Planning through retirement, rather than to it
By John M. GroganMr. Grogan is a graduate of Georgetown University in Washington, D.C. and of the Northwestern University School of Law in Chicago. He also completed the Kellogg Management Institute at Northwestern University’s Kellogg Graduate School of Management. Visit www.northwesternmutual.com
Achieving financial security in retirement has become a far more complex equation in today’s world and requires the thoughtful integration of risk management, income optimization and legacy planning.
To begin with, the responsibility for retirement security has shifted significantly to the individual – and by extension their financial advisor. From 1980 through 2008, the proportion of workers participating in defined benefit pension plans fell from 38 percent to 20 percent according to the Social Security Administration.
Historically, people have relied on a variety of income sources to meet their retirement needs. However, today, volatile financial markets and record low interest rates have left many people’s retirement savings earning less than projected. Combine that with the fact that people are living longer, and the critical need for individuals to take proactive planning steps, work with a financial advisor, and be prepared to secure their own retirement income becomes even more apparent.
People are unprepared
Research by Northwestern Mutual has found that people are feeling startlingly unprepared financially to meet the realities of this new retirement landscape. Only slightly more than half (56%) feel prepared to live to the age of 75, less than half (46%) feel prepared to live to the age of 85 and barely more than a third (36%) feel prepared to live to the age of 95.
The best plan an advisor can put in place for clients is the one designed to remove risk from retirement to the greatest extent possible, provides a guaranteed flow of income for life and enables the individual to leave a legacy for heirs or charities. This is only possible through a balance of offensive and defensive strategies in order to best mitigate potential issues and successfully reach investment outcomes.
Defensive strategies can protect clients from life events that hurt their ability to earn income or erode their savings. Offensive strategies seek to ensure income throughout retirement, using guaranteed income to meet essential expenses and personal savings for discretionary expenses.
This approach can sometimes seem counter intuitive to individuals who have grown up in a retirement planning environment dominated by discussions of asset allocation, withdrawal rates and ‘magic numbers’ that might determine whether or not you might live comfortably in retirement.
To be certain, factors such as asset allocation and withdrawal rates are important. But they don’t exist in a vacuum and can be significantly impacted by a myriad of risks people face both in the lead up to and during retirement.
For example, if an individual becomes disabled during their peak earning years, and is unable to work and earn an income, the future nest egg can be detrimentally affected. No amount of sound asset allocation can offset this risk.
By the same token, an individual who has saved diligently but whose portfolio is negatively impacted by a severe market downturn just as they retire, finds themselves with eroding financial security and limited time and options for recovering.
What’s more, with health and long term care costs continuing to rise, and people living longer, the risk of needing long term care at some point during retirement is relevant to almost every individual. Putting it in concrete terms, according to our research, a person needing three years of in-home care, eight hours a day, could find themselves tapping their retirement nest egg to the tune of $200,000 or more.
Too few conversations between financial advisors and clients talk about these risks, let alone plan for them, highlighting not only a critical need, but a real opportunity for advisors to be adding greater value to their clients by helping them understand that the best offense is a good defense.
The idea is to plan through retirement, not to it. Too many retirement plans obligate clients to pick a date of death and stick to it. We say, it’s time to take age off the table. Clients need financial plans that give them confidence that they can achieve their goals over a lifetime even in the face of an increasingly complex financial environment. At the same time, plans must give them the flexibility to accommodate life’s opportunities and challenges.
Advisors must therefore help clients see goal-based planning as both the ability to achieve a goal and the risks of not achieving a goal. It’s a more holistic approach—one that incorporates strategies for building wealth, alongside strategies for preserving it.
What does a total risk management strategy look like in the context of a financial security plan
We believe there are six key risks that must be addressed and they include longevity risk, health care risk, market risk, inflation and tax risk, long-term care risk and legacy risk. Probability analysis simulations show that failure to address these risks can leave retirees unable to afford their living expenses deeper into retirement.
Addressing these risks means a combination of the following:
Managing risk with asset protection
Protecting a client’s assets against the possibility of costly life events means addressing funding for future health care expenses as well as protecting against the financial impact of disability and long-term care events. Depending on the client’s individual situation, permanent life insurance, disability insurance and long-term care insurance can all play a role here.
For example, permanent life insurance, in addition to its death benefit, is able to provide a number of flexible financial options that can be leveraged through retirement. It has the benefit of being an asset that has low market volatility and continues to grow, while also providing cash value that can be used as a source of income to help meet financial needs such as paying estate taxes or funding health care costs.
Managing risk with predictable income
To truly address risk management, your client’s plan must incorporate a variety of income sources to meet the complexities of a retirement that may last 30 years or longer. This includes meeting essential living expenses such as housing, as well as the flexibility to fund discretionary needs such as travel and entertainment, and also legacy planning.
For example, one approach is to use a blend of investments and income annuities to provide a balanced and reliable source of income to last a lifetime.
An opportunity…and a responsibility…for advisors
Individuals seem to recognize the importance of such an approach and it’s my observation that long-term planning, prudent risk management and an emphasis on financial security is taking hold. Industry wide sales of risk products (life insurance, disability income and long term care) over the last three years have increased about five percent, which indicates people’s willingness and interest in managing risk in their planning efforts.
What’s more, in a recent Northwestern Mutual study, we found that 25 percent of Americans said that having enough money to live in retirement gives them the greatest peace of mind, and one in four owns life insurance as part of that retirement planning. However, our studies have also shown that clients do not fully understand the range of options available to them in leveraging their life insurance policies.
This speaks to a real opportunity for advisors. Those who take a holistic approach to client needs by addressing not only asset accumulation needs but also risks like market volatility, inflation, and expanding life expectancies have the opportunity to build deeper relationships with their clients.
Clients report greater levels of satisfaction with their advisor when engaged via a comprehensive planning approach. When engaging clients in a broad-based planning discussion, we have found that 92 percent of clients report being satisfied with the advisor and more than half say they are willing to provide referrals to the advisor. This underscores a dual opportunity: first, for deeper relationships with clients and second, for building your practice via highly prized referrals.
Selecting the right risk products for your clients
The risk management strategy of a financial plan is only as good as the products used to implement it. When you are recommending to your clients that they buy something they may not use for 15, 20, 30 years, it really matters who they buy it from. Look carefully at the financial strength and stability of the provider first and foremost and ensure they have the highest strength ratings awarded by all four of the major credit rating agencies. Also, factor in the impact of dividends, which can significantly lower the overall cost of risk protection and are only available from mutual insurance companies.
If you don’t provide risk management solutions yourself (such as life, disability or long term care insurance and annuities) partner with an experienced and accredited financial representative who does, and make sure that they share your philosophy about financial planning and the importance of offensive and defensive strategies.
You can’t predict your client’s future, but you can help them plan for it
In every stage of life there are risks. If unmanaged, those associated with retirement can have lasting financial consequences. By working with clients to both preserve and manage their wealth, while also mitigating risks, advisors can help them achieve sustainable levels of financial security throughout retirement.