Tag: retirement asset planning

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Retirement Asset Planning Retirement Income Planning

Do You Want to RAP or Do You Prefer to RIP?

Retirement planning is unquestionably the most difficult type of goal-oriented financial planning. Most goal-based planning is straight-forward, solving for the amount, and frequency, of payments that need to be made to accumulate a sum of money at a future date using two assumptions: rate of return and inflation rate.

College education planning is a good example of the use of this methodology with a twist. Unlike other planning where the future value will be withdrawn in one lump sum, college costs are generally paid for over a series of four or five years. This complicates the planning since it requires the calculation of the present value of the future annual costs of college at the beginning of college, which in turn becomes the future value that must be accumulated.

Retirement Asset vs. Retirement Income Planning

Retirement planning is a whole other world. For starters, there are two stages of retirement planning, i.e., retirement asset planning (RAP) and retirement income planning (RIP). Until recent years, RAP was the only type of retirement planning and, as such, is what’s considered to be traditional retirement planning. RAP’s focus is the accumulation and “spending down” of assets. Although it’s more complicated, much of the methodology used is similar to other types of goal-oriented financial planning.

While RAP works well in the accumulation stage, it isn’t designed for calculating, and planning for, projected retirement income amounts that need to be available to pay for projected retirement expenses during various stages of retirement with unknown durations. As a result of the uncertainty of traditional RAP as a solution for providing a predictable income stream to match one’s financial needs in retirement, RIP was born.

Retirement Income Planning Issues

In addition to possessing the knowledge and experience of financial planners who specialize in RAP (RAPers?), retirement income planners (RIPers?) require an expanded skill set and associated knowledge to assist their clients with issues that are unique to RIP before and throughout a client’s retirement years. Planning issues extend well beyond asset accumulation and include, but aren’t limited to, the following:

  • Medicare
  • Long-term care
  • Social Security claiming strategies
  • Conversion of assets into sustainable income
  • Income tax minimization
  • Choosing strategies to address gaps in income
  • Retirement plan distribution options
  • Retirement housing decisions
  • Philanthropic
  • Estate transfer

Recommended Timeframe

Retirement planning is a time-sensitive and arduous task that requires a high level of discipline and commitment over the duration of one’s adult years, not to mention specialized expertise. Given the relatively short accumulation period compared to the potential duration of retirement complicated by an unknown escalating cost of living, the RAP phase should begin as soon as possible.

There are always competing goals, including saving for one’s first house and education planning, to mention a couple. All financial goals must be balanced against one another, keeping in mind that the ability to provide for your support – before and throughout retirement – supersedes all other goals.

RIP works best when it’s initiated long before you plan to retire. In addition to the nature and complexity of the various planning issues, this is very important given the fact that historically approximately 50% of all retirees retire before they plan on doing so. Given this reality, a 20-year pre-retirement RIP timeframe is recommended.

Finally, it’s important to keep in mind that RIP doesn’t end the day you retire. The success of your retirement years is dependent upon your ability to employ and adjust RIP strategies for the duration of your, and your spouse’s, if applicable, retirement years.

Do you want to RAP or do you prefer to RIP? As I hope you can appreciate, you need to do both at the appropriate time in your life in order to enjoy your retirement years on your terms.

See Planning to retire? Start with the right question

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Retirement Income Planning

The Retirement Income Planning Disconnect

tug of war between husband and wife

When I began writing and publishing Retirement Income Visions™ almost five years ago, retirement income planning was a relatively new concept. What people thought was retirement income planning turned out to be traditional retirement asset planning in most cases.

While the distinction between retirement income and retirement asset planning has gotten more attention in the media over the last five years and has come to the forefront for financial advisors with The American College’s establishment of the Retirement Income Certified Professional® (RICP®) designation two years ago, the importance of implementing a retirement income plan hasn’t caught on yet with most pre-retirees.

According to a TIAA-CREF survey, 72 percent of retirement plan participants said that either their plan didn’t have a lifetime income option or they weren’t sure if their plan offered one. While 28 percent said that their plan offered a lifetime income option, only 18 percent of plan participants actually allocated funds to this choice.

