Democratizing Retirement Income Planning Through the Lens of Economics and Finance: The De-Accumulation and Stewardship of Assets
Traditional thinking focuses most individuals or families on saving money for retirement, climbing to the top of the mountain, or what is often referred to as the accumulation phase. If the peak of the mountain represents the day you decide to retire, a climber might say, “I reached the top; I achieved my goal.” This is a tremendous accomplishment that not all Americans will effectuate; however, this goal in isolation is deficient, a half truth. Your goal is not only to make it to the top; your goal is to make it safely down the other side (i.e., making the retirement assets you have accumulated achieve your spending, legacy, and philanthropic goals to an unknown end date). Sometimes, coming down the mountain can be more dangerous than going up. Approximately 80% of all climbing accidents happen on the descent. It is this second half of the journey that presents a risk and requires important and thoughtful planning.
Two questions to consider are: How does the stage set by recent history affect the descending landscapes of the retirement mountains in the near future? How does one effectively transition from a mindset of accumulating resources to preparing oneself for not only the mental fortitude of spending what you have accumulated, but also the lurking risks of taking retirement income?
The mid-1980s to the Great Financial Crisis (GFC) of 2007 has been the accumulation phase for many of our readers – we experienced relatively systematic monetary policy and reduced inflation, setting the stage for years of price stability and a significant decline in macroeconomic volatility. This time period is referred to as the “Great Moderation” by Ben Bernanke, former Chair of the Federal Reserve. However, since the interruption of the financial crisis and the more recent global pandemic, we have major fault lines as markets have reverted into unsettled territory due to economic, financial, and geopolitical instability. In theory, these factors could potentially bring about a period of volatility for the next twenty to thirty years. With an extended bull market pushing the downturn of the financial crisis behind us and the pandemic coming to what is (hopefully) an endemic phase, one may now ask, what else will drive the disequilibrium for current or soon to be retirees?
We have never seen an invasion of Ukraine before (not to mention a possible invasion of Iran into Israel) in the 21st century, and we must consider the potential economic and financial consequences of these historic developments. In that context, we have the possibility of entering a geopolitical depression that will have massive economic and financial consequences well beyond Ukraine. A key geopolitical observation: there is a major escalation of “Cold War II”, in which four revisionist powers – China, Russia, Iran, and North Korea – are challenging the long global dominance of the United States and the Western-led international order created after World War II. As the new cold war rivalry between the US and China continues to escalate, Taiwan, too, will increasingly become a potential flashpoint, pitting the West against the emerging alliance of revisionist powers.
In addition to the potential geopolitical depression, we have significant amounts of public and private debt, deglobalization, the Balkanization of global supply chains, aging populations, wealth and income inequality, stagflation, and the fragmentation of the global economy. While inflation has been more persistent (as opposed to transitory), central banks have put themselves behind the curve. We need to prepare for the volatility that could potentially be before us. Considering the aforementioned, proper income distribution planning is vital, meaning your attention should be just as engaged when distributing assets as it was when accumulating, if not more.
Weighty topics, certainly, but when it comes to retirement income planning, it is important to flesh out not only expectations but the things you can and cannot control. This realization allows you to take prudent steps when stressful eventualities occur, keeping in mind that no action could be the best step, though it may be a hefty pill to swallow. When it comes to your individual retirement, you have control over your existing assets and your existing habits. Averages are great tools that we can use to be directionally accurate, but when you are close to, at, or already in retirement, the individual is the archetype for their own plan. It doesn’t matter how long the average person lives or what the average stock market returns are, it only matters how long we actually live and what kind of market conditions we actually encounter. For example, an individual can have some control over their health or lifestyle which can affect their longevity (e.g., smokers may not have the same life expectancy as a non-smoker). But we can only prepare for how the market is going to behave on a daily basis or how policy is going to react over the next ten or thirty years. Even so, when mental preparedness (stress inoculation) meets the unknown future, prosperity has the best chance to manifest.
