A Practical Guide to Retirement

Transcription

1 431 A Practical Guide to Retirement Planning Clay Gillespie, CFP, CIM Hello, my name is Clay Gillespie, and I have been asked to give a session on dealing with clients and prospects just before they enter retirement. My entire practice is geared to the retirement income planning market. These individuals are different, and they expect different information and different discussions than your accumulating clients. If you want to succeed in this market, you need to know how to deal with these types of individuals. Today, I will discuss how I deal with this type of individual and what I have done in my practice. I hope you find this information useful and that you find some tips on how you might incorporate some of these ideas into your practice. My Market First, I would like to start by telling you a little bit about my market. I deal with middle class or upper middle class clients. I do not deal with high-net-worth clients. To me, this means someone who will use a significant portion of his investable assets to maintain his desired lifestyle through his expected lifetime (investable assets between $750,000 and $2 million). I deal with this particular segment of the retiring market as there are a significant number of these individuals and I feel they are quite underserved by the financial services sector. For me, a prospect is someone who is approximately five years from his or her expected retirement date. I do not grow (existing) clients; I acquire them when they contemplate retiring. This does mean that most of my new clients already have existing relationships with some type of advisor before they become my clients. Since I deal with a retired clientele, I lose about $6 million to $12 million every year due to death. In addition, my practice pays out approximately $12 million a year in payments (scheduled withdrawal payments) to my clients, not including fixed annuities. It is important to realize that your assets under administration figure in your practice will not increase as quickly as they would in an accumulation practice. What Is Retirement? The definition of retirement has changed. It now means having the ability to do what you want when you want to do it but not for income reasons. It is when your pension entitlements and investable assets can maintain your standard of living for the remainder of your lifetime. This does not necessarily mean that you quit working; you may just change how much and what type of work you do. It is important to understand and empathize with your prospects and clients that retirement is actually a very difficult and emotional transition for most people. Many people do not initially realize how much of their social life and personal sense of worth is tied up in their profession. For many people, their job is also their identity. Many individuals take a great deal of satisfaction from being able to support their families through their hard work. It is very difficult for many individuals to have to suddenly come to grips that it is no longer their personal abilities that will maintain their lifestyle and that their income will come from investable assets and pension entitlements instead. Individuals will also need to develop new relationship models in retirement. The traditional model where the husband works and the wife takes care of the family can be quite stressful in retirement: The husband retires and proceeds Clay Gillespie, CFP, CIM Gillespie is a 10-year MDRT member with seven Top of the Table and one Court of the Table qualifications. He has volunteered for MDRT in many capacities, having previously presented at the MDRT Top of the Table Annual Meeting and currently on the Top of The Table Program Committee. Gillespie has presented at many industry events and contributed to several Canadian publications on estate, financial, retirement and investment planning topics. He specializes in retirement income planning and is the managing director of Rogers Group Financial, a financial planning firm. Rogers Group Financial 1770 W. 7th Ave. 5/F, Vancouver, BC V6J 4Y6, Canada phone: cgillespie@rogersgroup.com Order a copy of the presentation on MP3: MP1143 CD: C1143

2 432 Focus Sessions: Wealth Management to tell his wife how to run the household even though she has been doing so successfully for the past 35 years. In addition to this, couples will now spend a lot more time together. This is one of the reasons divorce rates increase around retirement age. 1 From my experience, people who retire slowly enjoy a significantly better retirement than people who retire suddenly. I encourage people to work a couple days a week, if possible, until they start to develop a retirement lifestyle. There is typically a two-year period where newly retired individuals will satisfy many of their pent-up demands. This means going someplace they ve never gone or finishing up projects around the house. They will probably spend more money in the first two years of retirement because of these pent-up demands. Eventually, most individuals develop some type of retired lifestyle. It can take up to three years to figure out what it costs to maintain their desired retirement lifestyle. The client needs to be aware of this when planning a retirement income strategy. My Process A typical prospect for me is someone who is approximately five years from retirement. He or she has accounts with one or two different firms and typically has some type of company pension plan. I find that about five years prior to retirement, people start to seriously consider what retirement will look like. They start looking for answers and, if their current advisor has not discussed these topics, they begin looking elsewhere. It is not that they are not satisfied with their current advisor; it is just that their current advisor tends to focus solely on accumulation issues and not on retirement income planning issues. The whole process starts with the prospect calling in to book a meeting. Most of my new clients come from referrals and other marketing activities. At this point we will send out an introduction package: it can either be in hard copy or electronic format. In this package we provide all the relevant information that a client would want or need to know about our firm. This package includes: 1. Introductory Letter In this letter, I let prospects know that the first meeting will be at our expense (no charge). In addition, I ask them to come prepared to the first meeting to discuss their top three financial concerns. 