This is despite the fact that 34 percent of retirement plan participants surveyed said that the primary goal for their plan is to have guaranteed money every month to cover living costs and another 40 percent wanted to make sure that their savings are safe no matter what happens in the market. Furthermore, while 74% are concerned about security of their investments, only 21 percent expect to receive income from annuities.

Given the fact that fixed income annuities are the only investment that’s designed to provide guaranteed lifetime income, there’s an obvious disconnect and associated lack of understanding between what pre-retirees want and what they’re implementing when it comes to retirement planning. A large part of the problem is attributable to the fact that employees are relying too much on their employer’s retirement plan to meet their retirement needs. See Don’t Depend on Your Employer for Retirement.

Most employers today offer a 401(k), or defined contribution plan, to their employees vs. the traditional defined benefit plan that was prevalent several years ago. The latter plan is designed to provide lifetime income beginning at a defined age whereas a 401(k) plan is designed to accumulate assets, the value of which fluctuates over time depending upon market performance.

Since an income tax deduction is available for contributing to a non-Roth 401(k) plan and the maximum allowable contribution level is fairly generous for most employees, the incentive to seek out lifetime income options in the marketplace is limited for most retirement plan participants. This is the case even though people like the idea of lifetime income and their employer’s retirement plan doesn’t usually offer this option.

As the marketplace becomes better educated about the importance of having a retirement income plan, this is reinforced by the next stock market downturn, and employers increase the availability of lifetime income options, the disconnect between the desire for, and inclusion of, sustainable lifetime income in one’s plan will lessen over time.

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Retirement Asset Planning Retirement Income Planning

Don’t Plan to Squeak By Into Retirement

Let’s face it. We’re a “just in time” society. With our busy lives, we do a lot of things at the last minute. Many people thrive on the adrenaline rush that often accompanies completion of a project right before its deadline.

Retirement income planning lesson #1: Don’t plan to squeak by into retirement. We simply cannot apply our “just in time” thinking to retirement. Retirement income planning is complicated, with too many things that can go wrong, many of them beyond our control. It requires a totally different mindset that runs contrary to the way most of us are use to thinking.

While there are no guarantees, a retirement income plan that’s begun and frequently revisited well before and throughout retirement provides the best opportunity for success. The basic goal of any retirement income plan is for your money to outlive you. When you see headlines like “Boomers’ Retirement Confidence Sinks,” you know this isn’t an easy goal to achieve.

Retirement income planning is especially tricky. It is quite different from retirement planning where the primary objective is accumulation of assets to obtain financial security throughout one’s retirement years. Traditional retirement planning isn’t enough to get you to the finish line in most cases today.

It’s too easy to have a false sense of comfort that one’s accumulated assets are sufficient to last for the duration of retirement only to be unpleasantly blindsided by the “sequence of returns” in the first several years of retirement. For those of you who aren’t familiar with this term, it is a series of investment portfolio returns, usually expressed annually, that has a direct impact on the longevity of an investment portfolio during the withdrawal stage. See The Sequence of Returns – The Roulette Wheel of Retirement that includes a comparison of three scenarios to help you better understand the importance of this risk to a retirement asset plan.

Retirement income planning takes retirement planning a step further. It requires planning for a predictable income stream from one’s assets, that when combined with other sources of income, is designed to meet an individual’s or family’s financial needs for the duration of retirement. This is a very important distinction. Locking in a predictable income stream in advance of one’s retirement reduces the impact of a down market in the early years of retirement.

A retirement income plan needs to have a secure floor of retirement income that will last for your, and, if applicable, your spouse’s lifetime. The timing and after-tax amount of the floor needs to correspond to ongoing and one-time predictable and unpredictable expenses that will fluctuate during different periods of retirement adjusted for inflation. To the extent that known income streams, e.g., Social Security, aren’t projected to be sufficient to cover expense needs, other sources of sustainable income need to be developed well in advance of retirement.

Don’t plan to squeak by into retirement. Trust me – there won’t be any adrenaline rush.