Given the context above, consider the following three concepts for your own retirement preparedness:
Address your mindset - transition from asset allocation to income allocation
Address your habits - what is the prudent amount of money to live on given your accumulated resources?
Address retirement risks - determine what eventualities could derail your retirement income plan and work to reduce them, insure against them, or possibly retain them
TRANSITION FROM ASSET ALLOCATION TO INCOME ALLOCATION
While saving for retirement places heavy emphasis on asset allocation (i.e., accumulating wealth by diversifying holdings among different types of asset classes to balance risk and reward to generate returns), retirees should consider re-focusing when withdrawing money. The focus shifts to turning their assets into life-long income streams that provide for our needs and wants throughout retirement - their income allocation. To effectively make the transition, one must assess available assets and redeploy them most efficiently into various income streams as needed. In addition to retirement accounts, take inventory of the reliable income sources available (e.g., pension benefits, Social Security benefits*, rental income, royalties, etc.). Your individual income allocation will consider these income streams in concert with your market-based retirement accounts. Keep in mind, there is no “set it and forget it” plan. What is an optimal income allocation during your first few years of retirement may not be the ideal as markets, the regulatory environment, and your own personal goals change.
DETERMINE A SUSTAINABLE WITHDRAWAL PERCENTAGE
When it comes to determining whether or not we are financially prepared to retire, the typical question is, “Do I have enough money?” However, the real question is, “What percentage of my savings can I withdraw each year to meet my income needs throughout retirement?” You must begin to build a retirement income plan based on a withdrawal rate that helps ensure you will not run out of money during retirement.
A retirement actuary would make the following actuarial determination as a ‘rule of thumb’:
A husband and wife joint life expectancy would require: $200 for every $1 of desired monthly retirement income.
A Single life would require : $125 per every $1 of desired monthly retirement income
By applying this equation, a couple desiring to retire with $10,000 per month of income, would need to reach $2 million at the end of their accumulation phase. An individual desiring to retire with $10,000 per month of income, would need to accumulate $1.250 million at the end of the accumulation phase. This rule of thumb (again, a great tool to be directionally accurate) can then be adjusted each year as you approach retirement. Monitor your spending on a monthly or annual basis to continually adjust course, keeping in mind some of the budget items that may not apply in retirement (e.g., current retirement savings, a mortgage that will be paid off) while other budget items that could be more costly (e.g., more travel costs, increased health insurance).
POTENTIAL RISKS OF RETIREMENT
As we have previously mentioned, there is no “set it and forget it” financial plan; therefore, after aligning your retirement resources for a proper income allocation and determining a sustainable spending limit, you still need to consider the unknown (i.e., the risks of retirement). Please review the following list of eventualities that could upend retirement:
1. Longevity: The risk of you living too long and outliving the assets you have set aside for retirement. Medicine and care have improved immensely and increased life expectancy; as such, a sound retirement plan must last for a lifetime not just until your theoretical life expectancy.
2. Liquidity: The risk that your assets (or portfolio) are only going to provide you with a limited amount of income or no flexibility when unexpected needs arrive. For example, you may have an unexpected health event but if your money is illiquid in real estate that would have to be sold at an unfortunate time (possibly at a discount), that could be detrimental to the longevity of your plan.
3. Market Sequence of Returns / Volatility: A hypothetical model can be forecast, however the future is still going to be unknown. The risk of taking out funds in a down market could negatively impact your portfolio, for example.
4. Inflation: What retirement looks like today may not be what retirement looks like 20 years from now as the cost of goods increases. The purchasing power of your dollar is constantly changing. Make sure your financial plan has an inflation adjustment baked into it to handle the increased spending over time.
5. Health: Being forced to deplete the assets that you have accumulated for the purposes of a health event, surgery, or long term care. Planning for your health resources to be taken care of when you are going to need them in your eighties or nineties is significant.
