By Betty Meredith, CFA®, CFP®, CRC®
The U.S. Senate Special Committee on Aging asked the Government Accountability Office (GAO) to report on recommendations of professionals and choices made by American workers regarding retirement income. For this report, the GAO interviewed officials from the Department of Labor, the Internal Revenue Service, the Securities and Exchange Commission, the Social Security Administration, and the National Association of Insurance Commissioners and a several financial professionals, industry sources, and academics.
I must say I was somewhat surprised to receive an invitation from the FPA awhile back to participate in a conference call with representatives from the GAO on recommended retirement income solutions for American workers. I’ve pointed out the need for the retirement planning profession to establish more concrete guidelines around this issue several times in articles I’ve written on retirement and the mid-market1.
Recommendations and choices made today
The GAO randomly selected five scenarios from the Health and Retirement Study (HRS) in the lowest, middle and highest quintiles with varying dependence on defined benefit and defined contribution assets. Those interviewed were asked to recommend retirement income solutions for near-retirement workers, ranging from a single individual below the poverty level to a millionaire married couple. Professionals most often recommended delaying Social Security and increasing annuitized income.
Table 1: Recommended savings strategies for five hypothetical households2
Retirement income choices being made by retirees today include:
Figure 1: Sources of Income for ages 65+3
1. Depending on employment income for almost one-third of their income. Average sources of aggregate retirement income today for individuals over age 65 are shown here. Note that the income from assets produces less than 13% of total income because the average 401(k) account balance of a 60 year old today is $200,0004, with income from assets producing less than 13% of total income.
This substantial dependence on employment income is of concern if it is not properly protected, because of the increased risk of retirement income failure if the health of the retiree or spouse precludes them from working.
2. Starting Social Security around age 62. Social Security is the most cost-effective, inflation-adjusted option for increasing lifetime retirement income. It’s also probably the world’s least expensive annuity. Today, 43% of people take their benefit within 1 month after their 62nd birthday5. About 73% take benefits before age 65, which means they get penalized $1 for every $2 of income earned over the 2011 earnings limit of $14,160. Only 14% take benefits the month they reach their full retirement age and 3% began after their 66th birthday. If health allows, delaying receipt of Social Security until age 70½ will increase lifetime income for the primary earner, and their spouse/survivor around 75%6 more than if they collected benefits at age 62, possibly eliminating the need to annuitize any savings at all.
3. Decreasing equity exposure in their retirement portfolios. 401(k) holders in their 60s have steadily reduced their allocation to equities over the 2005-09 time period. Around 30% now have less than 20% in equities; 42% have less than 40% in equities. A key principle for the success of a 4% systematic withdrawal plan is that equity exposure needs to be at least 50% of assets7 if assets are to have a high probability of lasting at least 30 years. These individuals are trading future inflation and longevity protection for principal protection today, and need to be educated and counseled about the need to protect their retirement income and assets from other retirement risks as well.
People Need Advice
In sum, the results of the GAO study clearly indicate the urgent need for better retirement income decisions by people who today are over age 60. Just to give you perspective of the enormity of this issue, the total U.S. retirement market now consists of $18.2 trillion in assets, more than the $13.6 trillion in banking deposits in FDIC insured U.S. banks and savings and loans, and more than current GDP.
Figure 2: Annual Historical Amount of Assets in Various Types of Retirement Plans8
As of now, most of the owners of these savings receive insufficient guidance on how to make informed decisions about when and how to convert their savings into retirement income. This huge amount of capital is critical to the underlying financial stability of our country. Poor decisions made will eventually affect everyone – not only the retiree – as the effect of the decisions “potentially place a heavier burden on public need-based assistance and other resources.”9
What the InFRE is doing to identify or establish generally accepted standards
The International Foundation for Retirement Education (InFRE) is currently working with the Financial Planning Association (FPA) and the Society of Actuaries (SOA) Post Retirement Needs and Risks Committee to build on work begun by the Society10 to more formally define retirement income best practice solutions and standards for middle mass and mass affluent consumers. Here are some of questions we seek to answer:
- What are retirement counselors and planners doing to serve this market? What issues do they have in serving the market? Are there some changes that would enable them to serve the market better and more cost effectively?
