Dallas Salisbury spends the better part of his time at work researching the probabilities of retirement success for American workers. So when Salisbury, the chief executive of the Washington, D.C.-based Employee Benefit Research Institute, is calculating his own retirement plan, he uses figures he calls very conservative.
But to most planners, Salisburys figures may sound alarming or just plain crazy. His plan must get him to age 108, he says. He sets projected rates of return at 1% over inflation and, when analyzing annuity products, he sets inflation at 8% compounded annually.
I dont want to have any chance of outliving my money, he says.
At 65, Salisbury plans to continue working for some time. Thats also part of his retirement plan. Most financial planners would look at our situation and theyd say weve saved too much, he says. My wife says we havent saved enough.
WHAT IS ENOUGH?
The question of how much money is enough leads to another question, which is perhaps the most difficult and most central issue advisors face when helping clients plan for retirement: How long should you expect clients to live?
Getting this variable exactly right is virtually impossible. Getting it wrong can have a profound impact on a clients quality of life, lifestyle and legacy.
Will your clients live to 85? 95? 105? Underestimating life span can leave clients vulnerable to outliving their assets and forced to live on Social Security benefits alone. (For those worried about the stability of the Social Security system, this is an even scarier thought.)
Yet being overly conservative with your longevity assumptions could mean clients enjoy their money (and their lives) far less than they could have both before and during retirement.
Theres a fundamental tension, says industry researcher, blogger and Financial Planning columnist Michael Kitces of Pinnacle Advisory Group in Columbia, Md., who has questioned whether advisors may be too conservative in their assumptions. Choosing an arbitrarily long time horizon ensures that clients dont overspend, but they die with money left over.
Some planners also argue that longevity fears are overblown, because minor adjustments to life expectancy wind up having relatively minimal impact on a spending or investing plan. Once you are planning beyond 30 years, you dont gain that much by shortening the time horizon, says David Yeske, managing director of Yeske Buie, with offices in San Francisco and Vienna, Va.
Similarly, he adds, a fairly conservative estimate means that clients will still be safe with even longer life spans: Once you plan for your money to last for 30 years, its likely going to last a lot longer.
Advisors may start their planning by looking at life tables, but for most clients, average life expectancy is of limited help. After all, if the average life expectancy of a 65-year-old female is about 85, there is a 50% chance that she will live past that age an unacceptable basis for planning, advisors say.
Besides, its clear that clients are above average when it comes to longevity. The healthier, wealthier and more educated people are which is to say, the more likely they are to be a planning client the longer they are likely to live. And the older they are, the longer they can expect to live. The life expectancy of a newborn is 76 years for a male, according to the 2010 Social Security period life table. A 65-year-old male, however, has already beaten infant mortality and other early-onset ailments; as a result, he is expected to live to 82.5.
Marriage also adds another dimension because in any couple, theres a greater chance that at least one member will live longer than either is expected to live individually a factor Kitces says many advisors fail to recognize. The joint life expectancy for a 65-year-old couple is 27.1 years, based on the 2000 annuity mortality table. And, of course, the expenses for the surviving spouse arent simply half of what they might be for a couple an important planning consideration.
Yet planning for both members of a 65-year-old couple to reach a certain age say, 95 may make plans more conservative than advisors realize, Kitces argues. Lets say those clients have an 18% chance of at least one spouse living to 95 and their portfolio plan has a 90% success rate in Monte Carlo tests. That means the 10% chance of running out of money will only be relevant for the 18% of scenarios in which at least one has lived to 95. The true joint probability of failure is only 1.8%, Kitces explains. Their plan is actually 98.2% successful now, not just 90% from the Monte Carlo software.
There are also emotional issues that complicate the calculations. One of them is guilt, Kitces says: Advisors dont want to be the one who lets clients outlive their assets.
Both advisors and clients also have built-in biases. Another factor creeps in advisors own money scripts, says Jonathan Guyton, principal of Minneapolis-based Cornerstone Wealth Advisors, who has done research on retirement horizons and withdrawal strategies. In my upbringing, if I were exposed to a fear of running out of money, unless Im really self-aware, its going to influence my advice.
The same can be said for clients. If clients have seen many people in their lives live to their late 90s, or are caring for elderly parents, they are more likely to be adamant about using a longer horizon. But if the reverse is true, clients are likely to resist higher longevity assumptions.
Of course many argue that the trade-offs are unequal that outliving ones assets is a far worse outcome. This, and other conspiring factors, means advisors often take a more cautious approach.
No matter what, its clear that client longevity assumptions are a gamble. Advisors who want to be almost certain that clients wont outlive their assets are approaching this conundrum in a variety of ways.
AVERAGE WITH PADDING
Karen McIntyre, managing director and senior financial advisor at Philadelphia-based Wescott Financial Advisory Group, uses a strategy common among planners: We overestimate the things that will negatively impact projections and we underestimate things that will have a positive impact so clients are more likely to meet their goals. We build in a cushion.
With couples, she plans for the youngest spouse to reach age 95. Twenty years ago that might have been a pie-in-the-sky estimate, whereas now its more of a reality and we present it to clients that way, she says. For clients who are currently in their 80s, McIntyre further extends life expectancies.
Yeske points out that the only way to have a high probability of success is to follow a plan that likely ensures you die with a lot of money but for most clients, thats not really a negative outcome.
