Defusing new time bombs

In truth, many boomers should be concerned about funding their retirement spending – but not for the reasons they believe.

There are at least three developments that threaten secure retirements but are not well understood. Without wishing to be alarmist, we could call them “time bombs.” The following developments will change retirement for many Canadians:

– life expectancies continue to increase;

– medical costs that continue to escalate as people age; and

– sustainable portfolio withdrawal levels that may drop from historical levels.

Your first responsibility as a financial advisor is to ensure that the retirement plans you develop with your clients reflect accurate assumptions about the future. You should also include a margin of safety should these assumptions prove to be optimistic.

One result may well be that you take a hard look at the common view that an annual 4% withdrawal rate in retirement is sustainable. This may result in changes to how long your clients work, how much they save and how they invest.

Once you’ve addressed existing clients, there’s an opportunity to talk to prospective clients about the state of their retirement planning.

On the surface, there appears to be an anomaly in the marketplace today. On the one hand, you have middle- and upper-class Canadians who are approaching retirement being overly concerned about their financial situations. Yet, most haven’t invested the time to develop a solid, well-considered retirement plan.

Further thought suggests that this isn’t an anomaly at all. Arguably, the reason for the concern about retirement among many boomers is that they lack a clear plan that they can be confident will take them through their retirement.

It is your ability to talk to prospects about your track record in developing those plans for clients that creates an opportunity to convert that anxiety into useful prospecting conversations.

– time bomb no. 1: life expectancies continue to increase

Most people are aware of the remarkable improvement in life expectancy that’s taken place in the developed world over the past 2,000 years.

Here are average life expectancies in Western Europe as of various milestones:

– 0 AD – 26

– 1100 – 26

– 1800 – 36

– 1900 – 46

– 2000 – 78

Much of the gain in the past century is due to significant reductions in death in childbirth and medicinal improvements, such as vaccines and antibiotics that dramatically reduce the most common causes of death.

In 1900, the maternal death rate in childbirth in the U.S. was 1 in 100; today, it is 1 in 10,000. The top three causes of death in that year for the population at large were pneumonia, influenza, tuberculosis and diseases of the intestine.

As recently as 20 years ago, there was broad consensus that we’d see significant deceleration in the lengthening of life expectancies. In fact, average lifespans have continued to lengthen by three months per year. So, two decades ago, a client who was 65 years old could be expected, on average, to live for another 20 years to age 85. Now, a 65-year-old can expect to live to 92.

This has a very big impact on retirement planning. Here’s an excerpt from the blog of science writer Josh Mitteldorf on the topic of lengthening life expectancies:

“In 1970, in the developed world, the low-hanging fruit had already been picked clean: infectious disease, childbirth and infant mortality were no longer major factors in actuarial risk. Most people could expect to live out their full life [expectancy]of about 70 years. Everyone expected – that is, demographers, epidemiologists and policy-makers – that the life expectancy had risen to a natural limit, and that any further progress would be slow and difficult.

“But surprise! Since 1970, countries with the longest life expectancies have continued to improve just as fast as before, even though the progress is now all at the ‘back end.’ The increase in life expectancy since 1970 has been more than 10 years in Japan [and] nine years in Europe. For every year that goes by, three months are added to life expectancy. And this progress applies almost entirely to people over 70.”

– time bomb no. 2: escalating costs for health care as people age

One of the implications of longer lifespans is the amount of time many people will spend in retirement and nursing homes and needing costly health care.

Dementia is especially troublesome. Not only is it crippling for family members, but it is one of the fastest-growing conditions among seniors. (See story on page B11.)

Harvard economist David Laibson has pointed out that after age 70, the risk of dementia doubles every five years.

And, in April, the New York Times ran a story highlighting that today’s cost to care for Americans with dementia is probably higher than it is for Americans with heart disease or cancer. Furthermore, this cost is likely to double within 30 years.

Another recent article talked about a new treatment for prostate cancer with a cost of $100,000. Yet, there is a growing view that Canadians’ medical system will struggle to pay for more than the basics – and that many people who want advanced treatments will have to fund them directly.

You have an obligation to raise these realities with your clients and to incorporate them into their retirement plans. The challenge is to do it in a way that doesn’t appear negative or alarmist. We’ve all read accusations that the financial services industry creates undue anxiety over issues such as income-replacement rates to panic consumers into saving more than they need to.

One solution might be to discuss long-term care insurance, assuming the client’s health is good enough to qualify.

– time bomb no. 3: declining sustainable portfolio withdrawal rates

For the past 20 years, thinking on safe withdrawal rates has been driven by research by American financial planner Bill Bengen.

His research, first published in 1994, led to the 4% withdrawal rule: based on historical experience and assuming the portfolio of a 65-year-old is 60% in large-company stocks and 40% in intermediate government bonds, the owner of the portfolio could withdraw 4% of savings annually, increased each year at the rate of inflation, and have a 90% chance of having the money last for a 30-year period.

Increasingly, this view is being called into question. A March article in the Wall Street Journal with the headline “Say goodbye to the 4% rule” summarized the growing sentiment that historically low bond rates may be with us for an extended period as global economies continue to struggle. Indeed, in an interview, the head of retirement research for Morningstar Inc. summarized some research indicating that the risk of failure for a 4% withdrawal rate after 30 years using the traditional stock/bond mix is no longer 10%; it’s now 50%.

This research indicates that withdrawal rates could be enhanced by using annuities instead of bonds. That said, the conclusion of the research was that retirees, to be safe, should consider withdrawing 3% of their savings rather than the traditional 4%.

Dan Richards is CEO of Clientinsights (www.clientinsights.ca) in Toronto. For more of Dan’s columns and informative videos, visit www.investmentexecutive.com.

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