenges, however, there’s also an opportunity for the informed advisor. Getting involved with clients’ children at this critical time for them—teaching them budgeting skills and perhaps even providing career advice—can not only help your clients address this financial problem but can also build bridges with that next generation who could be your next generation of clients. You might also point out that when it comes to employment, it’s still the case that the higher the education level attained, the lower the unemployment rate: The unemployment rate for all workers with at least a bachelor’s degree was only 3.2% in January 2014, compared to the overall jobless rate of 6.6% —James J. Green

Issue 4: Retirees Spending Too Much

In a presentation at the Think Retirement Income Symposium last year, advisor Harold Evensky displayed a photograph he had recently taken on a luxury cruise: a passel of walkers, wheelchairs and oxygen tanks parked beneath a cruise ship stairway. Evensky’s point: Advisors’ assumptions that people spend less as they age is misguided. “People continue spending until they die,” he argued. While the assumption is that people grow sicker as they age, and thus spend less in retirement, the fact is that “people are living longer and are healthier for longer,” he said in an interview last year.

Traditionally, researchers have suggested that an income replacement rate of somewhere between 70% and 80% of pre-retirement income is necessary to maintain a similar lifestyle in retirement, but pinpointing that amount requires an accurate picture of a retiree’s actual expenses. Bureau of Labor Statistics’ data suggests that spending on health care increases by 25% during the first decade after age 65—even while overall spending drops. A study published in November 2013 by David Blanchett, head of retirement research for Morningstar Investment Management, reviewed the wealth of research on the topic, both in the United States and abroad, and concluded that his own research indicates that expenses “actually decrease in real terms for retirees throughout retirement and then increase toward the end.” Blanchett concluded that “the real change in annual spending through retirement is clearly negative.”

A November 2013 Fidelity Investments report that heavily relies on the Bureau of Labor Statistics’ “Consumer Expenditure Survey” noted that for planning purposes, “many people experience above-average expenses” in retirement, “particularly if they live longer than today’s average life expectancy or incur long-term care costs.” There’s also solid evidence that a wealthier person tends to live longer and be healthier in old age than their less-wealthy counterparts. Wealthier people tend to keep more of their income in retirement than their poorer counterparts due to their lower taxes in retirement.

Then there’s the psychological expectations of retirees. “Most people see their standard of living increase throughout their working lives and look to at least maintain that in retirement,” the Fidelity report said, quoting Steve Feinschreiber, a senior VP for Fidelity Strategic Advisers.

Wealthier retirees can control more of their expenses since, as Steve Devaney, director of financial solutions at Fidelity Strategic Advisers, argued, “Higher-income earners use less of their income for essential expenses and more of their income for savings and discretionary purchases.”

Using data from the annual U.S. Bureau of Labor Statistics’ “Consumer Expenditure Survey” and from the biennial “Health and Retirement Study” survey conducted by the Survey Research Center at the University of Michigan, Morningstar’s Blanchett made these conclusions on retiree spending for the average U.S. retirees:

• Spending drops modestly (14%) immediately after retirement, partly due to the cessation of work-related expenses and changes in food expenditures.

• Inflation-adjusted spending continues dropping slowly after retirement as retirees age into their late 70s.

• Housing and housing-related expense is by far the largest spending category for all age groups.

• Health care expenses rise with age, but remain substantially lower than housing expenses.

• Increases in health care spending are not sufficient to change the downward trend in total inflation-adjusted spending, at least not until late in retirement.

Moreover, Blanchett said that the size of the typical spending drop upon retirement “is inversely related to household wealth.” However, he also provided some insight into actual retiree spending: “Not all retirees exhibit a spending drop: About 53% of households exhibit a drop in spending at retirement, another 35% report a negligible change in spending at retirement, while 12% reported an increase in spending at retirement.” Finally, expenses in retirement must also take into account the 25% to 28% of people who involuntarily retire, usually due to health conditions.—James J. Green

Issue 5: Off-Target Target-Date Funds

Assets flowing into target-date funds at the end of 2013 totaled $13 billion, according to Morningstar, up from $2.3 billion in the third quarter. That’s in spite of average total returns coming in at just over 5% for the fourth quarter—half the return of the S&P 500—and about 16% for the year—again, half of what the S&P returned in 2013.

So what do investors see in target-date funds? Assuming most advisors don’t choose TDFs for individual clients, are they appropriate for plan sponsors to include for participants?

Catherine Gordon, principal in Vanguard’s Investment Strategy Group, said that for some plan participants, the attraction is a combination of investors’ confidence in investing and how they want to spend their time.

“Someone might feel perfectly comfortable and say, ‘I can build my own portfolio, but there are other things I want to do,’” she said. “There’s an appeal there, as opposed to someone who might say, ‘I really don’t have a lot of confidence in my ability to build my portfolio,’ and target-date funds are a reasonably straightforward concept to communicate.”

However, Ron Surz, CEO and president of PPCA and president of Target Date Solutions, said that at least some of the flow of assets into target-date funds aren’t from investors choosing them at all.

“The vast majority of the assets, from what I’ve read, are there because the plan sponsor, and actually the plan advisor, has chosen target-date funds” as the qualified default investment alternative (QDIA) for automatically enrolled participants, he said in an interview.

By choosing TDFs as a QDIA, sponsors could be “removing a layer of fiduciary insulation” because when the fund is chosen for the employee, it’s no longer participant-directed. Gordon, however, disagreed. “Employers who select target-date funds as a default are given safe harbor under the Pension Protection Act. I’m not sure I would agree necessarily that it removes a layer of protection because the fiduciary responsibility comes at the plan level, not at the individual fund level,” she said.

Surz sees advisors often make two assumptions about defaults that are wrong. “They have this misperception that first of all, any QDIA will do because it’s qualified so it’s a safe harbor; and second, that you can’t go wrong with the big three: Fidelity, T. Rowe and Vanguard. ERISA attorneys tell me that both of those perceptions are wrong,” he said.

Surz said that “throwing a dart at the QDIA dart board is not a fulfillment of fiduciary responsibility,” and even though TDF providers may have products that can replace pay and manage longevity risk, not all participants have the same objectives for a fund. “If you’re going to replace pay for a work force of 20,000 people, the best you can do is try to structure a portfolio for the average employee, but among 20,000 people, there are going to be some people that are not at all like the average employee.”

The idea behind TDFs is not a bad one, Surz admitted. “The general idea is good in that it can—but it doesn’t—provide important benefits for plan participants: broad diversification and risk control. The cons are, in my opinion, the industry has a long way to go to provide the best it can in those two areas.”

Diversification is improving in TDFs, Surz said, although he thinks they’re still too U.S.-centric, but the big problem is the risk allocation in funds for investors nearing their target date.

“If you look at the risk at the target date today versus where it was in 2008 for funds near retirement, it’s the same. Nothing has changed. Diversification is getting a little bit better, fees are getting a little better, but the risk controls are still as lousy as they were when we had this catastrophe,” Surz said.

Surz thinks TDFs should have zero allocation to risky assets by the time they reach their target date. The funds he manages are entirely allocated to 90-day Treasury bills and two-year TIPS at the target date. To people who say retirees can’t live on T-bills and TIPS, he says, “‘You’re absolutely right. All I’m trying to do is get them safely to their target date with their assets intact.’”

The Department of Labor has said that it expects to release in March more details about a rule requiring more disclosure on the investments in TDFs, and the SEC is considering a rule this year as well. —Danielle Andrus