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Long-Term Care Longevity Insurance

The Retirement Income Planning Sweet Spot

Retirement Income Center

If you know me professionally, you know that I’m big on distinguishing between retirement income, vs. retirement asset, planning. This isn’t about semantics. It’s about being practical. Unless your lifestyle allows you to survive solely on Social Security or a comparable monthly benefit if you don’t qualify for Social Security, you need to create your own pension. This is, after all, the theme of this blog: Innovative strategies for creating and optimizing retirement income.

In order to create your own pension, you need assets. The question is, when should you transition from a retirement asset planning to a retirement income planning approach? Tied into this question is a related question: Is your current financial advisor trained, experienced, and equipped to offer solutions to assist you with making this change? If not, it may be time to look for a new adviser who specializes in retirement income planning.

See What Tools Does Your Financial Advisor Have in His or Her Toolbox

So when should you begin creating your own pension? This is a daunting task since the primary goal is to ensure that you won’t outlive your income while surrounded by many unknowns, including, how long you will live, potential health issues and timing and cost of same, as well as changing inflation and tax rates, to name a few. Given this situation, there ideally needs to be a significant amount of lead time to do the necessary planning.

As with all financial planning goals, you need to work backwards from your target date. By definition, the applicable date for retirement income planning would be the age at which you would like to retire. Given the complexity of the process together with the many unknowns, a 20-year lead time is generally advised. Assuming that you would like to retire at age 70, you should have an initial retirement income plan prepared at age 50.

This doesn’t mean that you need to transfer all of your nonretirement and retirement investment assets into income-producing assets on your 50th birthday. This is simply when the transition from a retirement asset planning to a retirement income planning process should begin. Strategies will generally be implemented gradually over the course of the years leading up to, as well as after, retirement as your situation changes and different opportunities present themselves. Your retirement income plan needs to be vibrant, proactive, and responsive to change since you will experience many of them at an increasing rate as you approach, and move into, your retirement years.

In addition to retirement income planning strategies, your plan should include income protection strategies for yourself and for your spouse if married. An unprotected, or under protected, life event such as disability, long-term care, or death can severely reduce the longevity of, and potentially prematurely deplete, your, or your survivor’s, investment assets. Income protection strategies should be included and implemented as part of an initial retirement income plan due to the fact that they become increasingly expensive and potentially cost prohibitive with age, not to mention the risk of being uninsurable as you get older.

So what if you’re within 20 years of retirement and you haven’t begun retirement income planning? No need to panic. While your strategies and potential opportunities may be more limited depending upon how close to retirement you are, it’s never too late to start a retirement income plan. As previously stated, retirement income planning strategies are generally implemented both before and during retirement as your situation changes and different opportunities present themselves.

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Fixed Index Annuities Retirement Asset Planning Retirement Income Planning

What is a Retirement Income Planner?

Retirement Income Center

Choosing the right fixed index annuity (“FIA”) with the right income rider for your situation requires that you first choose the right individual who specializes in this unique retirement income planning strategy. The conclusion of the post, Retirement Income Planner Key to Success When Investing in Fixed Index Annuities, was that the person you choose should be a professional retirement income planner.

What is a retirement income planner? Before answering this question, let’s start by stating what a retirement income planner isn’t. Although it’s possible that the same individual may perform both services, a retirement income planner isn’t the same thing as a retirement planner.

Simply stated, a retirement planner develops and manages strategies for building assets that are intended to be used for retirement. Retirement planners practice retirement asset planning, As defined in Retirement Income Visions™ Glossary, Retirement Asset Planning is:

The process of planning for the accumulation of sufficient assets to be used for retirement and “spending down” of those assets during one’s retirement years.

Retirement asset planning is all about accumulating assets. It begins when assets are earmarked for retirement, either by (a) the nature of the assets, e.g., qualified plans including 401(k) plans, or (b) dedicating nonqualified assets for retirement. By definition, retirement asset planning ends at retirement whether or not there are sufficient assets that will last for the duration of retirement.

Retirement income planning, on the other hand, begins during the asset accumulation process and ends at death. As defined in Retirement Income Visions™ Glossary, Retirement Income Planning is:

The process of planning for a predictable income stream from one’s assets, that when combined with other sources of income, is designed to meet an individual’s or family’s financial needs for the duration of retirement.

