J.P. Morgan Asset Management recently released its fourth Guide to Retirement, which Katherine Roy, its chief retirement strategist, described as an “across-the-table” piece that advisors can use when meeting with clients.
We reviewed the guide and attended a lunch with Roy and Anne Lester, Global Head of Retirement Solutions, and thought the following points were important for advisors to keep top of mind.
Lower Expected Returns Mean Saving More or Spending Less
Lester joked that “6 is the new 8,” referring to the expected annual returns that advisors and investors can expect in a model balanced portfolio. That’s about 1.5% to 2% lower than expectations a decade ago and about 1% lower than the 7% annual return that advisors historically use, said Roy.
Given this weaker outlook, investors will need to save more in order to have enough funds to retire comfortably, and once in retirement, spend a little less, said Lester. The expected return for those already retired is 5% because those investors will likely keep more cash on hand.
Managing Income Taxes Becomes More Important
With lower returns limiting the growth of retirement savings, managing the tax liabilities of retirement becomes crucial, according to J.P. Morgan Asset Management. Taxes must be paid when assets are withdrawn from tax-deferred accounts and the resulting shrinkage can be very dramatic. That tax bill “is often investors’ biggest surprise,” said Roy.
A tax-deferred account like a 401(k) or rollover IRA worth $505,941, for example, shrinks almost $50,000 for those in the 5% tax bracket but more than $100,000 for account holders in the 33% tax bracket. “We are encouraging advisors to put this chart before every client they talk to,” said Roy.
”Individual investors have been receiving statements that might have been telling them that their IRA was worth $505,941 and that’s really where the client is anchored,” said Roy. “What they have forgotten is that for 35 years they haven’t paid any tax on that account … The tax man is coming.”
She noted that the tax bite is even larger in states with high income taxes such as California (top rate is 13.3%) and Oregon (9.9%). Are Your Clients Saving Enough for Retirement?
The most popular slide in the retirement guide is the Retirement Savings Checkpoints chart, which illustrates how much advisors’ clients should have already saved, based on their ages and income, to support their current lifestyle in retirement.
The chart assumes a 5% annual contribution to a retirement account with an annual return of 6.5% before retirement and 5% thereafter, a 30-year retirement starting at age 65 and 2.2% inflation rate.
It shows that a 50-year-old in a household with an annual income of $100,000 should have already saved $450,000 for retirement while a 60-year old with a similar household income should have $730,000 saved.
The numbers are “critical” in order to build a retirement plan, said Roy, noting that less than half the workers surveyed by EBRI have actually calculated how much money they need in retirement. The numbers, however, may be too high for households where with two working spouses because they assume Social Security benefits for a single wage earner retiring at age 65 plus a spousal benefit at age 62.
Plan for Clients Living Longer
Everyone knows that in the U.S. life expectancy is rising at a fairly steady rate. A 65-year-old woman in the U.S. could expect to live slightly more than 84 years in 1990 and 85.2 years in 2010, according to the Social Security Administration. The comparable figures for men are 80.1 and 82.6 years, and they are expected to continue to rise.
But advisors and their clients should use life expectancy numbers as a guide only. “Most people don’t understand that half of them will be above average,” Lester said.
The issue is even more pronounced for millennials. “Their life expectancy is going to continue to grow and they have to plan for that …. requiring them to save even more money,” said Roy. Plan for Higher Inflation With Rising Health Care Costs
As people live longer, their health care costs will increase. The median health care costs for a 65-year-old today is $4,660 — 6% more than the median costs a year ago, according to J.P. Morgan, which analyzed data from EBRI and SelectQuote.
By 2036, that same senior can expect to pay $18,030 in health care costs, which include Medicare premiums for doctors and hospital insurance (Part B) and for drugs (Part D) as well as Medigap coverage (Plan F) and vision, dental and miscellaneous costs.
Premiums are even greater for those with high incomes – almost $1,900 more per person for married couples filing taxes jointly with incomes above $214,000 up to $320,000.
— Related on ThinkAdvisor:
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- 4 Things You Need to Know About the Social Security Spousal Benefit
- Time to Rethink TDF Use in Retirement Plans: Financial Engines