2. Corporate Brochure This is a brochure designed for our firm that sets out the guiding principles of our firm, a financial lifecycle description (so they can see where they are), and our planning process. 3. Newsletter The content for this newsletter is developed in-house. We send this newsletter out quarterly to our clients. The advisors of our firm write all the articles. (If you would like to see a copy of our newsletter, please go to our website.) This newsletter allows us to discuss the issues that are important to our clients within our business model. Many firms seem to use a newsletter service and just print their name on it, or they do not send a newsletter at all. 4. My Personal Services Guide This is a guide to the services of Clay Gillespie. It sets out my specialties, the services they can expect to receive, and how I m paid. 5. Team Bio It is important to build the team concept right from the start. It will make client management easier in the future. Once prospects and clients get to know other members of your team, it will start to free up time for you to do other things. This also gives you the opportunity to promote the education and experience of you and your team members. 6. Media Clippings I include a recent media article where I am quoted. This is a topic for another session, but the media can be used to build your credibility with prospects and make it much easier for existing clients to refer to you. You re in the media so you must be an expert. First Meeting The first meeting I have with the client is very important. I have 99 percent of my meetings in my office. This frees up a lot more of my time since I am not traveling and I have all the resources at my fingertips. Making prospects comfortable at the first meeting is very important. I have a certain strategy that I use with all new prospects when they first come to see me. These steps may seem trivial, but they are very important when dealing with the front edge of the baby boomers. The clients arrive in the lobby where they are met by one of my assistants. They are taken to my office, and the assistants have been trained to engage in some type of small talk to make the prospects feel more comfortable. They are offered coffee or tea that is served in nice cups, never in paper or Styrofoam. They are seated in my office so they have a good view of two things. First of all, from our office, there is an incredible view of the city. Second, they can easily see my educational credentials on the wall.

3 433 I do this so that when I enter into the office they should be feeling comfortable. I am walking into their space rather than them walking into my space. You will want to do everything possible to take some of the stress out of the first meeting. Before the meeting I would have prepared an agenda to make sure all the points that I want to discuss in the meeting are noted so I do not forget anything and so I have control of the meeting. One of the first questions I ask is, What needs to happen over the next 45 minutes for this meeting to be successful in your eyes? This question gives the prospective client a time line, and it allows me to find out if there is a burning issue that needs to be dealt with immediately. It is important to answer the questions that the client needs answered. I am trying to find out if they are a good fit for me, and they are trying to find out if I am a good fit for them. It is no good trying to be all things to all people. If they are not going to be a good fit, it is best to find out early in the relationship because it can be much more stressful dealing with this situation later. A messy breakup down the road is not worth a couple years of revenue from the client. Make sure that you ask them about their previous advisors and why they left. This will give you a good idea of what level of service they expect. We discuss what their top three financial concerns are. Once I figure out what type of report they require, I will quote a fixed price to prepare a financial plan for them. The price I charge is not designed to make money, but it encourages a buy-in to the process. I do not charge by the hour since prospects are always looking at their watches, which makes the meeting much more stressful than it needs to be. I tell them that I will prepare a plan and that they are free to implement it anywhere. I send them home with a detailed questionnaire to complete, along with a postage-paid envelope. I rarely discuss specific details of their investable assets or pension entitlements during the first meeting. I tell them that if I have not heard from them in six weeks time I will follow up with them, and if they decide not to proceed, I ask that they send me an or leave me a voice message. I believe if prospects are not willing to pay a fee for their financial future, they probably will not be a good fit for me. In addition, it takes a lot of stress out of the meeting since they know any questions or concerns that they have are being answered in the report and they do not feel pressured to buy anything. I tell them that the day we receive the questionnaire back, we will call and book a meeting for approximately ten working days later. I explain to them that this allows us time to do our work. This gives the client structure for the process, and the client knows what to expect. Always give your prospects the ability to say no. In this case, just because they have agreed to have you do a financial plan for them does not mean they have agreed to implement with you. Giving prospects the right to say no makes it much easier for them to say yes. Second Meeting For this meeting we have prepared a financial plan for the client. Typically, our reports include a detailed retirement income planning illustration. My team members will prepare the reports. I have not personally prepared a complete financial plan in over ten years. This illustration describes how much income they can generate for the remainder of their lifetime after tax and after inflation. As an aside, we typically use age 95 of the younger spouse as expected lifetime. (For a couple who are both 65 years of age, there is approximately a 30 percent chance that one of them will live to age 95.) 