Over the next decade, the majority of the 79 million Americans girding for retirement will begin to withdraw from their savings. This group is more likely to live longer, control their investment decisions, and be more active than any generation in history. These facts lead to the conclusion that setting up retirement spending plans is likely to become a service demanded of every financial advisor.The number of variables complicates the task.
The length of time is a moving target. Expenses could spike dramatically in some years due to highly probable medical events. Rates of investment returns and the rate of inflation might be predictable on average, but vary greatly from year to year.
"Nobody earns 6 percent every year, inflation isn't 3 percent, [and] assets and spending both fluctuate," said Mitchell Freedman, CPA/PFS, of Mitchell Freedman Accountancy Corp., in Sherman Oaks, Calif. "It's a myth that we can project a client's financial condition in any other reality than the theoretical."
As a result, a growing number of financial advisors see an opportunity to assist retirees.
Freedman has established an eldercare practice and is a member of the ElderCare Task Force of the American Institute of CPAs. He reported the common experience of other people on the task force of trying to figure out how to serve this populace. "We don't have the tools to paint the appropriate picture," said Freedman.
The first determination in a retirement plan is the required annual withdrawal. Advisors vary on methods of calculation. Freedman said he starts with a projection of what the client needs to maintain their lifestyle.
Peter F. Bauer, CFA, CPA and president of Oakbrook Financial Group Inc., in Oak Brook, Ill., uses the spending levels of working years as a starting point. He then reduces it by the expenses that the client expects will diminish. "Retirement expenses can go down by a third compared to working expenses," said Bauer. "Mostly the house and other debts are paid off, and commuting costs and clothing expenses both go away."
Clients of the eldercare practice of Hereford, Lynch, Sellars & Kirkham PC, in Conroe, Texas, project that spending figure. "We gather all the information and make projections," said practice head Debra Seefeld, CPA. "But the client tells us how much they want to spend and we start from there."
Uncertainty permeates the projections of annual spending as much as it does the projected rates of inflation and investment returns. Medical costs form the biggest wild card in retirement planning. Seefeld runs an uneven cash flow projection based on knowledge gathered about the clients' health and that of their immediate family. One variable she enters is the possible date of moving out of a home into a continuing-care retirement community.
A less predictable variable is the progression of a disease like Alzheimer's. "Alzheimer's patients progress from a few hours of care a day to 24/7, costing upwards of a hundred thousand per year," said Seefeld. "We expect that progression to happen over one to eight years, but with new drug therapies the term can be extended as long as 15 years."
How healthy, how long?
While some medical expenses occur annually, the unexpected can be more damaging to a spending plan. "We have some clients spending $1,200 a month on insurance and another $700 to $1,000 on prescriptions," said Bauer. "But what's hard to estimate is something like a heart transplant that runs into the hundreds of thousands."
To address the potential for emergency medical spending, Bauer assumes that every client will be unhealthy for about five years. "That five years could even come in the middle of the retirement years," said Bauer. "That's why one of the biggest mistakes we can make with financial projections is to become too precise."
A paper in the Financial
Analysts Journal of November/December 2005 attempted to quantify the uncertainty. The authors suggested a mathematical approach to calculate spending needs borrowed from the insurance industry. The stochastic present value of spending acknowledges the variability of human life span, annual withdrawal requirements, and rates of return and inflation. The calculation incorporates the probability of the variable occurring, rather than assuming an absolute number. The authors provide several tables showing results. For example, the probability of ruin for a 65-year-old spending $2 per $100 of their nest egg and earning 5 percent per year is 1.1 percent. The probability rises to 41.8 percent for retirees spending $8 per $100.
"Most clients we meet every month and redo the cash flow if anything changes in their lives that will affect their spending," Seefeld said.
Eldercare practices demand additional knowledge to fine-tune the planning process.
Seefeld's husband Mike is also a CPA, but expanded his skills by gaining an advanced degree in gerontology. As part of the eldercare services of Hereford, Mike and Debra educate CPAs across the country on the kinds of resources they'll need to serve the elderly. "We let them know about the information they can get from social service agencies and local chapters of the National Association of Geriatric Care Managers," said Seefeld.
Retirement spending is further complicated by legal, social and governmental issues.
Cash flow might come from a variety of sources laboring under differing tax structures. Advisors might be challenged to provide cash flow from trusts while generating assets for the remainder requirements. Advisors must know the constantly changing terms of Social Security, Medicare and Medicaid. "I've brought myself up to speed on Part D of the new Medicare Drug Plan, but if anybody tells you they truly understand it, they're lying," said Freedman.
Freedman follows a big-picture method of helping retirees of keeping reserves, running what-if scenarios, and using a few simple rules to guide decisions. But he's convinced that assuring retired people that they won't outlive their assets is a growth area for advisors. "The process is not dissimilar to financial planning," he said. "But so many CPAs discard clients after their income-generating and asset-building years."
