The 2008 financial crisis market downturn has created new challenges for those nearing retirement, as well as those who are already retired. Many people need to work longer, but will have a difficult time doing so because of physical productivity and a declining job market. There is a new version of retirement forming, and this is an opportunity for financial advisors to help individuals in navigating the short- and long-term challenges.
At a June Capitol Hill presentation sponsored by the American Academy of Actuaries, actuaries suggested that the traditional three-legged stool of retirement security included:
1) Social Security
2) Traditional pension plans, including defined benefit (DB) plans
3) Personal savings, including defined contribution (DC) plans
The presenters claimed that there are now seven legs needed for retirement. Besides the standard three areas above, the added categories included:
4) Health insurance coverage and long term care financing
6) Housing wealth
7) Family and community
There clearly has been an evolution in the pension coverage provided by employers. Research from the Center for Retirement Research shows that, in 1983, 62 percent of employers in the private sector had DB-only plans, 12 percent had DC-only plans and some had both. In 2007, the numbers reversed to the extent that 17 percent of the private sector employees had DB-only coverage, 63 percent had DC-only and a smaller number had both types of coverage.
This change to DC plans often compounds the challenge faced by people nearing retirement -- that there is more pressure on personal savings as a source of retirement income. Many people have a savings rate that is too low for their contribution into the DC plans. Additionally, many people who can take lump sums do so and increase their risk by putting their funds into an undiversified portfolio.
There has been a difference in the perceptions of retirees throughout the past year, as noted in a recent study, jointly sponsored by the Society of Actuaries, LIMRA and International Foundation for Retirement Education (InFRE). The study "What A Difference A Year Makes," is the result of a survey of 1,500 retirees with $100,000 or more of investable financial assets. It showed significant changes over one year to the same group of retirees when asked the question, "Are you as financially secure now as you thought you would be when you first retired?" In 2008, only 20 percent responded that they were less secure than when they first retired. In the 2009 survey, that same question generated a 49 percent response indicating that they were less secure. That same survey also asked retirees if they were confident that they saved enough money to live comfortably throughout their retirement years. The number of respondents that said they were very confident had declined from 37 percent in 2008 to 26 percent in 2009. And this is the decline from a group that had significant savings and more financial resources than the general population.
Prior to the financial crisis, the retirement age was increasing. Now for more and more people, there is an increased "transitional retirement" period between full-time work and total retirement that combines some form of income generating work and some leisure activities. The labor force participation rates of those aged 65-69 showed that in 1994, 27 percent of men and 18 percent of women were in the labor force. In 2007, those numbers increased to include 34 percent of men and 26 percent of women. Surveys of pre-retirees showed that with the recent loss of savings, they are planning to postpone retirement by an average of 4.2 years; however, many people ignore the possibility of involuntary early retirement. Mathew Greenwald and the Employee Benefit Research Institute compiled Retirement Confidence Surveys from 2002-2007. The surveys show that throughout that time period, anywhere from 37 percent to 43 percent of people had retired earlier than planned. So, four out of 10 people did not work as long as they had anticipated. It is unlikely that many of the pre-retirees will actually postpone retirement by over four years.
So how can a financial advisor use this research?
1. First, you are a key player in helping people decide when to retire and claim Social Security. Far too often, people are looking only at the life expectancy numbers for someone who is at birth, and use a time horizon that is too short. Projecting the current mortality improvement factor to live until 2025 shows that for a married couple, both age 65, there is a 78 percent chance that the female will survive to age 80, a 72 percent chance that the male will survive to age 80 and a 94 percent chance that either one will survive to this age. In fact, there is a 59 percent chance that either will survive to age 90. It is important that the proper time horizon is used.
2. Consider all seven factors of the stool in financial planning, not just the three traditional factors. Non-financial assets are about 70 percent of total assets for the average retiree (not counting Social Security and DB plans). Look at the amount and the risk of those non-financial assets. Ask questions about the amount and level of health coverage that people carry. Discern what family resources might be available.
3. Present the facts about working longer. It is imperative to let clients know that over 40 percent of retirees had not worked as long as they expected, either due to involuntary early retirement or health issues.
4. Stress diversification, safety and efficiency. When clients suggest that they will make up for the drop in their savings now by investing in a high-risk investment, it is important to stress diversification, safety and efficiency. Diversification means that you do not put all of your retirement security in one basket. Safety means not gambling only on high-risk/high-return investments to try to rescue your portfolio after the financial crisis. Efficiency means that you protect against the mortality risk of dying too young and that you are concerned about longevity risk and outliving your savings.
A key objective is to help clients navigate this "new retirement" and cope with the current market challenges, thinking about not only today's issues but also the long-term risks.