Whatever Suits

Art by Jillian Tamaki

It’s in the news almost daily: Many Americans are simply unready for retirement—whatever their notion of retirement may be. Yet, depending on their personal circumstances and retirement goals, many may be readier than those nay-sayers believe.

To gauge “retirement readiness”—loosely, having enough money saved to translate into adequate income—plan sponsors and participants often look to online calculators. Many of these, though, fail to factor in key personal financial information, which is needed for an accurate assessment. This is where plan advisers can step in to discuss readiness with plan participants.

Michael Foguth, founder of Foguth Financial Group in Brighton, Michigan, says the No. 1 determiner of retirement readiness is not the person’s total assets but how much income he will need. “It’s a misconception that people have to save a certain dollar amount or save for an 80% income replacement rate,” he says. “How much people need differs. It could be 80%—or more or less.”

Tracy Amabile, general manager of human resource (HR) services at Conduent in Atlanta, agrees that the necessary income replacement ratio will be different for everyone. “Seventy percent to 80% can serve as a good rule of thumb but cannot be used for each individual’s planning,” she says.

According to Amabile, retirement readiness is more a function of money outflow than just of compensation. Factors that must be considered are fixed expenses such as housing and debt-servicing costs, plus variable expenses such as travel. “Comparing projected expenses with available assets ultimately determines whether an employee is ready to retire or not,” she says.

Beyond Calculators: Lifestyle Factors

When an adviser discusses retirement readiness with a client, says Dan Hernandez, a Certified Financial Planner (CFP) and senior financial representative at Lincoln Investment in Voorhees, New Jersey, he needs to ask about the person’s current lifestyle and spending. “When some people retire, their mortgage or consumer debt is paid off, so they’ll need less money in retirement. But not everyone plans that way or can achieve that,” Hernandez says.

Advisers also should ask about plan participants’ lifestyle expectations for retirement. “Some retire and want to travel or maybe have a second home, while others may just want to spend time with their grandchildren,” he says.

“It’s about what the person wants to do, moving forward,” Foguth agrees. “A lower-paid employee may have a lower standard of living prior to retirement, but that doesn’t mean he wants his retirement lifestyle to be the same.” He adds that advisers will need the numbers for all of the person’s expected income sources—Social Security, pensions, assets from defined contribution (DC) plans, other savings, etc.

Also in calculating the projection, the adviser must consider the net amount the person will need, and be mindful of changing expenses, Foguth says. “Many people say they want the same gross income they are making before retirement, but they need to realize they don’t live on 100% of their gross income during their working years. They live on net income after taxes, retirement plan savings and perhaps medical premiums are taken out.”

Walter Wisniewski, CFP, owner of Arcadia Wealth Management in Smithtown, New York—and co-author with his daughter, Allison Vanaski, CFP, of the book “The Millionaire Within”—says many retirement income calculators overlook taxes and/or inflation.

Another factor for the adviser to consider—and another omission by calculators, Amabile says—is that the retiree may find other employment, which will affect total income. “We’re just starting to see the impact of the ‘gig economy’ on seniors. On-demand jobs will let older workers dynamically supplement their income and savings,” she says, noting that retirement readiness calculators should let users anticipate additional earnings through part-time work, to provide an accurate view of the future.

Advisers should also mention that the participant, once retired, may spend more, out of pocket, than when he was employed, Foguth says. “When you’re working, you do most fun things on Saturday and Sunday. When you’re retired, you have six Saturdays and one Sunday,” he says, adding that retirees today are more active than those in past decades. “They’re not likely to spend retirement sitting in a rocking chair on the front porch, reading.”

Such expenses can be estimated. But there are the unknowns to keep in mind, Wisniewski says. People do not know how healthy they will be, when they will die, what investment returns they will accumulate, he says. “There’s no hard-and-fast rule, but these three unknowns are the same for everyone.”

‘How Much Can You Live On?’