2 I do not include their principal residence as an income-producing asset. Thus, I leave this asset out of the illustration. It is very difficult for people to visualize what a dollar will be worth in 20 years, but it is easy for people to visualize what a dollar is worth today. It is also important to run a few illustrations to show them some scenarios of differing returns and inflation rates. I would recommend that you run your illustrations using real rates of return. For a typical illustration I use a 3% and a 4% real rate of return. As an example, a portfolio of 100% fixed income vehicles (bonds and CDs) should outperform the inflation rate by 2.50%. I stress that this is not a detailed prescription but an illustration using various assumptions to make sure that we are heading in the right direction. It needs to be redone about every two years to ensure we are still heading in the right direction. There are too many variables to depend on projections for very long. This report also includes an Investment Policy Statement (IPS). This document allows me to give some high-level guidance on how their funds should be invested. It does not usually outline exact investments but general asset class recommendations. Finally, there is an estate planning section that deals with wills, POAs, living wills, and any insurance needs that they may have. At the end of this meeting, prospects should have a very good feel for their situation. This does not mean that the news is always good, but I believe it is my job to make sure that clients have the ability to make an informed decision

4 434 Focus Sessions: Wealth Management about their situation. In most cases they are now able to start planning their retirement because they have a better idea of what retirement can look like. Next Steps At this point my relationship with the prospect can go three ways: 1. We part ways because I have answered their questions and there is really nothing else for me to do, or they have chosen to implement my plan somewhere else. (Remember, in the planning process I told them they were free and would have the ability to implement this plan anywhere.) 2. In many cases clients are in pension plans that do not allow access to the funds for three to five years. There is nothing for me to do at this point. I consider these individuals inventory. I continue to meet with them every year up to their retirement date to review their situation. 3. We set a meeting to start implementing some, or all, of the plan. Since they already paid for the financial plan, there are typically very few questions during the implementation stage other than logistical questions (payment details, withholding tax, beneficiary designations). What is important for you to realize when dealing with retiring clients is that they are more concerned about what type of lifestyle they can maintain during their lifetime than the rate of return they can expect. What are you going to do to protect their income? I now want to review some of the retirement risks that your prospects and clients will face in retirement. This information is presented in the exact format I use when I am presenting these items to the prospects and clients. Life Expectancy Life expectancy is one of the most misunderstood aspects of retirement income planning, yet it is one of the most important factors. Most people assume that life expectancy is the same as remaining lifespan. This, however, is not correct. Instead, life expectancy is a median number of years such that 50 percent of a particular age group will die before then and the other 50 percent will die later. For example, a male who is 65 years of age today has a life expectancy of 19 years. This means that he is expected to live until age 84. There is, however, a 50 percent chance that he will live longer than 19 years. (Interestingly, there is also a 30 percent chance that he will see his 90th birthday.) A female who is 65 years of age today is expected to live for another 21.5 years, to age But she has a 50 percent chance of living longer than 21.5 years (and a 41 percent chance that she will see her 90th birthday). More interesting is the result for a couple both age 65. In this case there is a 58 percent chance of one of the two surviving to see his or her 90th birthday Male Female Couple Age A B A B A C % % % A = Life expectancy (individual and joint) B = Percentage chance of living until 90 years of age C = Percentage chance of one of the couple reaching 90 years of age Source: Society of Actuaries Annuity 2000 Basic Table Thus, when planning for retirement, it is important to look beyond your life expectancy because there is a 50 percent chance you will exceed it. I would recommend that at least five years, and better still, ten years, be added to your life expectancy number when planning your particular retirement income strategy. In addition, with continuing advances in medical technology, it is anticipated that life expectancy numbers will continue to rise in the coming years. Rate-of-Return Expectations In producing any long-term financial illustrations, certain rate-of-return assumptions need to be made. How will your investment portfolio perform in the long term? The truth is that there is no way to tell with any certainty. Investing is more of an art than a science. Despite this fact, investing is far from being complete guesswork. There are some fundamental historic relationships that can help guide investment decisions and help set more realistic return expectations. Given the above figures, does it mean that if one were to invest in the S&P/TSX index that they should expect to earn 10.9% every year? The answer, as you would expect, is no : past performance does not guarantee, nor predict, future results. Instead, in setting return expectations, it is important to examine the historic relationships amongst these indices: The five-year GIC or CD should outperform the inflation rate by 2.5%. This relationship almost always holds, even in the short-term.

