Best Planning Ideas 2014: Retirement

The annual “Best Planning Ideas” presentation was held during the Advanced PFP Conference in January 2014. Participating in this year’s panel were Lyle K. Benson Jr., CPA/PFS (moderator), Stephen R. Akers, JD, Robert S. Keebler, CPA, MST, AEP (Distinguished), and Michael Kitces, MSFS, MTAX, CFP®. Discussion topics included income and estate tax planning, investments, the Defense of Marriage Act, the Patient Protection and Affordable Care Act, and retirement—the topic of this article, which includes various points made during the presentation. Read through to the end of the story to find out how to obtain an audio recording of the entire presentation.

According to a Financial Advisor article published in May 2014, the hottest market for financial advisors is providing advice and guidance on retirement issues to post-World War II baby boomers. Yet, in any discussion of retirement planning, a logical starting point may be to better understand the broad realities of finance, demographics and public policy. The numbers are not encouraging. In the United States, more than half of the adult population has no pension benefit and 35 percent have set no money aside for retirement. Today, Social Security provides 75 percent of retirement income for those over 65 years old, and in developed countries across the world, governments currently provide 59 percent of retirement income.

The youngest members of the boomers are now 50 years old, and with longevity increasing, the average length of retirement is now approaching 20 years. When you factor in a potential lack of savings, the outcomes are predictable and less than encouraging. In the United States alone, the shortfall in retirement dollars for those ages 55 to 65 is $113,000 per household (source: U.S. Census Bureau).

Though the averages these statistics measure may not represent the typical client base, the realities affect us all in terms of higher taxes, reduced or means-tested retirement benefits, inflation and rates of return. Certainly clients will need advice and guidance in retirement planning—and it’s up to you go provide this service.

Equity Glide Path
Traditional retirement planning advises clients to hold equities when they are young, and to reduce the equity portion of their portfolios as they approach and go through retirement. New research, however, suggests that retirees should consider ratcheting up the equities balance during retirement.

In fact, strategic variations in equity holdings make sense, given today’s changing retirement realities. Clients typically build up equities during their middle, higher-earning years. As a result, shifting to lower-risk, fixed-income investments as clients approach retirement is the traditional approach. However, new planning research suggests having a high equities balance when building for retirement and the lowest equities content when you have the largest overall account balance—precisely when retirees pull the trigger and start living off that money for the rest of their lives—exposes retirees to the damage an unexpected bear market would cause.

This new view on equity glide paths also suggests that clients should then live off annuities or other fixed income in the early retirement years, leaving equities untouched and, hopefully, to grow. This allows equities to slowly ratchet back up over time. If returns are good, that’s positive. If equity returns are less than optimum, clients can rebalance into equities and benefit from dollar cost averaging into equities as their exposure slowly rises.

Certainly, clients long schooled in the traditional strategy may find this equity model a bit hard to accept. Yet, by framing the approach correctly, and by discussing asset allocation in the context of today’s realities, planners can help clients understand this logical and productive strategy. Michael Kitces’ blog, Nerd’s Eye View, has more information on equity glide paths.

Annuity Income
After reviewing historic and more-recent research on retirement income, focused primarily on retirement glide paths and bucket strategies, retirees should leave a portion of their portfolios untouched, while drawing down other portions during retirement. Research shows that partial annuities support sustainable income during retirement with steady income and without heavy drawdowns of the portfolio during early retirement years.

For clients that eventually live beyond 90 years of age, an annuity provides an exceptional income stream and a very positive return. Because those long-lived retirees receive ongoing payments, regardless of how long they live, they win the so-called “mortality bet” against those who pass away earlier. That longer-living cohort is, of course, a smaller percentage of those who choose the annuity strategy, but they generate an outsized return.

Though the analysis has shown that retirees who live a more normal lifespan can also benefit from the annuity model, new research suggests that the benefits in such situations may actually not be due to the annuity itself, but rather, the kind of bucket liquidation strategy it creates.

