The reality of lifetime income is something the baby boomer generation is now forced to face, and millennials will have to start thinking about sooner than they may think. Last month, we examined the background of lifetime income and the importance of understanding the significant shift in demographics that brought us to where we are today. To quickly recap, lifetime income means an individual will have enough money to live a comfortable life after retirement. According to the Social Security Office of Retirement and Disability Policy, for the first time in modern American history, a group of people (baby boomers) will be retiring without the protection of a defined benefit, such as a pension.
Many companies that previously offered pensions have replaced them with a 401k. But 401ks were never designed to be the singular source of retirement income. As a defined contribution plan, a 401k will only grow based upon contributions and potential investment returns; thus many employees will never be able to contribute enough to secure 100 percent of their lifetime income via a 401k. Furthermore, Michael Finke and Sandra Huston of Texas Tech University, and John Howe of the University of Michigan, released a 2016 study that showed the ability to make long-term financial decisions begins to decline around the age of 49. This data begs the question as to what an average person can do to work towards making sure they can retire at a reasonable age while living in the manner they are accustomed to. The answer is taking a proactive and educated role in planning for retirement.
Planning for the goal of lifetime income starts with asking yourself some important and somewhat daunting questions. First, know what age you would like to retire, as that age will gauge how many years you have to pursue the goal of building the retirement account. If someone who is 30 wants to retire early at 45, they have only 15 years to work towards building the funds versus another 30-year-old who will retire at 65. The additional 20 years to work toward growing retirement income means the second 30-year-old probably won’t have to invest as aggressively as the first one. While it may seem premature for someone in their early thirties to start thinking about retirement, remember, the ability to make long-term financial decisions declines with age. The next important question is how long the retirement fund will need to last. The answer to this question entails estimating how long a person will live after they retire. Of course, this will be a guess, but factors like family health history and individual health should be used as a guideline. Longevity is not the only aspect; healthcare costs must also be considered. No one should expect Medicare to completely pay all healthcare costs. If a person is unhealthy in their forties, it is realistic to expect that when they are in their seventies, more healthcare will be required.
Other considerations may include the need for long-term assisted care. Individuals with family support may never have the need for assisted living, but a person without any immediate family to take care of them will need to think about the potential cost of living in a senior care facility. Knowing the rate of spending (withdrawal rate) is essential to retirement planning; the estimated rate of inflation is also a factor. Combing the costs of day-to-day living and healthcare, as well as what type of leisure activities are desired during retirement, are all part of the equation.
Once these questions have been answered, the time comes to decide how to fund lifetime income. There are multiple items that should be measured. What will the Social Security draw-down strategy be? Should investments be placed in a Roth IRA instead of a traditional one? Should a High Deductible Health Plan (HDHP) with a Health Savings Account (HSA) be selected over conventional insurance? What risk tolerance is appropriate and at what age or circumstances should that tolerance be adjusted? These are just a sampling of the important but complicated decisions that must be made. For the average person, making these decisions without the assistance of a financial advisor may be imprudent. Luckily, access to qualified financial advisors is available. But each individual should find an advisor that is right for them.
Before looking for an advisor, check with employers, as corporate financial wellness programs are gaining popularity. Typically, these types of corporate programs are offered at no charge to employees. Other alternatives include both big firms and private advisor groups. Big firms, sometimes referred to as recordkeeping companies, may have a menu of proprietary products to offer. While those products can be very attractive, those proprietary products are owned by the entity recommending them. Thus, there is a potential for a conflict of interest. Smaller or private advisor groups generally don’t own any of the products they suggest, helping to alleviate concerns of conflict. To make advisor selection easier as well as to protect consumers, the Department of Labor has created a new Fiduciary Rule, which goes into effect in April 2017. The new rule includes categorizing financial professionals that work with retirement planning to the level of a fiduciary. Fiduciaries are legally and ethically bound to put the best interest of their clients first, disclose potential conflicts of interest, and provide transparency with regard to fees and commissions.
Unless someone is a financial professional or natural born fiscal savant, planning and managing to seek lifetime income can be very complex and overwhelming. While lifetime income may not be something most people think about every day, the day may come that they wish they had. Therefore, be proactive by taking advantage of all the great professional options that are available. Taking the time now to understand and prepare for the goal of lifetime income will help when it is time to retire.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Securities offered through LPL Financial, Member FINRA/SIPC. Investments advice offered through Global Retirement Partners (GRP), a registered investment advisor. GRP, StoneStreet Advisor Group and LPL Financial are separate non-affiliated entities.