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Betty Meredith, CFA, CFP®, CRC®, Director of Education, and Research, InFRE

Betty Meredith, CFA, CFP®, CRC®, Director of Education, and Research, InFRE

By Betty Meredith, CFA, CFP®, CRC®
Director of Education and Research, InFRE

The financial planning industry is not ready to help the middle market make informed retirement decisions when they need it most.

In my April, 2013 article in the Journal of Financial Planning (Still MIA: Comprehensive Best Practices for the Mid-Market), I referred to a recent study by the Society of Actuaries (SOA), “The Impact of Running Out of Money in Retirement”i , which concluded that “running out of money is too large of a risk to self insure.” The point of the article is that today’s commonly used asset management-focused approaches fall far short of meeting the needs of the middle market because they implicitly assume the individual can afford to self-insure their retirement risks.

This follow-up article highlights another recent SOA paper, Middle Market Retirement: Approaches for Retirees and Near-Retireesii. It spells out the strategies or models most used today by individuals, professionals and other service providers, and evaluates how well they meet the retirement income and risk management planning needs of the middle market.

Characteristics of the Middle Market

2009 SOA-sponsored research by Millimaniii defined the middle retirement market in the U.S. as representing approximately 12 million households (11% of all households) headed by people ages 50 to 75 years old who are either approaching or currently in retirement and have a net worth between $50,000 and $1,000,000. It excludes the 25% of this age group with less income/assets and the 15% with more.

Other research concludes that the planning approaches to use for middle market couples and singles are different what would be used for their wealthier peers of same age and/or gender.

  • They have significantly less investable assets (their largest asset are their Social Security benefits and home equity)
  • Being resource constrained limits their options for income and risk management options
  • They are less inclined and able to pay for advice, and are less trusting of advisors and financial institutions.
  • Income planning is focused primarily on cash flow and debt versus investing
  • They have to make trade-off decisions to get the most bang for their buck in lifestyle and healthcare options
  • An efficient process is key to being productive and profitable in serving this market.  Asset under management models do not serve their needs.

A Summary of Models Applied Today

Most of today’s retirement income strategies or models focus on how to manage investable assets to provide a retirement income stream with a high probability of lasting at least thirty years. For most people in the mid-market, their largest financial assets (in order of financial value) are the present value of their future Social Security and/or pension benefits, their home equity, and then their IRA and/or defined contribution savings.iv Only the last of these assets are potentially “manageable” over time by financial professionals, and in most cases it has the least value of the three. In sum, most of today’s asset-oriented, “best practices” retirement income models aren’t designed to address the retirement income and risks management needs of mid-market.

According to the SOA’s Middle Market Retirement whitepaper, the retirement analysis/advice models commonly used today can be categorized as follows:

  1. Asset management models that focus almost exclusively on retirement asset value targets, where the investment objective is to meet income and growth and/or legacy intentions. Other retirement risks are minimally considered. Sub-categories include:
    1. Pure asset allocation models.
    2. Asset allocation models (i.e., Monte Carlo modeling) which are accumulation models adapted to provide retirement income (the approach used by most securities firms today).
    3. Bucket strategies, where assets are divided and managed according to an identified risk profile and time period for anticipated withdrawals.
    4. Asset liquidation models which consider tax and other characteristics to arrive at a distribution plan.
    5. Target date funds where assets are managed according to a common risk profile.
    6. And the most popular of all, “rules of thumb” models such as the 4% rule, or the “invest conservatively and live off the interest” rule.
  1. Income and cash-flow models that focus on producing a smooth, sustainable income stream that preserves income and asset values. Financial-product focused, this approach generally provides little consideration of other retirement risks or life circumstances.  Sub-categories include:
    1. Necessary vs. discretionary expense models that are geared to securing lifetime income sources for necessary expenses and use of riskier investments for discretionary expenses.
    2. Cash flow models that take into account expenses and multiple income sources.
  1. Risk management models that focus on providing risk management, income security or preservation of assets by evaluating key risks beyond mortality and financial risk. Most software today typically evaluates retirement risks in isolation from one another. Sub-categories include:
    1. Integrated models that cover multiple risks and provide recommendations for how solutions can address a combination of risks.
    2. Step-wise models that address one risk at a time until funds run out based on a consumer’s prioritized risks (i.e., financial security pyramid).
    3. Non-integrated models that evaluate multiple risks as standalone decisions.
  1. Holistic Models that evaluate a host of risks and decisions together, including lifestyle decisions as well as those that are non-financial, in order to provide a financially-sound life plan. Sub-categories include:
    1. Integrated financial models (only a few software packages actually do this)
    2. Multi-disciplinary models that provide an evaluation of the whole person or entire family and that make both financial and non-financial recommendations.  Sophisticated software versions do not exist today for this model; however there are some consumer or professional software packages which holistically provide guidance for individuals in the second half of life.

How to Evaluate Today’s Strategies for Use with the Middle Market

The centerpiece of this whitepaper is a chart that compares the above models to what your mid-market clients need you to do for them. It states whether the model includes, usually includes, sometime includes, usually doesn’t include or doesn’t include addressing the characteristic from the perspective of the mid-market. I highly recommend reviewing the complete version of this summary of Table 2 that begins on page 7 of the report, where you’ll get a clearer picture of how well the models apply to different market segments. In sum, the asset management models most used today don’t include what we should be evaluating to help middle market clients make informed decisions.

A comparison of today’s retirement analysis/advice modeling approaches:  How well does the model analyze…

Financial Management Issues?

  • Investment risk
  • Inflation risk
  • Order of pay-down of assets
  • Disposition of IRAs, 401(k)s, etc.
  • Projection of future assets
  • Projection of future cash flows
  • Debt (incl. mortgage) management
  • Social Security claiming
  • Defined benefit plan option choice
  • Annuitization
  • Disposition of life insurance
  • Use of reverse mortgage

Tax issues?

