Friday, February 6, 2015
I was recently approached by the US website www.newretirement.com to answer a few questions about retirement planning and issues facing individuals nearing retirement. Here are the questions and answers.
Tell us about RetireWare … what does your software do? Who should be using it?
RetireWare is a Web-based retirement planning software that helps users understand how their assets and future income can create the lifestyle they want. I should mention that it is only for Canadians, because the software takes into account Canadian taxation and retirement savings programs. We plan to have a US version available, but only in 2016.
There are basically two versions, one for individuals who want to do their own planning and one for financial advisers. The version for individuals are usually financially literate persons who do their own investing and want to make their own decisions. They are a few years away from retirement or about to retire, and have significant assets.
Professional users get the same product, but the application has a collaborative component: the adviser can provide an account to a client and the client can do their own planning, review or tweak what the adviser has done or vice versa. There are social media features that let users spread the good word about their adviser using email, Facebook, LinkedIn or Twitter. This way, advisers can grow their referral networks online.
Advisers providing personalized retirement planning reports to their clients often find that there is low engagement with having a lengthy paper report. Having online access and being able to dabble is a great way to leverage technology and increase engagement. Moreover, monitoring the plan and keeping it fresh every few months really creates value for clients.
You’re based out of Canada … can you tell us some of the biggest headlines or trends for retirement in Canada? What are the most important issues right now?
I would think it's similar to the US. We have similar demographics, but Canadians have a longer life expectancy, so even more money will be required to fuel our retirements!
One trend is that 40% of baby boomers do not choose their retirement date. A large segment retire sooner than they wish because of job loss or health issues. Others must defer retirement and continue working because there's not enough money to fund their retirement.
Another trend is that the middle class is quite vulnerable. High earners have investments, pensions and real estate to draw from, and low earners are covered by Canada's "safety net". But the middle class struggles to accumulate significant assets and the safety net provides them inadequate protection. This has been caused largely by declining employment pensions, which is now down to 25% of the active working population.
What are some best practices for determining how much an individual will need to save for retirement ? What are some common factors we fail to consider when coming up with a savings goal?
You need to calculate how much you'll need. It is an iterative process. Set your retirement income goals, then determine how much lifetime income you'll receive (such as social security or employment pensions). You must then determine if the money you expect to have at retirement will be able to fund the difference.
It sounds simple enough, and there are many free online calculators, some that are quite good, that can help in this process.
But there are a few pitfalls: you don't know how much your investments will return and how long you (and your spouse) will live. As well, you don't know how much inflation there will be in the future.
So to complement this approach, many software products include a Monte Carlo simulation. We don't know how the economy will perform in the future, but we can simulate future returns and volatility of capital markets. We can determine our odds of success after doing a large number of random simulations. This information is very helpful to decide if our retirement income goals are adequate relative to the retirement assets.
Another approach is to "stress test" the financial plan for retirement for adverse events and see if the plan can deal with the main post-retirement risks, such as longevity, investment and inflation.
To sum it up, I like a "holistic" approach: one that looks at the plan from many angles. If all signals point to success, then the plan is probably good.
Why is managing risk so important to planning retirement? What happens if you don’t do it?
Risk management provides a framework around which we can make decisions.
When assessing risk, we determine its likelihood and magnitude. Armed with this information we can decide whether we want to apply techniques to reduce, eliminate, transfer, or retain each risk.
For retirement, a sound plan must examine each of the potential risks that can occur: market, longevity, inflation, health care costs, long-term care and early death.
Failing to plan is planning to fail, to repeat an overused cliché. The idea is to avoid catastrophic outcomes by having a plan of action to deal with each risk should it occur.
We don’t know about the rest of your clients, but when we hear the words “risk management” and hear references to math, we get a bit overwhelmed … especially as it relates to that giant sum of money we’ll somehow have to save leading up to retirement. What do you tell clients who are intimidated by the subject of risk management?
Risk management has come to the forefront in the last 10 years. Corporations have to evaluate all risks and it permeates all their decisions. Investors select an asset allocation that reflects their risk tolerance. When you buy home insurance you are managing risk: you pay a (relatively) small premium to protect yourself against a large potential expense (destruction of property and civil liability).
The Society of Actuaries (the body that qualifies actuaries and conducts research) has many excellent publications on managing post-retirement risks and it's a great starting point to learn about this. One I recommend is Managing Post–Retirement Risks–A Guide to Retirement Planning.
What do you think are the biggest oversights individuals make when it comes to managing risk in their retirement planning?
I think many don't appreciate their longevity risk. While we all wish for a long life, the "risk" of living too long is running out of money, especially at a time when assisted living and long-term care can become a real possibility.
A good strategy is to try to cover essential expenses (rent, food, health care, etc.) with sources of lifetime income, such as social security and annuities. Then cover discretionary expenses (e.g. travel and lifestyle expenses) from invested assets. This approach lets you control a good share of your money and leave what is left to your heirs.
What do you think are the biggest challenges facing individuals nearing retirement today?
The biggest challenge is knowing if there is enough money to maintain our standard of living. This creates uncertainty and doubt, and the outcome is that we tend to be overly conservative with our spending. Having a reduced lifestyle is losing the opportunity of enjoying life to the fullest after a lifetime of hard work, raising a family and contributing to society.
That's why we need to put numbers behind our dreams and see the possibilities that the future holds.
How will retirement for Baby Boomers and after look different from those of our parents and grandparents?
Baby Boomers have a much longer life expectancy than the previous generations, in part due to lifestyle changes and advances in medicine. Life expectancy has increased more than 6 years since 1980.
Longer life coupled with a longer healthy lifespan also means that expenses during retirement will be significant for many, with travel, vacations, sports and hobbies.
Another difference is that defined benefit pensions have all but disappear other than for civil servants. This means that they have to invest their funds and decide how to use these funds for retirement income.
The good news is that technology and the Internet facilitates the dissemination of information on investing and retirement planning, including many excellent software products in Canada and the US.