There are several moving parts and material contingencies that one may encounter on the journey of making sure your clients' wealth lasts for as long as they need it to. For some, having resources last for their own life expectancy is the goal, while for others making assets last for generations is the objective.
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Among the most significant and unpredictable of the moving parts is the anticipated return on your assets. If your client is a very conservative investor looking for ironclad guarantees, this low rate may have a profound impact on your possible outcomes. Even more interesting a decision is what to use for the risk-free rate of return that may be attainable for this low-risk client in 10 or 20 years. Because this question is very difficult to answer, perhaps you should test your forecasts using a range of estimated rates. Using too high a future rate in your forecasts could cause irreparable harm to your clients' financial future. On the other hand, if your clients' financial situation is not compromised when using today's low rates in your forecasts, making assets last can seem quite achievable.
For a client who is not risk-averse, a higher rate of return may be appropriate for the forecasts. Be sure to stress-test your forecast and understand just how low their returns can go before your client has a problem sustaining their desired level of spending.
A good way to keep a closer tab on the impact of earnings in your forecast is to revisit the forecasts no less than annually. Make sure that your client understands the importance of keeping the forecasts current and adjusted for your actual experience.
TOOLS FOR A LIFETIME
When generating adequate income is your clients' No. 1 objective, you must also consider using annuities to provide a lifelong stream of guaranteed income. It may be deemed negligent for you not to have considered using annuities to provide retirement income. If your client chooses annuities, evaluate the chosen product's ability to provide a rising income stream to keep pace with inflation. Another consideration will be the strength of the underlying issuer of the annuity. Guaranteed income can be a beautiful thing as long as the guarantor remains financially healthy and the payment stream continues.
While using an annuity may narrow the range of possible outcomes, it should not be viewed as the be-all and end-all for your client's retirement income planning. Beware of overzealous agents who want to tie up too much money in annuities. While the income may be higher than what you can generate using safe alternatives, some of the income-based contracts would offer poor lump-sum withdrawal possibilities should your client need a lump sum for any unforeseen reason. Another way to mitigate the risk of any one annuity product would be to diversify, and spread your income-producing investments to more than one company.
The next variable is inflation. Forecasts of future inflation may be as difficult as forecasting future interest rates. Once again, I believe the most prudent way to evaluate whether inflation will eat away at your client's ability to make assets last is to stress-test your assumptions with higher rates of inflation than we are experiencing today. In general, it may make sense to use a higher rate of inflation than today's low-inflation environment for practical purposes also. Expenses such as leisure, food and energy may actually inflate faster than the published CPI statistics.
Perhaps the most controllable part of making your client's money last lies in their ability to control spending -- especially during the earlier years of retirement. Drive home this point to your client as early as your initial fact-finding sessions, in hopes of their providing an accurate and realistic analysis of spending. Be sure to probe for the wish list, and be sure to include some of the lifestyle components that your clients want to change. Don't let your clients' vision of what they think they can afford cloud the visioning of what they'd like to do. In a perfect world, our job would be to help our clients live their dreams.
Spending, like any other part of the forecast, needs to be revisited and examined to be sure that your clients are on track. Not all clients have a good handle on their spending and will get hung up on this part of the forecast. Tips to figure out monthly spending are to go through six months of bank statements or to ask your clients to consolidate their spending to come from one account for a few months while they examine spending.
THE GREAT UNKNOWNS
The wild cards when forecasting spending are contingencies and unknowns. These can come from anywhere -- from perils such as home loss and accidents to health issues that may materially increase your cost of living. In your analysis, attempt to forecast the client's future under the scenario where unprotected risks occur and under a scenario where the client purchases protection such as long-term-care insurance to protect against catastrophic long-term issues. Some of your clients will have to make some very difficult choices. There will be some who want LTCI, and there will be those who do not. For those who do, illustrate their cash flow including that expense. For those who do not want coverage, illustrate what their financial life looks like if a catastrophic health event strikes.
Beyond your clients' income streams, there are many who will want to engage in legacy planning, and ask your assistance to help their assets last beyond their lifetime and for the lifetimes of their children (or further). This process may start with helping to keep your client's overall estate tax burden as low as possible. Be sure to illustrate the estate tax shrinkage anticipated from your client's current estate plan and offer suggestions for both mitigation and replacement.
Mitigation techniques, from current gifts to remainder trusts and family partnerships, must be evaluated. When a family or closely held business interest is among the assets that your client would like to last beyond their retirement, you must be sure that a solid succession plan is implemented. This includes a contingency plan in the event that your client dies prematurely or becomes disabled while running the business. The succession strategy should also address future leadership, incentives for key employees to remain with the company, and a funding mechanism to both replace the talents and efforts of the deceased owner and for the buyout of the deceased's shares.
Another concern of your clients may be their beneficiaries' ability to manage money. This may be from special needs, financial problems or spendthrift issues. In the case of special needs or a beneficiary who currently faces financial challenges, asset protection may be the primary concern. For the beneficiary who can't seem to hold onto a nickel, spendthrift provisions may be in order. These provisions are best when manifested though the terms of a trust with an independent trustee who is willing to control the flow of funds for the spendthrift beneficiary.
Certain annuities also provide protection from spendthrifts through restrictive beneficiary language. While these restricted beneficiary elections may work, many attorneys actually prefer trusts to better control the language and the possibilities that the grantor's wishes will be implemented.
For clients whose primary objective is to have money last as long as possible through the generations, consider a life insurance-based legacy trust. From simply creating an estate to ensuring that the estate is large enough to accomplish the objective of creating a lasting legacy, life insurance may be one of the most cost-effective ways to accomplish this. Factor the cost of this coverage into your forecasts to be sure that your client has not unintentionally compromised their lifestyle today for a legacy tomorrow. And when selecting an insurance contract, the internal rate of return on death benefit may be one of the more meaningful numbers to compare from product to product and company to company. Understand the variables used in each illustration that you examine to be sure that you are evaluating policies with similar sets of assumptions.
It is your clients' money, and a good financial planer must address their wishes in order to have a successful engagement. As in most planning engagements, make sure that your analysis and the basis for your recommendations is well-documented. This may be especially true with helping assets last beyond retirement, because the necessary tactics may be very different from those for other objectives.
John Napolitano, CFP, CPA/PFS, is the chairman and CEO of U.S. Wealth Management, in Braintree, Mass. Reach him at (781) 849-9200.