- How do they set goals with this market?
- What is the process used for looking at risk?
- What is the process used to minimize taxes?
- What process is used to set strategy for the distribution period?
- How should housing and housing equity considered in financial/retirement planning?
- How does long term care financing fit in?
- What would they recommend if they were free from policy constraints?
- What types of products would they like to see available to serve their clients?
- How do they engage in life issues other than specifically financial issues, such as helping clients think about what they need to do to get re-employed?
We held two focus groups during the May, 2012 FPA Retreat to define common mid-market retirement income planning approaches; we’ll publish the notes from these in the next issue of Retirement Insight and Trends. In March, 2012 we also designed and co-sponsored a survey of how planners currently work with the mid-market and where they feel they need additional resources, insight and support in order to make serving the mid-market a productive and profitable business. Results are being tabulated by university professors and will be available in the next few months.
Final food for thought for the GAO: A colleague recently pointed out that states require barbers and cosmetologists to complete 1,500 or more hours of classroom instruction and practical training, and many states also requiring continuing education courses for license renewal. There are no minimum professional qualifications for advisors working in this space. Validation of professional expertise should be added to the GAO’s list of recommended solutions for helping workers and retirees make informed retirement income choices.
Betty Meredith, CFA®, CFP®, CRC® is the Director of Education and Research for the International Foundation for Retirement Education (InFRE), and Managing Member of the Int’l Retirement Resource Center, LLC. She participates in and incorporates research findings and best practices into InFRE’s Certified Retirement Counselor® certification study and professional continuing education programs to help professionals meet the retirement preparedness and income management needs of middle-market Americans.
A shorter version of this article was published as The Need for Retirement Income Planning Standards for Mid-Market Americans, Journal of Financial Planning, December, 2011. (www.FPAnet.org/Journal).
1“It’s Time for a New Retirement Model for the Middle Market,” Journal of Financial Planning, Seibert and Meredith, April 2011
2Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices,” U.S. Government Accountability Office, Report to the Chairman, Special Committee on Aging, U.S. Senate, June 2011.
3Notes: Data reported by the Social Security Administration for pension income includes regular payments from IRA, Keogh, or 401(k) plans. Non-regular (non-annuitized or lump sum) withdrawals from IRA, Keogh, and 401(k) plans are not included. Social Security income includes retirement, auxiliary (such as spousal), survivors, and disability benefits. Data reported for income from assets includes interest income, income from dividends, rents or royalties, and estates or trusts. Other income includes noncash benefits, veteran’s benefits, unemployment compensation, workers’ compensation, and personal contributions. Income from others is excluded. The 95 percent confidence intervals for the share of aggregate income are 35.9 to 37.1 percent for Social Security, 29.1 to 30.3 for employment earnings, 17.9 to 18.9 for pension and annuity income, 12.3 to 13.1 for income from assets, 1.9 to 2.3 for other, and 0.5 to 0.7 for cash public assistance.
4401(k) Balances Tend to Increase with Participant Age and Job Tenure, Figure 7.9, 2011 Investment Company Fact Book
5Social Security administrative data compiled by the Office of the Chief Actuary, Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices,” U.S. Government Accountability Office, Report to the Chairman, Special Committee on Aging, U.S. Senate, June 2011.
6Social Security Calculator, www.ssa.gov, FRA 2011 benefits for a 66-year-old, born 1945, $44,500 annual income.
7“Asset Allocation for a Lifetime”, William P. Bengen, CFP®, Journal of Financial Planning, August, 1996
8Total retirement assets in the U.S., June, 2011. Investment Company Institute
9Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices,” U.S. Government Accountability Office, Report to the Chairman, Special Committee on Aging, U.S. Senate, June 2011
10Segmenting the Middle Market: Retirement Risks and Solutions–Phase 2 Report, Society of Actuaries, September, 2010