Five steps to help clients win the retirement income challenge
by Craig HawleyMr. Hawley is head of Nationwide Advisory Solutions. Visit nationwide.com
Americans are living longer. The average life expectancy in the United States is now 79 years as of 2018, compared to just 70 years back in 1968. The average 65-year-old couple today has a 52 percent chance that at least one of them will live to be age 95. What’s more, half of the babies born today in the U.S. will live to age 100, if current life expectancy trends persist.
As lifespans increase, and investors face a retirement that can last 20 to 30 years or more, the retirement income challenge is real and growing. The challenge is compounded as pension plans disappear, the cost of living and cost of healthcare rise, and the safety net is stretched thin by more than 10,000 Boomers turning 65 every day.
The pressure starts early. It might be surprising to learn that saving enough for retirement is among the top four financial concerns for Millennials (Ages 18-37) according to Nationwide Advisory Solutions’ fourth annual Advisor Authority study of 1,700 RIAs, fee-based advisors and individual investors. Likewise Gen X investors (Ages 38 – 53) say that saving enough for retirement is their number-one financial concern—and the number-one reason why they work with an advisor.
More than ever before, investors of every generation, and every level of net worth, need RIAs and fee-based advisors to help them manage longevity risk, and confront the retirement income challenge head on. Here are five steps to help clients take control:
The Foundation for Making it Work
Longevity planning is fundamentally changing the way that advisors help their clients prepare for and live for multiple decades in retirement. By taking a more holistic view, longevity planning builds a bridge between the financial, emotional and physical, focusing on the profound changes and hard choices that come with longer lifespans—including sensitive and potentially uncomfortable topics such as elder abuse, living wills and end of life issues.
For advisors who practice comprehensive longevity planning, a well-structured retirement income strategy remains the foundation for making it work. Steady cash flow is essential to finance a client’s pursuit of their passions and goals for as long as possible. It determines if they can afford to live with the level of independence they desire. It matters when managing the complex costs of Medicare, Long-Term Care and “aging in place.”
While the vast majority of RIAs and fee-based advisors (93%) have a strategy in place to help protect clients against outliving their savings in retirement, just under three fourths (74%) of all investors have such a strategy, according to Advisor Authority. Among RIAs, fee-based advisors and investors alike, Social Security is among the top solutions, followed by variable annuities with living benefit riders, dividend yielding stocks, and fixed income/bond ladders. Today there are single premium immediate annuities (SPIAs) designed expressly for RIAs and fee-based advisors, to help maximize sources of guaranteed income as part of a client’s holistic financial plan.
The Importance of Starting Early
When it comes to retirement income the basic rule still applies: The more clients accumulate, the more income they can generate. For those Millennials and Gen-Xers who feel the pressure to save more, it takes an advisor with foresight to structure an accumulation strategy that can hit an income target three to four decades away. It takes discipline to balance clients’ long term goals with the priorities of today—from buying a home, financing children’s education while paying off their own student loans, raising a young family while possibly caring for their own aging parents.
Make sure clients start early to maximize accumulation with the power of tax deferral. Start in their 20’s maxing out tax-deferred 401(k)s to take advantage of any employer match—or risk leaving free money on the table. Balance between traditional tax-deferred IRAs and tax-free Roth RIAs, over time including catch-up contributions for clients in their 50’s. For your high earning and High Net Worth clients, who can easily max out the low contribution limits of qualified plans, investment-only variable annuities (IOVAs) help maximize the power of tax deferral with low or flat fees, no commissions, more underlying funds, and virtually no contribution limits.
The Benefit of Tax Diversification
Taxes remain top of mind for clients—and one of their biggest investing expenses—especially for the more affluent. According to our latest Advisor Authority study, taxes are investors’ number-two financial concern—and the number-one concern for the Ultra High Net Worth. RIAs, fee-based advisors and investors alike say taxes are one of the top three factors adversely impacting portfolios.
