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Retirement Planning Ain’t What It Used to Be

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Advisors helping clients plan for retirement should focus not only on accumulating assets but also on projected liabilities, according to David Blanchett, head of retirement research at Morningstar.

“Think about assets and liabilities separately,” said Blanchett, who spoke at this week’s annual Morningstar Investment Conference in Chicago. “What will assets earn and what are the liabilities, spending needs, over 30 to 40 years.”

The traditional 4% withdrawal rule from retirement funds may not be appropriate for future retirees, said Blanchett, explaining that the rule is based on historical returns for U.S. stock and bond markets, not future return projections, and assumes a constant income increased for inflation over 30 years, which is “not reality.”

(Related: What Boomers Need, and Aren’t Getting, From Advisors)

U.S. large caps, for example, are not likely to return the 10% average annual gains that have prevailed since 1926 and the 10-year Treasury is unlikely to maintain its historical 5.5% annual yield.

“We have to adjust our expectations,” said Blanchett. A reasonable annual return for U.S. large caps over the next 10 years is 0.95%, said Blanchett, adding that for international equities Morningstar’s projection is 5.4% annually and for small caps 2.88%.

The retirees who will be most affected by these relatively low expected returns will be those closest to retirement, either five years from or five years into retirement, said Blanchett. “You have to incorporate lower returns” in retirement plans today. “The 4% rule is not as safe as the historical data shows.”

On the spending side in retirement planning — the liabilities — Blanchett recommended that  advisors focus on realistic expectations. The assumption that they will spend more as they age, above the inflation rate, is wrong, said Blanchett.

“Retiree spending doesn’t rise above inflation because spending evolves.” They will spend more on health care as they age but less on travel and other activities and items as they slow down, and this applies to wealthy retirees as well, according to Blanchett.

“The average retiree spending $100,000 a year at 65 spends $75,000 by age 95.”

Another major consideration in retirement planning is longevity risk, whether retirees will outlive their assets. Here, too, Blanchett warned against using conventional analysis of average life expectancy, which have been rising.

“Your clients are not average. Consider the unique risks today for wealthy Americans.” Males in the top 1% today will live to about 90 on average versus 80 for the remaining 99% and  longevity for the top 50% of earners is rising much faster than the longevity of the bottom half, said Blanchett. “Where are your clients on this spectrum?”

As for guaranteed income for life, Blanchett said only annuities can provide that and Social Security is the best example of that.

He also reminded the audience that in the worst case scenario, when they appear to be running out of money, retirees can usually adjust their discretionary spending.

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