It is becoming increasingly difficult to open a newspaper or magazine without being bombarded with news about the retirement of the Baby Boomer generation. But the fact of the matter is, this really is big news -- not only for the 76 million boomers, but also for the ongoing success of your business.
In this article I'll discuss the opportunities and challenges you'll face as an increasing number of your boomer clients leave the workforce. I'll also describe a disciplined process you can use to help your clients generate sufficient retirement income.
A Growing Opportunity
The number of Americans age 65 and over has grown in step with the retirement of the first wave of boomers. In fact, the number of Americans aged 65+ is expected to double from 35 million in 2000 to more than 70 million in 2030.
Boomers, unlike generations of retirees before them, will largely fund their retirement with their own savings in defined contribution plans, such as 401(k)s. For your boomer clients, generating sufficient retirement income is now their own responsibility.
Both of these trends trigger opportunities for financial advisers. For example, as boomers retire, the IRA rollover market is expected to balloon. And many do-it-yourself investors will turn to financial professionals for retirement planning expertise. By demonstrating the value you add as a retirement planning expert, you can capture a larger share of rollovers and:
o Increase the retention rates of your key boomer clients.
o Generate new clients who are nearing retirement or have recently retired.
To make the most of this opportunity, it's important to begin assisting your boomer clients (and prospects) when they start to think about transitioning to retirement.
Clients at the Crossroads
Retirement may be life's most significant transition. Aside from the obvious personal implications, retirees may encounter a number of financial issues, such as:
o How will they move from receiving a regular paycheck to developing an ongoing income stream?
o Should they downsize their home or relocate?
o How will they meet rising health care expenditures?
o Do they have a plan to fund long-term care expenses for themselves or elderly relatives?
o Could they possibly outlive their savings?
In each case, you can help your clients overcome these challenges and potentially meet their financial goals by developing a comprehensive retirement plan -- one that seeks to ensure that they have adequate lifetime income.
Easing Into the Planning Process
The retirement planning process can be extremely challenging. As a case in point, consider the many personal and potentially sensitive questions you'll want to ask clients regarding their current and future financial status.
All too often, financial advisers who are extremely qualified at "running the numbers" are not prepared to also manage the emotional aspects of their clients' transition into retirement. Before asking your clients detailed questions about their finances, ask them to envision their retirement lifestyle. Start by asking these types of questions:
Take a minute to reminisce about some of your most enjoyable memories. Which of these would you like to duplicate when you retire?
Imagine a retirement in which you can live completely on your own terms. Describe some of the ways you can make this happen.
Think about your first day of retirement. How old will you be and what are three things you'd like to do during your first year of total freedom?
A Disciplined Approach to Retirement Income Planning
Once you've gained a client's trust and confidence, you can begin the due diligence process. This stage is critical, as you'll need to understand a client's exact needs and financial circumstances in order to develop a customized plan to meet his or her goals. To keep the process manageable and on track, use the following five steps.
Step 1: Create a Budget
Every good retirement income plan begins with a budget. To get started, discuss what a person may need in terms of retirement income. Traditionally, advisers have estimated that individuals may need 70% to 80% of preretirement income when they leave the workforce. However, while 50% of pre-retirees expect to live on less, 68% of recently retired individuals indicated that their income needs initially following retirement exceeded 100% of their preretirement income.
During the budgeting process, it's also important to educate clients about some of the ways their retirement income needs may change over time. For example, you'll need to account for rising healthcare and long-term care costs, increased travel/entertainment expenses, and potentially higher residential maintenance expenditures. In fact, there are many factors that come into play when trying to project a client's retirement income needs over a 20- or 30-year period. As such, any assumptions you make must be revisited regularly and a client's retirement income plan must be adjusted over time.
Step 2: Define a Client's Income Needs and Objectives
Before you allocate specific numbers in a budget, you'll need to probe to learn the client's income needs and objectives. It's helpful to break out a client's expenses into two categories -- basic income needs and lifestyle income needs. Then associate expenses with the items contained in each category.
Sample Basic Income Needs
o Food/Shelter
o Auto
o Insurance
o Utilities, telephone
o Clothing
o Health care
o Insurance (life, medical, long-term care)
Sample Lifestyle Income Needs
o Travel
o Entertainment
o Hobbies
o Membership dues
o Gifts and donations
o Loans and credit cards
Step 3: Take Inventory
The next step is to develop a comprehensive list of client assets that can be tapped for income. Be sure to include both current and future assets. These may include annuity-type incomes, such as Social Security and pensions; discretionary income sources, such as taxable savings and tax sheltered savings; and other available assets, such as real estate and life insurance. During discussions with a client, you may uncover "hidden assets" you don't currently manage, such as dormant IRAs or 401(k)s from previous employers.