Hernandez says the annual 4% withdrawal rule is comfortable for spending if a person stays invested in stock and bond mutual funds. “I’ve been in the business for 30 years, and when I went through CFP training, 5% to 6% was a comfortable spending rate. What I believe has changed is market volatility,” he says.

According to Hernandez, a historical look at market cycles and at a hypothetical 60% equity/40% fixed-income portfolio shows that the portfolio returns were predictable over a seven-year rolling period of time. Therefore, when an adviser discusses retirement readiness with someone within seven years of retiring, he needs to consider the person’s sequence of returns risk and whether savings should be moved to safer investments.

“I determine with people how much it will cost to live per month in retirement and work backward from that to suggest a savings amount,” Wisniewski says. “There’s an amount that is ‘acceptable,’ covering basic expenses and medical care, and an ‘ideal’ amount—what would allow for going out to dinner or traveling. Once those amounts are determined, we can figure out how much a person needs to save for each goal. The earlier one starts to save, the better.”

To back into a savings rate in this way, Hernandez says, “the projections need to predict rises in income and assumed rates of returns [ROR]. Adjustments for determining retirement readiness can be made throughout an employee’s career.”

Conversations for Different Situations

Wisniewski says the retirement readiness conversation varies based on the individual’s income group—low, middle or high—but all should understand that they need more than Social Security.

According to Hernandez, for a lower-income worker, Social Security will probably be a proportionally larger part of retirement income than for someone who earns more. That same person is much more conscious of expenses and the need to pay bills and may already expect a more frugal lifestyle in retirement. An adviser can help that person plan a budget for retirement and, perhaps, show him how to pare down spending, both now and in retirement.

However, Amabile says, retirement readiness conversations can be unpredictable when looking at compensation alone. “You may have a lower-paid employee who lives in a low-cost-of-living area, but with a spouse who works, who may be in a better position to retire than a higher-compensated employee who lives in a high-cost-of living-area and is the sole income provider,” she explains.

Foguth says his conversation with individuals is the same no matter their income. He assesses what amount they will be need monthly, then figures out where the income will come from. “For example, if a person needs $5,000 a month in retirement and he knows Social Security will be $2,000 per month, he has to solve for only what he is short. Maybe he has a pension plan that will provide $1,000. He then needs to look at other savings,” Foguth says.

For participants who want contractually guaranteed income, an annuity is the only option, Foguth says. “The question is, which annuity is right for you?” He suggests advisers warn clients to stay away from variable annuities with expensive riders—or any annuity with a rider. Immediate annuities or deferred income annuities are preferable.

“These days, every insurance company has an annuity to mimic a pension,” Hernandez says. “Some have living benefits, with guarantees for a person and his spouse for the rest of their lives. Those are good options, but advisers have to be careful when recommending an annuity, because it can be constrictive, and clients can lose flexibility and liquidity. I rarely recommend putting a large chunk of money into an annuity, but maybe some.”

If the participant is in poor health before retiring, this calls for a different conversation, Foguth says. “In this case, a [lower] life expectancy should be considered,” he says.

With a single person, “in some ways the conversation is relatively black and white,” Hernandez says. “Advisers don’t have to discuss what happens to Social Security when a spouse dies or consider what income sources a spouse adds to the equation.”

For a married couple, any defined benefit (DB) plan income or Social Security payments may decrease upon the death of one member, so the survivor will probably need to make the remaining money last longer, Hernandez says, noting that one spouse will probably outlive the other. The one who is left may have to downsize or move, or cut back on travel.

Readiness discussions will differ significantly, too, based on the participant’s generation, Amabile says. A Millennial still has an opportunity to save his way into retirement readiness; a Baby Boomer may have to temper spending or retire later. She says assessing retirement readiness should be done well before an employee contemplates retiring. “The earlier people start planning for retirement, the more time they have to make changes that can impact their future plans,” she says.

“By understanding employees’ current financial pain points and providing education about retirement planning, advisers can help these people plan for their future and better manage their needs,” she says.