Retirement income planning is practiced by retirement income planners. Per Retirement Income Visions™ Glossary, a Retirement Income Planner is:

An individual who is professionally trained, licensed, and experienced in developing and managing strategies for creating and optimizing retirement income to meet one’s financial needs for the duration of retirement.

“Income” and “duration of retirement” are the key words and phrases, respectively, in this definition. In today’s low-interest rate environment, it’s difficult to find investments that will generate decent income streams that will meet one’s short-term financial needs, let alone for the duration of retirement.

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Retirement Asset Planning Retirement Income Planning

Retirement Income Planning – The End Game

Retirement Income Center

If you’re a subscriber to Retirement Income Visions™, you may have noticed that, although there have been nine posts prior to this one, none of them has stayed true to the theme of this blog, i.e., Innovative strategies for creating and optimizing retirement income. This post will be no exception. As the saying goes, there’s a method to my madness. In order to understand and appreciate the strategies and apply them to your situation, it’s important to understand the origin of retirement income planning, including the limitations of the retirement asset planning approach.

As explained in The Retirement Planning Paradigm Shift – Part 2, retirement planning is undergoing a paradigm shift. Instead of relying on retirement asset planning as a solution for both the accumulation and withdrawal phases of retirement, people are beginning to recognize, understand, and appreciate the need for, and value of, employing retirement income planning strategies during the withdrawal phase. No doubt about it, per Retirement Asset Planning – The Foundation, retirement asset planning is the way to go in the accumulation stage to build a solid foundation for a successful retirement plan. However, as discussed in The Retirement Planning Shift – Part 2, as a result of the uncertainty of traditional retirement asset planning as a solution for providing a predictable income stream to match one’s financial needs in retirement, retirement income planning was born.

Is Your Retirement Plan At Risk? introduced six risks common to all retirement plans: inflation, investment, income tax, longevity, health, and Social Security benefits reduction.

Beginning with Retirement Asset Planning – The Foundation, the inadequacy of retirement asset planning during the “spend-down” phase was discussed. This begins with the process itself. Unlike most types of financial planning where you get to see the results of your plan after reaching a specified target date, this is not the case with retirement asset planning since the timeframe is undefined.

Withdrawal Drag – The Silent Killer contrasted the beauty of compound rates of return during the accumulation stage with the erosion of portfolio income and the associated benefit of compounding, otherwise known as “withdrawal drag,” in the withdrawal stage of retirement. There is yet another phenomenon that can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years. The Sequence of Returns – The Roulette Wheel of Retirement exposed this investment phenomenon and provided an example of how “luck of the rate-of-return draw” can prematurely devastate a conservative, well-diversified portfolio.

As if all of these variables and financial phenomenon were not a wake-up call to your planning, we mustn’t forget about the “safe withdrawal rate.” Safe Withdrawal Rate – A Nice Rule of Thumb demonstrated how the widely-accepted 4% “safe” withdrawal rate doesn’t necessarily guarantee that you won’t outlive your investment portfolio. Furthermore, the withdrawal amount that is calculated using this methodology typically won’t match your retirement needs.

All of the foregoing financial risks and phenomenon contribute to the inherent uncertainty associated with the retirement asset planning process during the withdrawal phase of retirement. As pointed out in Retirement Asset Planning – The Foundation, even if you’ve done an excellent job of accumulating what appear to be sufficient assets for retirement, you generally won’t know if this is true for many years

Retirement income planning is truly the end game in financial planning. Assuming that your goal is to generate a predictable income stream to match your financial needs in retirement while minimizing your exposure to withdrawal drag, the sequence of returns, and the various risks common to all retirement plans, it generally makes sense for you to begin employing retirement income planning strategies for a portion of your assets ten years before you plan to retire. The amount of assets and the exact timing of implementation are dependent upon your particular retirement and other financial goals as well as your current and projected financial situation.

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Retirement Asset Planning Retirement Income Planning

The Sequence of Returns – The Roulette Wheel of Retirement

Retirement Income Center

So here you are, crossing the threshold from earning a living to going into retirement. You worked hard for many years. You built a sizeable, diversified investment portfolio. You hedged your bet by purchasing life insurance and long-term care insurance. Your will and other estate planning documents have been updated to reflect your current goals and financial situation. Everything’s in place, or so you think.