5 435 The S&P/TSX (an index of the top 300 stocks on the Toronto Stock Exchange) should, over time, outperform the inflation rate by approximately 6%. If the inflation rate stays at 2.0%, the best expected average return from the market is in the neighborhood of 8.0%. From a balanced portfolio, the expected longterm return is about 6.0%. It is important to keep in mind that this relationship can take at least two market cycles to hold. Inflation Rate The inflation rate is usually measured by the year-over-year change in the Consumer Price Index (CPI). It measures how much a basket of commonly purchased goods and services increases in price over time. As demonstrated above, there is a high probability that your retirement could last over 30 years. Therefore, it s important to understand how the inflation rate can affect your ability to maintain your desired lifestyle. The following chart demonstrates that if you desire an income of $50,000 per year during retirement, you will need to spend more every year to maintain that standard of living. For example, if the inflation rate were 4% (remember, this is the historical long-term average), you would need an income of $109,556 in 20 years time to buy the same basket of goods that you could buy today for $50,000. Inflation Rate 10years 20years 30years 2% $60,950 $74,297 $90,568 3% 67,196 90, ,363 4% 74, , ,170 5% 81, , ,097 Even at today s historically low inflation rate, you must plan for the negative consequences of inflation. How Much Do I Need? This is a very difficult question. There is a general principal that states you only need 60% to 70% of your income immediately preceding retirement in order to maintain your standard of living during retirement. The rationale behind this rule of thumb is that in retirement you are no longer saving or having employment-related expenses. However, this number will be different for everyone. It matters what you intend to do with your life in retirement. This will drive your particular retirement income requirements. Stock Market Risk In retirement, you should be prepared for a stock market correction every single day. When you are working and accumulating retirement savings over a long period, stock market volatility is not a concern as long as your portfolio is properly diversified. One of the greatest risks in retirement planning, however, is having the stock market drop substantially just before or just after you retire. Proper diversification techniques will not, alone, offset this problem. Instead, in generating an income during retirement, it is important not to withdraw funds from an asset class that is declining in value. If you are unlucky enough to retire when the stock market is performing poorly (and you need to generate income from your portfolio), then you could deplete your capital at an alarming rate, ultimately reducing the chances that your portfolio will be able to generate your required net spendable income throughout your remaining retirement years. Example If you had invested $100,000 in a diversified portfolio (a mixture of stocks, bonds, GICs, term deposit, mutual funds) and were withdrawing $450 per month and the stock market corrected and your portfolio lost 7%, then you re account would only be worth $87,600 one year later. You would need of return of 14.16% to get back to $100,000, assuming you stopped any further withdrawals. However, if you wanted to continue with a withdrawal of $450 per month, you would need a return of 19.56% to get back to an account value of $100,000. A Real Life Example Between August 1995 and August 2005, the average Canadian Balanced Fund earned 7.4%. 3 If you invested $100,000 in this average Canadian Balanced Fund in August 1995 and started a withdrawal rate of 7% ($583 per month), this account would have been worth approximately $107,700 in August Thus, from this analysis, one would assume that you could withdraw 7% from a balanced portfolio and still maintain your capital. If, however, you had invested $100,000 in the average Canadian Balanced Fund in August 2000 and withdrew at a rate of 7% ($583 per month), your account would have been worth $75,600 in August Why the Difference? In the first scenario, where you retired in August 1995, the market performed very well for the first five years, and thus, a