Investors often have other goals, whether it is to live comfortably or leave money to their children or a charity, Yeske explains: The conservative path means they have enough money for their other goals.
ASK HARD QUESTIONS
McIntyre also digs deeper with individual clients, trying to tease out the most realistic life expectancy for each one. She typically asks clients whether there are any major health issues or terminal illnesses, what health issues are present in the family and what the history of longevity is in the family.
These topics can be painful, but theyre important, she says: Thats where a little empathy comes into play.
McIntyre tells clients: We may not have talked about this before, but it impacts your planning and we want to make this as meaningful as possible.
Cheryl Krueger, an hourly, fee-only planner in the Chicago area, says she talks about longevity with clients but only so far as they need to feel comfortable with the assumptions made. Its really a conversation about how flexible you are. Its so uncertain, she says. You dont want them to be scared, but you also want them to have a realistic understanding.
In an effort to get even more accurate estimates and make sure clients feel comfortable with the assumptions being used, some advisors say they have pointed clients to customized life expectancy calculators. The one on livingto100.com takes clients through a series of questions and bases the calculations on a study of centenarians. Developed by Dr. Thomas Perls, the founder and director of the New England Centenarian Study, it takes about 10 minutes and goes into much more depth than most planners or planning software programs do.
Yeske contends that one of the most important question advisors can ask is this: Are you a smoker? Because smoking can dramatically reduce ones life expectancy, it would be disingenuous to put their life span assumption at age 100 and force them to spend accordingly, he adds.
KNOW SOFTWARE LIMITS
In fact, this is one of three important questions used by MoneyGuidePro financial planning software, according to Bob Curtis, the founder and CEO of PIETech, the designer of the software.
Those questions are:
- Are you a smoker?
- How is your general health? Poorer than average, average or above average?
- How is your family health history? Poorer than average, average or above average?
MoneyGuidePro uses the answers to generate a wide range of life expectancies from 82 for a 65-year-old male smoker to 97 for a 65-year-old male with above-average health and a family history of longevity.
In an attempt to balance between assumptions that are too conservative or too aggressive, MoneyGuidePros default setting gets clients out to an age with about a 30% probability for a 65-year-old, thats 90 for men and 93 for women. Advisors can customize those assumptions by having clients answer the three health history questions or selecting another age and also adjust assumptions on inflation, market returns and spending.
Yet advisors say that some planning software has trouble incorporating up-and-down adjustments of spending rates. Software programs have a hard time addressing nuances, McIntyre says. Its harder to project that some lifestyle expenses increase at 4% or 6%, while some stay flat.
For Guyton, this flexibility in clients spending and withdrawal rates is a critical element of his strategy and part of what he says makes planning software ineffective for him.
Even smart expense assumptions, once entered into many programs, he says, become too static. When [the software] starts to get bad runs, it assumes you do nothing thats not how the planning relationship works, he says.
KEEP WITHDRAWALS FLEXIBLE
In reality, says Guyton, clients need to be able to adjust to changing conditions. Most rules people follow that say, This spending amount is safe, assume that you never, ever plan to make adjustments along the way, he says.
Guytons strategy to maximize withdrawal rates assumes the opposite. His method is at once more conservative he uses a 40-year retirement and more flexible, because spending increases can be frozen or cut as needed. After all, he says, most people are accustomed to making adjustments in their spending habits before retirement, he argues, and will be willing to do the same during retirement.
If you will make adjustments, then you can withdraw nearly [one percentage point] higher than the classic 4% withdrawal rule would permit, Guyton says.
And if you start with a higher withdrawal rate and are forced to alter it due to market conditions either freezing or cutting inflation increases the plan eventually ends up looking a lot like the 4% rule, he says. Soon the numbers are the same as if the scenario hadnt been bad, he says. The flexible, evidence-based spending approach will get you to the same place as if youd known it would have been so bad.
Guytons strategy has another key element categorizing expenses as fixed or discretionary and then separating clients assets into these different buckets. While the assets in the fixed-expense bucket must be able to reach that 40-year horizon, the discretionary money can be spent down at whatever rate the clients want presumably more at the start of retirement but once its gone, its gone.
In the end, perhaps conservatism isnt the right way to think about longevity assumptions. The whole concept of conservative is misleading because it makes for an aggressive decision on the other side, says pioneering planner Harold Evensky.
We ignore costs and consequences taking an age that one couldnt reasonably expect to live to, adds Evensky, who helped develop the MoneyGuidePro software. Unless clients have all the money in the world and it doesnt matter, then they either have to spend less during their lifetime or invest more aggressively thats not exactly conservative.
Using the MoneyGuidePro defaults and client questionnaire, Evensky also uses assumptions that get clients to around a 30% probability of living past the chosen age. Theres no such thing as conservative; we just try to do the most reasonable thing we can, he says. If someones got enough money and a reasonable risk level, its not a problem, but most people arent in that circumstance.
For clients who arent well prepared for retirement, adjustments will have to be made, advisors say. Theres no way to have it all, Guyton says. Clients may choose to spend less, work longer or die earlier but of course, not all of that is in their control. Most planners dont want to be too conservative, he says, but they want to be conservative enough. FP
Samantha Allen is digital managing editor of SourceMedias Investment Advisor Group, including Financial Planning.