Client Service December 4, 2015

Global Thinking Can Help U.S. Retirement System in 2016

Hundreds of thousands of frequent flyer miles and dozens of client meetings across several continents will give a DC industry pro some interesting perspective on cross-border financial planning trends.
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Many of the problems facing the U.S. retirement system today are far from local phenomenon, says Fredrik Axsater, State Street Global Advisors’ head of global defined contribution.

In a recent interview with PLANADVISER, Axsater suggested three long-developing themes have clearly crystalized in 2015 as global retirement challenges—faced by plan sponsors in the U.S. and across Europe and most other developed economies.

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“Often as I attend client and prospect meetings across the various markets we serve, I hear clients talking about their challenges as if they are unique,” Axsater explains. “Really it’s the same list of problems we are hearing about, whether talking with plan sponsors in the U.S., the U.K., Australia or elsewhere.”

The three problems will certainly be familiar to U.S. industry practitioners, he adds. These are the difficulty of saving enough and efficiently converting savings to distribution income; the tendency of non-professional investors to chase performance and sell the portfolio when stock prices have fallen; and the increased understanding of the importance of good governance in the face of regulatory and market pressures.

Different retirement systems have started to take different approaches to solving these challenges, and so the contours of the issues are playing out differently in markets around the world. Axsater suggests a helpful framework for thinking about global retirement issues and comparing the progress of different countries goes as follow: On one side of the spectrum is the U.S. system, in which individual choice has been preserved at the heart of the retirement savings effort. In the middle is the U.K., which has started to move down the path of more mandatory savings (more than in the U.S.) but has maintained some aspects of individual choice. Finally, on the other side of the spectrum is the Australian approach, in which most savings decisions have been mandated.

“Thinking about and comparing the progress of these three systems over the next several years and beyond will be a tremendous case study for what types of public policy approaches can help overcome the familiar challenges we have all been talking about,” Axsater predicts.

NEXT: Who does retirement planning best? 

Another commonality across the different markets, Axsater says, is that with every piece of progress in the retirement savings effort, one can usually expect a new challenge to emerge.

“So for example, we are all familiar with the fact that in Australia they’ve gotten very progressive about the retirement savings effort and are, broadly speaking, at a 9% automatic and mandatory savings rate for most workers, moving up to 12% over time,” Axsater says. “They have had success in boosting average balances because of this, but it’s highlighted how much of a challenge leakage and early withdrawals still are.”

The system still is far from perfect, in other words, partly due to a lessening of choice.

“The U.S. is facing essentially the opposite scenario,” Axsater continues, “where people talk about being ‘overwhelmed by choice’ when it comes to deciding how to save for and spend money in retirement.”

This is one of several reasons Axsater says he is looking forward to watching and participating in the growth of the U.K. defined contribution planning market. He suggests the market could easily triple in size in the next decade, and it will be interesting to see how the middle-ground approach performs relative to the U.S. and Australia.

Turning to the U.S., Axsater feels innovative thinking is still needed in the area of encouraging workplace retirement plan savings—and savings outside the workplace, should it be through individual accounts or even retirement plans established by the U.S. states for private sectors workers otherwise lacking coverage. He falls squarely in the camp that feels state-run plans for private sector workers would benefit existing private market defined contribution plan providers by bringing more people and more investible assets into the financial system.

“The global lesson from a client service perspective is that plan sponsors and participants are looking for holistic support, whether on automated plan designs or financial wellness,” Axsater concludes. “We are starting to see a real shift globally, I think, where plan sponsors are realizing they have to be somewhat paternalistic about the retirement plan to bring good outcomes.”

Client Service December 4, 2015

Retirement Planning for Couples with Big Age Differences

Many couples face the special challenge of planning for two retirement dates that may be years or even decades apart.
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Even if couples are just three years apart in age, when the older spouse retires, they have to think about how to replace lost income, because most of the time it goes down, says Howard Hook, a certified financial planner (CFP) with EKS Associates in Princeton, New Jersey.

However, May-December couples—a popular term for those more than 10 years apart in age—have a much longer period to plan for, he tells PLANADVISER, not only because the time between their retirement dates is much longer, but because they must base much of their planning on the life expectancy of the younger spouse.

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“The considerations are something that shouldn’t creep up on anyone; they should think about it from the beginning, and lay out a longer term plan to ultimately deal with issues down the road,” Hook says. “People tend to want to bite off whole thing in one chunk, but that’s overwhelming and they could shut down.” He suggests these couples think about what’s going to happen in the next 10 years, then worry about the 10 years after that, not worry about what’s going to happen 25 years down the road.