The reason is that if wealth and asset allocation are graphed, income is depleted as the annuity is spent down and equity rises as the growth runs. This creates a scenario in which total equity exposure increases throughout retirement. This counter-intuitive approach can actually be helpful, and it is implicitly part of the value of using an annuity; but notably, clients can realize these same benefits without using an annuity in the first place.

The research suggests an optimal approach is cutting equity exposure down to around 30% at the start of retirement, and then liquidating bonds during the early years of retirement, and finally allowing the equity portion to rise incrementally during retirement to as much as 60% of the latter-stage portfolio.

Revisiting the Strategy
As retirement approaches or continues, planning should ensure that projections are conservative enough to account for higher taxes, as well as increased health care and longer-term care costs.

Planning reviews should also evaluate changes in inflation and rates of return, increased longevity, uncertainty relating to pensions and Social Security, and changes in the needs of dependents. Based on research and real-world experience, planners may want to consider a few sensible guidelines.

Given that many clients fall in the range of $1 million to $5 million in net worth, post-retirement tax planning will be crucial. Governments around the world will be seeking higher tax revenues to support the coming demographic wave of retirement entitlements.

At the same time, real pressure is mounting to limit or means-test Social Security, public and private pensions, and other fixed retirement payouts. For clients 50 years old or younger, many planners now project retirement income, using just 75% of expected Social Security benefits, an outcome that will occur if we never do anything to fix the system for the rest of the century.

Given the global economy, the children and grandchildren of our clients are not doing as well as previous generations. So, retirees often help those relatives with financial assistance and other support, thus further drawing down their own resources.

Many CPA financial planners deal with the top earners in which clients will hopefully be somewhat better prepared. The vast majority of people, however, are going to work longer, depend more heavily on their children and experience lifestyle declines in their retirement years.

In summary, the panel suggested that you should not position yourself as a doomsayer; yet, you may want to advise clients to plan for higher costs and taxes, and for more modest rates of return. Offer a total cost-of-living perspective on retirement planning and encourage your clients to save and invest more for retirement.

Retirement Planning Resources
Michael Kitces, along with Stephen R. Akers, JD, Robert S. Keebler, CPA, MST, AEP (Distinguished), and Lyle K. Benson Jr., CPA/PFS, participated in the “Best Planning Ideas Panel” presentation during the Advanced PFP Conference held in January 2014. In addition to retirement, panelists discussed income and estate tax planning, investments, DOMA, and the Affordable Care Act. An audio recording of this presentation is available in the AICPA’s online library. Registered attendees for the 2014 conference have complimentary access when they log in through the website (see instructions to access). Those who did not attend can create an account to purchase audio recordings and presentation materials.

A webcast, “Retirement Planning and Issues Related to Aging,” was held June 10, 2014, from 1-2:45 pm, ET, featuring panelists and CPA/PFS credential holders, Jean-Luc Bourdon, Lori Luck and Ted Sarenski and moderator, Lyle Benson. Register for the webcast with CPE (discounted for PFP/PFS, Tax and PCPS members); register to attend for free without CPE (PFP/PFS members only).

PFP Section members, inclusive of CPA/PFS credential holders, have access to many retirement planning related resources, including, for example, The CPA’s Guide to Social Security Planning and The CPA’s Guide to Financing Retirement Healthcare. The Retirement Planning Resource page includes these guides as well as information on Roth IRA conversions, safe withdrawal rates, long-term care planning and more. Forefield Advisor provides clear and concise consumer-oriented materials on many of these topics with special resource centers for Social Security and healthcare reform.

Member Discount on The Kitces Report
If you liked this article, then you might be interested in a monthly subscription to The Kitces Report. Michael Kitces has extended a discount on a monthly subscription to The Kitces Report to PFP members, inclusive of CPA/PFS credential holders. To obtain the subscription, enter discount code AICPAPFP to obtain 10% off a new standalone subscription.