Retirees deserve peace of mind and should enjoy their hard-earned money to achieve their goals – not hold back in fear of outliving their savings.iStockPhoto / Getty Images
Sign up for the Globe Advisor weekly newsletter for professional financial advisors on our newsletter sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know.
How do you plan a client’s retirement when it’s impossible to know how long they will live? After all, no one knows at what age they will pass away.
On average, a 65-year-old woman can plan for approximately 22 years of retirement, according to Statistics Canada data. But to remain at least 90 per cent confident that she sufficiently planned for retirement, she will need to plan for 35 years (until she is 100 years old). To be 99.99 per cent confident, she will need to plan for 50 years (until she is 115 years old).
This trend isn’t going away, and it’s similar worldwide. For example, a 2021 report from The Stanford Center on Longevity showed that as many as half of five-year-olds in the U.S. could expect to live to the age of 100, which may become the norm for newborns by 2050.
Generally speaking, living longer is fantastic and should be celebrated. Still, planning for possibly living well into your 90s or even 100s introduces a substantial financial challenge. The time period of 22 to 50 years is a very wide range with many variables, and the consequences of miscalculating a client’s life expectancy can be detrimental.
On the one hand, underestimating their life expectancy can lead to running out of money, creating significant stress for clients and their families. But overestimating their life expectancy leads to a form of “self-insuring.” They will largely underspend, which can be just as damaging; as such, scaling back on travelling or not ticking items off their bucket list may leave them feeling unfulfilled.
Retirees deserve peace of mind and should enjoy their hard-earned money to achieve their goals – not hold back in fear of outliving their savings.
Managing for market risk is challenging enough, but managing for market risk along with the uncertainty of life spans and ensuring clients don’t run out of money presents an even larger challenge. And despite the numerous statistics showing we continue to live longer, one thing remains certain – life is unpredictable, and anything can happen.
Still, retirees should enjoy the next chapter of their lives to the fullest. Here are two ways that can allow clients to spend confidently, knowing they have a sustainable stream of income for as long as they live.
Shift mindset on spending
Spending behaviour in retirement is an area that deserves continued education. The way we’re wired during our working years affects our thoughts on how we spend in retirement.
Organizations typically pay their employees a fixed salary, adjusted regularly for inflation. Most people naturally think about spending in a similar straight-line manner, even after they retire. That’s why rigid spending strategies like the “4- per-cent rule,” proposed by William Bengen almost 30 years ago, still receives so much attention today despite research that confounds this approach and suggests it should be more of a loose guideline. It’s just how we think about spending.
Even financial planning tools often show illustrations using constant spending strategies. One of the problems with constant spending is that it doesn’t take what’s happening with a client’s portfolio value into consideration.
Instead, consider building a retirement plan that incorporates a variable spending strategy, which is dynamic and rules-based, always considering a client’s financial situation. Variable spending strategies can significantly increase the income a retiree can enjoy sustainably.
Build a plan with solutions to meet goals
A financial plan is instrumental in helping clients retire with peace of mind. A 2022 Fidelity Retirement Report showed that 83 per cent of pre-retirees with a financial plan feel financially prepared for retirement versus 47 per cent of those without. Unfortunately, less than a quarter (23 per cent) of pre-retirees have a financial plan in place.
Retirement represents such a significant shift in a client’s life in several ways, and they just want to know that they will ultimately be okay. A written plan can help alleviate a large weight off their shoulders.
Once a financial plan is built, it’s crucial to incorporate a diverse set of investments designed specifically to meet the plan’s goals in a tax-efficient manner. More than half the pre-retirees in the Fidelity study believe that longevity is a key risk to their financial security in retirement, so it’s important to build portfolios that tackle this issue directly for them to feel financially secure.
Insurance products like annuities and some retail investment mutual funds can play a role in providing income to meet life goals while also addressing longevity risk and providing protection against market risk.
By shifting the mindset on how to spend sustainably in retirement and incorporating income solutions that address longevity risk directly in all financial plans, clients can feel fulfilled as they reach their goals. They will also feel confident that they have the financial security to support them throughout the journey.
Simon Barcelon is vice president, Longevity Pension Fund, at Purpose Investments Inc. in Toronto.
For more from Globe Advisor, visit our homepage.