Life Risks?

  • Risk of “living too long”
  • Long-term care risk
  • Catastrophic illness costs
  • Death of a spouse
  • Inability to work for pay
  • Family member unexpected needs
  • Care for disabled family members
  • Loss of “guaranteed” income

Life Choices?

  • When retirement can/should begin
  • Post-retirement career changes
  • Lifestyle / expense management
  • Home downsizing / relocation
  • Choices of both couples addressed
  • Change in marital status
  • Gifts / bequests / education funding
  • Non-financial legacies

Applicability?

  • Pre-retirement (accumulation)
  • Early retirement
  • Late retirement
  • Affluent households
  • Upper-Middle income households
  • Lower-Middle income households

Other Characteristics?

  • Low cost per use
  • Small time commitment per use
  • Independent use by consumers

Source: Middle Market Retirement: Approaches for Retirees and Near-Retirees, Table 2, page 7ii

So Which Models Are Best for the Middle Market?

The most effective retirement analysis/advice approaches in practice today for use with the mid-market are the income and cash flow, risk management, and holistic models (in sum, not the asset management models). However, new and improved approaches and products are still needed. The market segment each approach is most appropriate for is bolded.

Type of Approach
Best applied to
1.  Asset Management Models  
      a. Pure asset allocation models
  • High net worth households
  • Pre-retirement savings
  • Managment of lump sums received
      b.  Asset allocation/retirement income
          models
  • High net worth households
  • Households that have other risks already covered
  • Managment of lump sums received
      c. Bucket strategies
  • Households with significant investible assets
  • Households with high risk tolerance
  • Single individuals or couples with similar life expectancies and spending patterns
      d. Asset liquidation models
  • High net worth households
  • Inherited assets
  • Assets with low liquidity
      e. Target date funds
  • Pre-retirement savings
  • People with no knowledge of investments
  • People who can afford not to optimize their own portfolio
      a. Rules of thumb
  • Households with significant investible assets
  • Households that have other risks already covered
  • People who can afford not to optimize their cash flow management strategy
2.  Income and Cash Flow Models  
      a. “Necessary vs. Discretionary” expense
          models
  • People living alone
  • Other non-complex financial situations
  • Middle income retirees
      b. Cash flow models
  • Middle income retirees
  • Households with simple or moderately complex cash flows
  • Households with coverage for other risks
    Risk Management Models  
  • Integrated models
  • High-middle income households
  • Near-retirees and early retirees
  • People with unusually large or complex risks
  • Step-wise models
  • Middle income households
  • Near retirees and early retirees
  • People with moderately complex risks
  • Non-Integrated models
  • Upper-middle income households, which can afford not-optimal combinations of decisions
  • People with few, small or non-complex risks, or who already have the principal risks covered
    Holistic Models  
  • Integrated financial models
  • Middle market households
  • People highly motivated to understand/resolve issues
  • People with multiple issues to resolve
  •   Multi-disciplinary models
  • Affluent or high-middle income households
  • People in crisis or facing unusually complex problems
  • People facing life decisions with important financial ramifications

Source: Middle Market Retirement: Approaches for Retirees and Near-Retirees, Table 7, page 11ii

Retirement Planning Software Opportunities and Solutions

Developers of more robust retirement planning software need to focus on key improvements to today’s software solutions:

  • A way that consumers can act on their own with or without software.
  • Ways for consumers to store documents and personal information for self-service that helps reduce costs of servicing them
  • The ability for consumers to enter their own data for professionals to confirm and use in planning, with adequate quality control to minimize errors
  • The ability for consumers and advisors to model trade-offs.

More is Needed

Most retirement income planning today is adapted from models used to accumulate assets.  These approaches are not relevant to the needs of people with few manageable assets who need to make critical decisions regarding timing of retirement and risk management.

There are also still many gaps and problems with the software available to planners for use with the mid-market.  Retirement income planning and risk management needs to be holistic so that it incorporates cash flow, assets that don’t need to be managed over time, risk management and life choices. Most planning resources today only address subsets of these approaches.

In sum, planners don’t have the comprehensive resources and planning tools which we need today to properly serve this market. We could sure use the help of the academic community in developing new approaches, products, software improvements and retirement plan design ideas.

The work mentioned here and many other resources can be viewed on the Society of Actuaries website at http://www.soa.org/research/research-projects/pension/research-post-retirement-needs-and-risks.aspx.  Key concepts and ideas for how planners can apply this body of knowledge can be found in my articles published by the Journal of Financial Planning over several years.  This article was originally published in the August, 2013  Journal of Financial Planning (www.FPAnet.org/Journal).

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.

(c) 2013, Betty Meredith

The Impact Of Running Out Of Money In Retirement, a joint project by the Society of Actuaries Committee on Post Retirement Needs and Risks, the Urban Institute, and the Women’s Institute for a Secure Retirement, November, 2012.   http://www.soa.org/Research/Research-Projects/Pension/Running-Out-of-Money.aspx

ii Middle Market Retirement: Approaches for Retirees and Near-Retirees, prepared by a working group of the Committee on Post Retirement Needs and Risks, March 2013.  http://www.soa.org/Research/Research-Projects/Pension/Approaches-for-Retirees-and-Near-Retirees.aspx
iii Segmenting the Middle Market: Retirement Risks And Solutions Phase I Report, by Noel Abkemeier, FSA, MAAA and Brent Hamann of Milliman for the Society of Actuaries, April 2009.  http://www.soa.org/research/research-projects/pension/research-segmenting-market.aspx
iv The Impact Of Running Out Of Money In Retirement, Exhibit 1, page 4