Welcome to the roulette wheel of retirement, otherwise known as the “sequence of returns.” If you haven’t planned for this financial phenomenon, your retirement could be quite different than you envisioned. To illustrate this important concept, let’s take a look at three hypothetical scenarios. In each one we’ll use the following five assumptions:

1. Retirement age: 65
2. Portfolio value: $500,000
3. Annual withdrawals: $25,000, or 5% of the initial portfolio value,
increasing by 3% each year
4. Life expectancy: 25 years, or until age 90
5. Average rate of return: 7%

The last assumption is the most critical one and can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years.

Let’s start with Scenario #1 – 7% Return Each Year. While this scenario never occurs in real life, it’s often used for illustration purposes. Once you review Scenario #1 – 7% Return Each Year, you will see that even after taking out withdrawals that begin at $25,000 and more than double to $52,000 at age 90, your portfolio value increases from $500,000 at age 65 to $576,000 at age 78 and then gradually declines in value to $462,000 at age 90. You’ve taken distributions totaling $964,000 and your portfolio has earned $926,000 over 25 years. Nice result!

Scenario #2 – Good Early Years assumes that you are fortunate enough to retire at the beginning of a bull market where your investment returns exceed your inflation-adjusted withdrawal rate of 5% for several years, you experience a couple of years of negative rates of return, and a bear market kicks in your final three years, resulting in negative rates of return each year. Per Scenario #2 – Good Early Years, although it doesn’t occur in a straight line, your portfolio increases from $500,000 at age 65 to a peak of almost $1.5 million at age 87, with a final value of $921,000, or double the value of Scenario #1, at age 90. Like Scenario #1, you’ve taken distributions totaling $964,000 and your portfolio has earned $1.385 million over 25 years. Life is great!

So far, so good. To illustrate Scenario #3 – Bad Early Years, let’s simply reverse the order of investment rates of return that we assumed in Scenario #2. As in Scenario #1 and Scenario #2, over 25 years, we’re going to end up with the same average rate of return of 7%, however, the first three years are going to be bumpy, to say the least. Unlike Scenario #2, where your portfolio value increases by $208,000 the first five years, going from $500,000 at age 65 to $708,000 at age 70, per Scenario #3 – Bad Early Years, it decreases by $224,000, going from $500,000 at age 65 to $276,000 at age 70, or a swing of $432,000 during the same period.

Your portfolio continues to decrease in value each year until it is depleted at age 81. Instead of taking distributions totaling $964,000 as you did in Scenarios #1 and #2, your total distributions over 25 years are only $541,000. Furthermore, instead of realizing portfolio income totaling $926,000 in Scenario #1 and $1.385 million in Scenario #2 over 25 years, your total portfolio income is a measly $41,000. Yikes!

In both Scenario #2 and Scenario #3, there are negative rates of return in only five, or 20%, of the total of 25 years of retirement. Two years of negative rates of return out of ten years, on the average, is fairly typical for long-term historical rates of return for a diversified equity-based portfolio. As you can see, in Scenario #3, it doesn’t matter that 80% of the returns were positive, nor is it relevant that there was an average rate of return of 7%. As a result of the portfolio being depleted at age 81, the hypothetical individual in this situation wasn’t able to experience the 11.4% average rate of return during the final nine years.

The most important factor in Scenario #3, and the #1 risk to any retirement asset plan, is the sequence of returns. While you have no control over this investment phenomenon, you don’t need to play roulette with your retirement assets.

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Retirement Asset Planning Retirement Income Planning

Retirement Asset Planning – The Foundation

Retirement Income Center

Last week, in Retirement Planning Risks, I discussed six risks associated with retirement planning in general. In order to understand and appreciate the value and importance of retirement income planning and its associated strategies, let’s take a closer look at retirement asset planning.

As was presented in The Retirement Planning Paradigm Shift – Part 2, the focus of retirement asset planning is on the accumulation and “spending down” of one’s assets. The accumulation phase is common to various financial planning areas, not just retirement, including house purchase planning and education planning, to name a couple. With most types of planning, you’re typically designing a plan for the purpose of accumulating funds for either (1) a single expenditure at some specified, or target, date, in the future, e.g., a down payment on a house, or (2) a series of expenditures for a limited and specified series of target dates, e.g., a four-year college education.

