Running on Empty?

From the very beginning the primary focus of the retirement plan industry has been the accumulation of savings toward an end goal – retirement – and the eventual opportunity to help manage the monies accumulated over the years. Participant savers heard that message, of course, but many never seemed to make the intellectual shift from saving what they could afford to set aside to a need to accumulate sufficient sums to fund an ever-lengthening retirement. As Clif Helbert, Principal for Retirement Plan Marketing at Edward Jones Investments, put it, “We’ve all been talking to baby boomers for years for developing strategies, but there’s nothing like the first ones that retire to give advisers a wake-up call that the time is here.” The changing demographic will impact firms at the strategic level as well as the product level, he says.

Dave Liebrock, Executive Vice President at Fidelity Investments Institutional Services Company, says there are three broad things creating a changing landscape that impacts advisers and how they need to change their business. First, due to the aging population, 75% of assets making up an adviser’s business belong to clients who are approximately within 10 years of retirement, according to Liebrock. A Fidelity survey of advisers found 43% of a typical adviser’s book of clients are retired or will do so within 5 years.

Secondly, the portion of replacement income in retirement that will come from Social Security has changed. While in years past that was the primary source of income on which retirees depended, Liebrock says now retirees will be responsible for generating almost 60% of their post-retirement income. Finally, Liebrock points out that health care costs will be a primary factor in retirement income planning. Fidelity estimates out-of-pocket health care costs for a 65-year old couple will range between $200,000 and $330,000.

Indeed, as millions of baby boomers approach retirement age, plan sponsors, providers and advisers are shifting focus to retirement income and the education and tools needed to help participants sustain themselves financially during their retirement years. But both Helbert and Liebrock stress there is no magic bullet – no single product or strategy that will address all factors affecting retirement income and provide a guaranteed financial stream that will last.

Now more than ever, Helbert says, there is a need to educate retirement plan participants, not only on basic investment principles, but also on factors like life expectancy, inflation, and withdrawal rates. He notes that participants tend to base their life expectancy on how long their relatives have lived, which, genetics notwithstanding, is often not accurate. Participants do not realize their cost-of-living can double throughout their retirement years, and, due to health care costs, the average retiree’s personal inflation rate will likely be greater than the general inflation rate. Helbert says it is also important that participants plan for the unexpected, such as caring for a parent who gets sick or a child who may need financial help.

According to Liebrock, asset allocation will be very important. Retiree portfolios should be based not just on investment risk, but also inflation risk, withdrawal rate risk, and longevity risk, and expenses should also be a factor. A proper retirement income solution will be a convergence of appropriate investments, asset allocation and withdrawal rate, along with appropriate retirement income and health care products. “An adviser understanding that will play a big part in future,” Liebrock says.

Annuities are gaining more attention as a solution for sustaining income during retirement. Helbert notes that products geared toward retirees should not only address their needs but be understandable. He predicts that those offerings will become more client-oriented and competitively priced. He also predicts health savings accounts will evolve into an important component of retiree income and long-term care insurance will change from a novelty product to a core financial planning product (see HSAs Get a Booster Shot, TK).

Retirement plan participants have long been provided with modeling tools to help them decide how much to save and how to invest their assets, but Helbert expects financial modeling tools to help individuals determine how much they will need in retirement and estimate withdrawal rates will become more popular. He also says including a Monte Carlo analysis, which factors in market performance and expenses, will probably become common in modeling tools advisers use to help clients plan for retirement.

However, as Helbert points out, Internet-based tools are typically not a driver of participant action. Both he and Liebrock say the only things plan sponsors can do to help participants maintain an income stream in retirement are provide education and provide access to a financial adviser.

According to Liebrock, ensuring participants feel prepared and are able to retire when they want should concern sponsors due to the potential financial impact on companies. Participants who feel financially unprepared for retirement will continue to work, which could result in higher employer health care premiums based on employee demographics. In addition, older, higher-tenured employees tend to have higher salaries than younger, lower-tenured employees, so a participant who keeps working past retirement age can affect a sponsor’s compensation costs. Helbert advised, human resources should “take education to heart.”

Meanwhile, Helbert says, the changing demographic provides a tremendous opportunity for financial advisers. Those who develop a business model focused on providing help to individuals with retirement issues, and those who offer “consolidation, clarity and convenience” will be a primary force in the marketplace.