6 436 Focus Sessions: Wealth Management cushion was built up in the portfolio. When the negative return years started, the portfolio was able to weather the storm. In the second scenario, where you retired in August 2000, your portfolio would have taken an immediate hit because there was no chance to build up a cushion you retired into a negative return stock market. In reality, it is difficult (and impractical) to accurately plan your retirement around the possible performance of the stock market. The above example also demonstrates that an initial withdrawal rate of 7% might not be achievable. Many studies have suggested that you should not have an initial withdrawal rate higher than 4%. In my opinion, with proper retirement income strategies, an initial withdrawal rate of up to 5.5% is sustainable. Implementation Details Your portfolio should be aligned with your retirement objectives at least five years before your retirement date. Thus, five years before retirement, you should have at least three years worth of your desired retirement income in a fixed income vehicle (CD or bond) that will mature the day you retire. If the stock market is performing poorly (five years before retirement), you will have at least five years to let the stock market rebound before having to draw money from your portfolio to generate income. I recommend the following strategy (see Appendix 1): Invest one year s income in a money market account or high-yield savings account that will be used for the first year s income. Invest one year s income in a one-year bond or CD. Invest one year s income in a two-year bond or CD. It is important that you own the fixed income (bond or CD) directly as you do not want the current market to influence prices. This way you will know exactly how much they will be worth at a specific time in the future. A bond fund or mortgage fund is not suitable for this purpose because both of these can fluctuate with changes in interest rates as interest rates rise, bond and mortgage fund market values decline. Invest the balance of your investments in a growth portfolio based on the results of your personal investment policy statement. How Does This Strategy Work? The rationale behind this strategy is that the money market account will deplete itself over the first year. After the first year, if the growth part of the account has increased in value then you will replenish the following year s income from the growth portion (use some of the growth part of the account to replenish the money market fund). If, however, the stock market performs poorly and the growth account decreases in value, then you use the maturing GIC (maturity value is known) to replenish the money market fund. If the GIC (or CD) is not used for income, it will be reinvested for a guaranteed period of two years. This strategy means that unless we have stock market decline that lasts over three years, you should not be forced to take income from your investments while they are declining in value. Thus, when the stock market is declining, you have some comfort in the knowledge that you will not be digging into the capital (for at least three years) and, hopefully, you will have enough fixed income investments to weather the storm. This strategy works because you avoid taking income from any part of your portfolio that is declining in value. From the previous example, if you had invested $100,000 ten years ago, and if you had implemented the above (noted withdrawal strategy), your account would have been worth approximately $105,500 today (ten years later). This is about $2,000 lower than if you had just invested all your funds directly in the average Canadian Balanced Fund. If, however, you had invested $100,000 five years ago and implemented the above noted withdrawal strategy, your account would have been worth approximately $87,000 five years later. This means that your account would have been worth approximately $12,000 more than if you had just invested directly in the average Canadian Balanced Fund. The whole rationale for this strategy is to increase the life span of your portfolio. Of course, this is not a perfect solution for every client. Some clients will have more fixed income than others. Some will be more aggressive than others in the growth portion of the strategy. Some will not use this strategy at all because they might have a variable annuity of fixed annuity instead. This is just a guide on how to present an investment income strategy to your clients and prospects. Thank you for your time today. Endnotes 1 Encyclopedia of Retirement and Finance, Society of Actuaries Annuity 2000 Basible 3 This example is based upon the average Canadian Balanced Fund from August 31, 1995, to August 31, I used this as a proxy for a diversified portfolio.

7 437 Appendix 1 Example: $100,000 to invest Income required is $583 / month (7% initial withdrawal rate) Income Account $7,000 Money Market Account - Represents 1 year s worth of income To bank account $583/mo B B Fixed Income Account A A C $7,000 1-Year Fixed Fixed Income Income Vehicle (Bond Account or GIC (CD)) -> Represents 1 year s worth of income (Year 1) $7,000 2-Year Fixed Income Vehicle (Bond or GIC (CD)) -> Represents 1 year s worth of income (Year 2) Growth Account Investment A -> $17,000 Investment B -> $17,000 Investment C -> $17,000 Investment D -> $17,000 Investment E -> $17,000 A B If Market Returns Are Positive If Market Returns Are Negative C If Market Returns Exceed Long-Term Market Returns i Encyclopedia of Retirement & Finances 2003 ii Society of Actuaries Annuity 2000 Basible