Studies show that tax diversification—using a range of different taxable, tax-deferred and tax-free investment vehicles—helps to control not only how much clients pay in taxes, but also when they pay those taxes. The benefit can be substantial. Likewise, locating clients’ assets between taxable and tax-deferred vehicles based on tax-efficiency may help maximize after-tax returns. This type of “asset location” strategy may help increase returns by 100 basis points or more, without increasing risk. Assets taxed at lower rates for long-term capital gains can be located in taxable accounts, while those taxed at higher rates for short-term capital gains and ordinary income can be located in tax-deferred qualified plans or a low-cost IOVA, to preserve all the upside without the drag of higher taxes.
Tax diversification can also help generate more income in retirement. Understanding how taxes impact retirement income, and structuring withdrawals accordingly, can extend the life of a client’s retirement portfolio, sustain income for more years, and preserve assets to pass on to heirs. Knowing the proper timing of which vehicles are used first for withdrawals and distribution may help clients avoid higher tax brackets and reduce unintended taxes on various guaranteed income sources such as Social Security.
It Pays to Delay Social Security
As Advisor Authority shows, nearly all investors, even the most affluent, count on Social Security to provide income in retirement. Not only is this income guaranteed, but it also includes an annual cost of living adjustment, set to increase 2.8 percent in 2019. However, too often retirees claim their Social Security benefits as early as possible, resulting in reduced benefits.
To maximize retirement income, at it pays to delay Social Security if possible. While individuals can currently begin taking Social Security at age 62, waiting until Full Retirement Age (FRA) helps ensure they will begin receiving 100 percent of their benefits. Note that FRA is 66 in 2018 and will increase to age 66.5 in 2019. More importantly, waiting until age 70 increases monthly income even more—potentially boosting Social Security payments as much as 76 percent.
Because clients are living longer, many will want to remain engaged by working longer. The longer they wait to draw down savings, the longer those assets continue to accumulate and compound tax-deferred. And because Social Security benefits are calculated based on the highest earning 35 years of their career, this is another way that working longer may have a positive impact on Social Security benefits. Spousal benefits should also be considered. If one spouse earns more, their partner is entitled to receive Social Security benefits based on those higher earnings. Widows or widowers can collect 100 percent of the high earner’s benefits.
Managing Gaps and Risks with Guaranteed Income
But what if a client wants to retire at 62 or even 65? Retiring earlier can cause an income gap if a client decides to delay filing. To bridge that gap and ensure the income they need until they file for Social Security benefits, consider other solutions for guaranteed income. SPIAs, now designed to fit the way RIAs and fee-based advisors work, are a simple solution to generate guaranteed income, for a fixed period or even for life. RIAs and fee-based advisors say that over the past ten years, investors are far more likely to seek guaranteed retirement income (64%), according to a recent poll by Nationwide Advisory Solutions.
The right SPIA and can help manage many risks in retirement—from longevity risk, to inflation risk, to market risk. This becomes more important when retirement may last 30 years or more. Traditionally, as clients age, their investment portfolio becomes less equities driven and more focused on fixed income. Today, that advice may actually create more risk. Studies show that a healthy dose of equity investing should be continued during retirement years to increase the longevity of the portfolio, increase spendable income and keep pace with inflation. The skillful use of a SPIA to provide a guaranteed income floor helps protect one part of a portfolio, while allowing for the use of riskier assets in another part of the portfolio in pursuit of higher returns.
Help Clients Act Now
As Americans live longer and reaching the age of 90 becomes the norm, they need your help to prepare for and live in a retirement that could last 20 to 30 years or more. Whether an individual client fears outliving their retirement savings, or they are a diligent saver looking to protect their assets, or a sophisticated investor looking to enjoy retirement to its fullest, you can help them with a holistic approach to longevity planning. Retirement income is the foundation for making it work. Help them start saving early, focus on tax diversification, find prudent solutions to delay taking social security, and manage the gaps and the risks with guaranteed income.◊