Retirement is becoming an increasingly risky proposition for a growing number of people. This puts greater onus on advisors to ensure that their clients are on track to live comfortably when they stop working. It is, therefore, important to understand the macro trends that are creating uncertainty in the global retirement system and the strategies that can be used to reduce the risk of retiring.

“Throughout the world, retirement risk is greater than it has been at any time since the birth of the modern welfare state in the late 19th century,” write David Hunt, Salim Ramji and Peter Walker in “Taking the risk out of retirement,” published in The McKinsey Quarterly (2005, No. 2). “Over the past two decades, the level of retirement-related risk has increased as employers shifted from defined-benefit to defined-contribution plans, life expectancies increased and health-care costs rose.”

In addition, say the authors, a looming crisis in public pension plans means that many individuals “must plan for retirement without knowing how much support the state will provide.”

These developments are compounded by lower fertility and savings rates, which have an indirect impact on the public retirement system. According to a 2005 study by London-based HSBC, entitled The future of retirement in a world of rising life expectancies, 66 countries with 2.7 billion people, or 43% of the world’s population, have fertility rates at or below the level required to sustain their populations. That means the number of working adults for each person over 65 will be halved in the next 50 years — to 2.2 from 4.5. As a result, a greater percentage of GDP, as much as 20%, will be needed to provide public pensions.

The paper forecasts 13% of total GDP will be required to fund public pensions in Canada in 2050, up from 5.1% in 2000.
Canadians are expected to spend an average of 21 years in retirement, compared with the Americans and Chinese, who will spend 24 and 26 years, respectively — up by an average of more than 20 years in the last century.

Living longer can be translated into saving more to sustain retirement. However, savings rates are set to decline significantly globally, including among Canadians. In another paper, “The demographic deficit:
How aging will reduce global wealth,” published in The McKinsey Quarterly, authors Diana Farrell, Sacha Ghai and Tim Shavers argue that because people save less after they retire and younger generations in their prime earning years are less frugal than their elders were, savings rates are set to drop dramatically.

The authors contend that no country will be immune and that finding solutions must go beyond raising the retirement age, encouraging families to have more children, boosting economic growth and increasing productivity. Essentially, savings rates must be increased to facilitate the wealth accumulation necessary to meet the retirement needs of an aging population that is living longer.

The HSBC study found that Canadians are the best prepared for retirement of the people surveyed in 10 countries — Brazil, Canada, China, France, Hong Kong, India, Japan, Mexico, Britain and the U.S. However, that conclusion is based on evidence of people who have consulted friends, talked to a bank or contributed to a private pension to prepare for retirement, and not necessarily on whether they have accumulated sufficient retirement funds.

Statistics Canada’s general social survey on social support and aging, published in September 2003, shows a substantial number of non-retired Canadians were uncertain about their retirement transition.
Almost one-third were either unable or unwilling to state the age at which they plan to retire; 18% indicated they did not intend to retire. The intention to retire is strongly linked to an individual’s financial situation — the lower the income, the less likely he or she is to intend to retire. The absence of private pension coverage also influences the decision not to retire.

While advisors can do nothing to reverse the macro trends that increase retirement risk, they can customize strategies depending on their clients’ situations — levels of income and benefits from either private and/or public pension plans, for example — to alleviate such risks.

“It’s a question of needs vs wants,” says Francis D’Andrade, CEO of Markham, Ont.-based RGI Financial Services Inc. “We need to determine how much is needed to retire comfortably based on our expectations of our lifestyle during retirement — and not [on] how much we want. People tend to get caught up with universal definitions of ‘how much is enough’ when, in reality, we all have different needs. Do we really need a million bucks? We may certainly want a million bucks, but do not need it to retire comfortably.”

@page_break@Philip Armstrong, president and CEO of Toronto-based Jovian Capital Corp., says increasing life expectancy requires a shift from the traditional view of using more conservative investments in portfolios as people near retirement age to using more equity investments. “People have to invest for the longer term and for a longer period of time, and not put all their investments in fixed-income products as they near retirement,” he says. In essence, retirees should invest more in equity markets to reduce the probability of outliving their money, a strategy that runs counter to current thinking.

Hunt et al. argue that 85% of advisors surveyed by McKinsey in 2005 say they are “well prepared” to meet their clients’ retirement needs. However, in a 2004 survey of consumers, a majority did not agree that they were “well prepared.” The authors suggest the “growing disconnect between advisors and clients results from the difficulty advisors have in changing from the asset accumulation strategies that made them successful during the long bull market of the 1980s and 1990s.”

Armstrong cautions that people tend to be more conservative in their views as they get older and may not readily adapt to being aggressive at or near retirement. He says the financial services industry will have to deal with the issue by creating more hybrid products that offer capital preservation as well as growth, as well as innovative products that “release equity” from homes, such as reverse mortgages.

The home is typically the single largest investment. People who have not put aside enough cash for retirement may find they have to rely on home equity to fund their retirements, he says: “This would mean not being able to pass on the entire value of their homes as inheritances.” Incidentally, StatsCan found that “intentions to forgo retirement were more prevalent among individuals who did not own their own homes than among those who did.”

Prem Malik, certified senior advisor and chartered accountant at Toronto-based Merchant Capital Wealth Management Corp., recommends “well-balanced, actively managed” portfolios for his clients. Advisors have a “critical” role to play in reducing retirement risk, he says, but the task is not easy because people preparing for retirement are disillusioned with the equities.

“People are losing out on the growth of the equity markets by being safe,” he says. “Yet they will need more money in retirement because they are living longer.”

Both Armstrong and Malik, however, contend that people tend to require less than they think they will during retirement; their expenses are lower and their needs come down. “Each individual is different,” says Malik. “You have to put some reality into the picture to get to where you want to be.”

Armstrong suggests setting realistic expectations based on a complete analysis of the client’s financial situation. He recognizes it is difficult to think ahead, “but it is critical to build a picture as you get closer to retirement,” he says.

Macro conditions aside, says D’Andrade, “Setting a trajectory to achieve your retirement goals and staying on track are what will provide peace of mind at the end of the day.” IE