Step 4: Match Resources with Income Needs and Objectives
In this step, match up the client's financial resources with his or her retirement income objectives. We recommend that you first focus on the client's basic retirement income needs. Compare those with the client's annuity-type resources, such as pension(s) and Social Security. Next, consider the client's lifestyle income needs and where the income will come from to achieve his or her lifestyle goals.
During this process, you'll want to determine the optimal "spend down" order for your client's available resources. In most situations, taxable investment accounts should be tapped before tax-sheltered assets such as IRAs and company-sponsored retirement plans. By matching the projected income and the projected expense "buckets" you can quickly get a feel for whether the client may face any shortfalls.
Step 5: Quantifying and Managing Risk
Developing a sound retirement plan hinges on regularly monitoring annual withdrawal rates to avoid premature depletion of assets. At the same time, withdrawing too little may cause clients to live a lifestyle that is inconsistent with their goals.
There is no set rule as to what constitutes a sustainable withdrawal rate. For example, some advisers assume a withdrawal strategy in which the dollar amount is determined in year one and then maintained (usually with annual adjustments for inflation) regardless of the portfolio's underlying investment performance. Others promote a strategy in which the withdrawal amount is adjusted each year to reflect market performance.
The chart on page 28 shows the results of various withdrawal rates calculated as a percentage of initial portfolio value and adjusted annually for inflation. Using historical investment returns from 1926 through 1995 and a hypothetical portfolio comprised of 75% stocks and 25% bonds, it shows the potential likelihood of running out of money based on various payout periods and withdrawal percentages.
For example, there has historically been a 15% chance of running out of money in less than 25 years, assuming a 5% withdrawal rate. Increase the withdrawal rate to 6%, and the historical odds of depleting the portfolio in less than 25 years increase to 35%.
This can give you a starting point to determine appropriate withdrawals for your clients.
Redefining Risk
Successful retirement income planning requires key risk redefinition and management. Risk takes on new dimensions as clients enter retirement. The old risks that clients once faced have changed, and new risk elements are now introduced. The types of risk that will have a significant impact on your clients' portfolios are: market risk, inflation risk, longevity risk, and health care cost/medical risk. While your clients may understand the concept of these risks, they may lack the tools and knowledge to quantify and manage them. As a result, it is important that you address these challenges with your clients so they can have a more successful transition into retirement.
While no investment is free of risks, there are various ways to help clients manage risk as they enter retirement. These include:
o Adjusting asset allocation strategy to be less aggressive, while keeping growth goals in mind.
o Discouraging market timing and emotion-based withdrawals in response to market (1) fluctuation, (2) volatility, or (3) downturns.
o Exploring longevity-risk mitigation alternatives such as annuities and longevity insurance.
o Factoring in potential future reductions in purchasing power for annuity-type income sources that are not inflation-adjusted.
Forecast Modeling
It's important to avoid basing a plan only on historical market averages or a set rate of return. Traditional methods of creating forecasts of income and spending scenarios are flawed nearly to the point of uselessness. That's because they are based on limited variables and historical averages, offer only one simulation, and generate only one proposed, static course of action. Of course, one scenario based on assumed averages can't account for the variables that life guarantees.
A more realistic approach is to make use of more advanced stochastic forecast modeling -- also known as Monte Carlo modeling -- which can run more than 2,000 simulations based on many crucial factors such as multiple income sources, risk tolerance, market volatility, tax-efficient disbursement, changing income needs over time, medical cost inflation, and required minimum distributions. These statistically significant projections help calculate your clients' probability of success in meeting retirement income needs..
Get Started Today
Retirement income planning is a critical component of developing a sound overall retirement plan. It also provides an opportunity for savvy financial advisers to showcase retirement expertise and stand out from the competition.
Ellen Schoenfeld is vice president and director of educational initiatives at OppenheimerFunds, Inc. She directs a group that develops educational programs for financial advisers and their clients. This article summarizes the presentation she gave to the Financial Planning Association at its 2006 annual meeting in Nashville, Tenn.