With all types of financial planning, there are two major stages:  (1) design, and (2) funding, or plan implementation. Similar to an architect, a financial planner, after consultation with his/her client(s), designs a financial blueprint, or plan, for achieving a particular goal, or series of goals. Assuming that the client approves the recommendations, the plan is generally funded with a single lump sum or a series of payments over a specified period of time, depending on the plan’s goals, the client’s current and projected resources, and various other factors.

With most types of financial planning, when you reach the plan’s target date, you immediately, or over a limited number of years, e.g., four in the case of college education, see the results of your plan. What distinguishes retirement asset planning from other types of planning and adds to the complexity of the plan design and funding strategy is the “spend-down” phase.

Unique to retirement asset planning, the timeframe of the “spend-down” phase is undefined. It can last for less than a year and, although it is unlikely, it can go on for as many as 60 years, depending upon when it starts and a host of many variables.

Unlike most types of financial planning where you get to see the results of your plan after reaching a specified target date, this is not the case with retirement asset planning. As a result of all of the risks discussed in last week’s post, there’s an inherent uncertainty associated with retirement asset planning. Even if you’ve done an excellent job of accumulating what appear to be sufficient assets for retirement, you generally won’t know if this is true for many years.

While retirement asset planning can provide a solid foundation for a successful retirement plan, unless it is accompanied by a customized retirement income plan at the appropriate stage in your life, there is a higher likelihood that your retirement income will fall short of your needs and that the plan, itself, may not succeed.

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Financial Planning Retirement Asset Planning Retirement Income Planning

Is Your Retirement Plan At Risk?

Retirement Income Center

Before I write about the specific risks associated with retirement asset planning and the strategies that retirement income planners use to address, and, in many cases, mitigate, these risks, let’s take a look at risks that are common to all retirement planning. While many of these are uncertain and/or uncontrollable, each of them needs to be addressed in a retirement plan.

The risks that will be discussed are as follows, with the first three common to all types of financial planning, and each one intended to be a brief introduction vs. a comprehensive discussion:

  1. Inflation
  2. Investment
  3. Income tax
  4. Longevity
  5. Health
  6. Social Security benefits reduction

Inflation

Although it is unpredictable as to amount and fluctuation as it pertains to individual and overall variable expenses, a key risk that must be considered in the design and funding stages of all retirement plans is inflation. Unlike most types of financial planning where it is a factor only in the accumulation phase, inflation is equally, if not more important, during the withdrawal stage of retirement planning. The longer the time period, the more magnified are the differences between projected vs. actual inflation rates insofar as their potential influence on the ultimate success of a particular retirement plan.

Investment

Unless you are living solely off of Social Security or some other government benefit program, you are directly or indirectly exposed to investment risk. Even if you are receiving a fixed monthly benefit from a former employer, although it isn’t likely, your benefit could potentially be reduced depending upon the investment performance of your former employer’s retirement plan assets and underlying plan guarantees. Whenever possible, investment risk should be maintained at a level in your portfolio that is projected to sustain your assets over your lifetime while achieving your retirement planning goals, assuming that your goals are realistic.

Income Tax

Even if income tax rates don’t change significantly as has been the case in recent years, income tax can consume a sizeable portion of one’s income without proper planning. With the exception of seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) that have no personal income tax and two states (New Hampshire and Tennessee) that tax only interest and dividend income), the rest of us need to be concerned about, and plan for, state, as well as, federal income tax. In addition, if you have a sizeable income, it is likely that income tax legislation will be enacted that will adversely affect your retirement plan on at least one occasion during your retirement years.

Longevity

Unlike other types of financial planning, the time period of retirement planning is uncertain. Although life expectancies are often used as a guide to project the duration of a retirement plan, no one knows how long someone will live. The risk associated with the possibility of outliving one’s assets is referred to as longevity risk. In addition, life expectancies, themselves, are changing from time to time. The August 19, 2009 edition of National Vital Statistic Reports http://bit.ly/pAgRk announced a new high of nearly 78 years for Americans. Planning is further complicated for married individuals since you are planning for multiple lives.