6. Survivor: Am I at risk of leaving a financial burden on those that I care most about? A spouse? Children? A business? Consider the lasting impressions you wish to leave.
7. Taxes: This specific retirement risk is not only the unknown tax regimes of the future, but the additional burden that could accompany distributions when facing any of the risks listed above. Consider consulting a tax professional in combination with your financial advisor (or when executing your individually managed financial plan) to see how current laws could affect the retirement projections.
Ultimately, the decisions we make during the risk management process will largely depend on individual situations and attitudes. The goal is to decide, based on our personal circumstances and overall tolerance to the various risks, how much risk we are comfortable retaining versus transferring to a third party (i.e., insurance carrier). In this way, you can plan for the future rather than trying to let the future take care of itself.
CONCLUSION
As innovation and technology, specifically in the healthcare industry, lengthen the human lifespan, retirement income planning will continue to play a major role as individuals and families ascend and descend their retirement mountainscapes. Educate yourself through the lens of economics and finance to determine what you can and cannot control with your own retirement income plan. Refocus, reassess, make course adjustments, and seek help whenever necessary.
SUPPLEMENTAL MATERIAL
A Sample Distribution Plan
This proprietary document has been developed by Valmark Financial Group for a better understanding of financial planning goals.
Click on image to open PDF document.
A Sample Social Security Analysis
*The optimal time to receive Social Security benefits can be determined, however, this will be addressed in a forthcoming article. Due to the importance of this benefit, for this writing, we wanted to include a specific sample of what can be achieved with a thorough analysis.
Click on image to open PDF document.
Securities offered through Valmark Securities, Inc. Member FINRA/SIPC. Investment advisory services offered through Valmark Advisers, Inc., a SEC Registered Investment Advisor.
Note: This article was originally published in Technolink Association’s Good News in Action Magazine, May 3, 2022
Zach W. Hurst is Director of Financial Planning at Valmark Financial Group where he oversees a team that assists independent financial advisors and wealth management firms with accumulation, income distribution, legacy planning, and product analysis. Zach is responsible for all aspects of design, marketing, and implementation of Valmark’s unique financial planning processes. Mr. Hurst is a presenter on financial planning topics at the University of Akron, where he graduated Summa Cum Laude. He is a A Certified Financial Planner ™ (CFP®), a Chartered Life Underwriter® (CLU®), and holds Ohio Life, Health, Accident and Variable licenses along with FINRA Series 7, 24 and 66 registrations.
Terry R. O’Neill founded his financial services enterprise in 1978, over four decades ago, specializing in the engineering of corporate employee benefit planning, executive benefit planning, and business succession planning for organizations. The enterprise designed comprehensive financial and wealth creation strategies, developed estate and retirement planning concepts along with multi-generational estate and wealth conservation strategies for families and individuals. He monetized the firm in 2017.
Over those four decades, Mr. O’Neill served on four major financial association boards: 3 domestic and 1 international. In addition, he was nominated to be an advisor to the Federal Open Market Committee, was an advisor to the Small Business Council of America, was an Associate Member of the Milken Institute and formerly a Member of Roubini Global Economics. Mr. O’Neill has advised two California Governors on economic and business issues. He has served on committees that have advised the U. S. Treasury and Congress on numerous financial topics.
He authored The Life Insurance Kit (1993: Dearborn Financial Publishing), and has written for numerous publications in the financial industry including Financial Services Week, Employee Benefit Plan Review and The National Underwriter. Mr. O’Neill has appeared frequently as a guest on television and radio to discuss the economic ramifications of issues in healthcare, employee benefits and retirement planning and was profiled in Leadership Magazine and the Orange County Register. He has spoken regularly on economic and financial topics at national conferences.
Since 2017, Mr. O’Neill has been working exclusively on special economic and financial consulting projects. The majority of his time is devoted to the Institute for the Study of Global Economics and Finance which he founded in 2015. The Institute focuses on the democratization of global economic information and advancing the frontiers of economic thought.