Health

An extremely important risk that is sometimes overlooked or not given enough consideration in the design of retirement plans is health. Under-, or uninsured, long-term care events as well as premature death in the case of a married couple, can deal a devastating blow to an otherwise well-designed retirement plan. It is not unusual for a prolonged long-term care situation, such as Alzheimer’s, if not properly planned for, to consume all of one’s retirement capital and other assets. Inadequate life insurance to cover the needs of a surviving spouse can result in dramatic lifestyle changes upon the first spouse’s death.

Social Security Benefits Reduction

Once considered to be unshakable, the security of the Social Security system, including the potential amount of one’s benefits, is questionable. In addition, it was announced in May that for the first time in more than three decades Social Security recipients will not receive a cost of living adjustment, or COLA, increase in their benefits next year. While beneficiaries have received an automatic increase every year since 1975, including an increase of 5.8% in 2009 and a 14.3% increase in 1980, this will not be the case in 2010.

Each of the foregoing six risks needs to be considered, and appropriate strategies developed, in the design and implementation of every retirement plan to improve the chances of success of the plan.

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Retirement Asset Planning Retirement Income Planning

The Retirement Planning Paradigm Shift – Part 2

Retirement Income Center

I hope that you’ve had a chance to read The Retirement Planning Paradigm Shift – Part 1. If not, please take the time to do so. This is a continuation, promoted at the end of Part 1 as “Return of the Blog.” Have no fear. While it’s definitely more technical than Part 1, it’s not scary. Break out the popcorn and read on.

Similar to the scientific breakthroughs that Thomas Kuhn discussed in his 1962 landmark book, The Structure of Scientific Revolutions mentioned in Part 1, retirement planning is undergoing a paradigm shift. This is quite natural given the fact that financial planning as a profession is still in its infancy. Its origins trace back just 40 years when Loren Dunton, the father of financial planning who is credited with coining the term “certified financial planner,” set up the Society for Financial Counseling Ethics with a meeting of 13 individuals at Chicago’s O’Hare Airport in 1969.

In order to understand the retirement planning paradigm shift, let’s start by taking a look at two basic financial statements:  the Statement of Financial Condition, or Net Worth Statement, and Cash Flow Projection.  Both reports are frequently prepared by financial planners at the outset of a planning engagement and are  typically updated throughout the course of a relationship with a client. A Net Worth Statement and Cash Flow Projection are used to plan for, and to monitor progress toward, the pursuit of one’s financial goals, including retirement.

The results of cash flow projections that professional financial planners have been preparing for years have only begun to be experienced and scrutinized by retirees during the last couple of decades. As with all new mthodologies, some prove to be successful and others need to be modified based on experience. Retirement planning is no exception.

Traditional retirement planning as it has been, and continues to be, practiced by most financial planners, focuses on the accumulation and “spending down” of one’s assets. This is, in essence, retirement asset planning.  While this type of planning works well in the accumulation stage, ideally resulting in projections of sufficient retirement capital when conservative assumptions are used, unfortunately, it often proves to be inadequate for meeting one’s needs when the plan plays out in retirement years. The reasons why this occurs are important and will be the subject of a future blog post.

As a result of the uncertainty of traditional retirement asset planning as a solution for providing a predictable income stream to match one’s financial needs in retirement, retirement income planning was born.  Cash flow projections incorporating the latter approach typically result in a better matching of projected income to projected needs, reducing the likelihood of outliving one’s retirement capital.

While this alternative approach is still evolving, it’s logically and emotionally more appealing than traditional retirement asset planning for someone who is within 10 years or so of, and throughout, retirement. When properly employed by professional retirement income planners, retirement income planning should ultimately prove to be a more effective strategy for meeting many indviduals’ retirement needs for the vast majority, if not the entire duration, of retirement.

Retirement income planning should supplement, and should not replace, traditional retirement asset planning at the appropriate stage in one’s life in order to provide a total solution. Understanding this phenomenon requires a paradigm shift that will become apparent in future blog posts and will hopefully be an “Aha!” experience, common to all paradigm shifts, that you can use to create a more rewarding retirement planning experience.