He adds that May-December couples should make sure the younger spouse is comfortable with handling money and informed about all finances long before the older spouse retires.

EKS uses a variation of a bucket strategy, called cash ladders. It helps clients set up a bond or cash ladder of the next three to five years’ cash needs, and replenish the cash or bond ladder with other assets after that time. According to Hook, the advantage is clients never have to sell in a declining stock market.

But, Hook says, people can also set up different buckets for different anticipated needs, such as a bucket investing for growth to take care of young children’s college expenses at a later time. He notes that this may be a more difficult thing to do for those with less assets; they will need to decide what they are funding first, and hopefully they’ve planned for this in advance of the older spouse retiring.

NEXT: Replacing lost income

The immediate issues when the older spouse retires are income replacement and benefits, Hook says. The younger spouse and children may have had health insurance and other benefits coverage under the older spouses’ coverage. This will need to change.

Before the older spouse retires, a trend analysis should be done to show if assets will peak too early and when the couple is projected to run out of money. “That will let you know what to start doing now to prevent those things from happening,” Hook says. It can tell whether the older spouse should delay Social Security or take it earlier. He notes that some clients go ahead and take Social Security at full retirement age to allow investment accounts not to be withdrawn so soon and allow them a longer time to grow.

May-December couples will need to decide if the 4% withdrawal rate rule is appropriate or if they should take less to account for a longer planning period. Tax issues should be a consideration when withdrawing from accounts; couples can’t pull from a younger spouse’s accounts without penalty. Those accounts should continue to grow tax-deferred; avoiding taxes preserves more income for the family.

According to Hook, a mistake EKS sees people make is thinking of income as how much stocks are paying in dividends and bonds paying in interest. Currently we are in a low rate environment, so if stocks and bonds are each paying 2%, clients may think that’s all they can take. But, he says if couples consider all assets together and use a cash ladder, they will always have the withdrawal rate they want to take out; it depends on their ages and how they allocate their investments.

Couples should also keep in mind the expense ratios they are paying on investments; it is crucially important to save on expenses to have more income.

One thing that will help, according to Daniel D’Ordine, a certified financial planner (CFP) with DDO Advisory Services, LLC, in New York City, is that these couples don’t have to follow standard required minimum distribution (RMD) tables. The Internal Revenue Service (IRS) lets them take smaller annual distributions because of the younger spouse. The couple has to let the IRS know.

“The extension of that is, while the older spouse is still working, he or she should put as much money as possible into a retirement plan. When they take an RMD, they will save on taxes and have more left over for the younger spouse,” he tells PLANADVISER.

NEXT: Long-term care and pension maximization

Another way to boost income when the older spouse retires is pension maximization, D’Ordine says. If the older spouse has a defined benefit pension plan, when distributions start he or she is given different options: one is single life annuity taken without regard to the age of the spouse and gives the highest payout, another option is a joint and survivor (J&S) annuity that pays a lower monthly amount as long as the pension holder is alive and keeps paying the surviving spouse when the pensioner dies.

Pension maximization means taking the single life annuity. The older spouse can use the higher payout to buy a life insurance policy on his or her life, so that when the pension holder dies the life insurance pays out tax-free money to the surviving spouse, presumably at an amount more favorable and higher than the J&S option.

D’Ordine warns there are lots of variables, though. Is the older spouse insurable and can he or she get a life insurance policy in the first place? And what is the cost of life insurance? It can be costly, so one must be sure the extra money received from the pension supplies enough insurance. A break even calculation should be done to see when this makes sense.

Another strategy is for the older spouse to defer Social Security payments. This can provide a higher payout for the older spouse, and the surviving spouse can get a survivor’s benefit until he or she is eligible for Social Security—a break even for those years the older spouse was not receiving anything.

At some point, the younger spouse may need to take care of the older spouse, and he or she may be taking care of children at the same time, Hook notes. The best scenario is that couples would buy some long-term care insurance ahead of time, but a lot of times people don’t do that and this can be another crunch on cash flow, he warns.

NEXT: “Accidental disinheritance”

Retirement planning for May-December couples may not only affect their immediate family. Older spouses may have children—even grown children—with prior spouses.

“Accidental disinheritance” is what D’Ordine calls it when an older spouse that is divorced or widowed with grown children remarries a significantly younger new spouse and changes his or her beneficiary designations and wills to give everything to the new spouse. The new spouse may not make any accommodations for children from previous relationships, so the older spouse may accidentally not give anything to them.

Even if the older spouse makes his or her older children secondary beneficiaries, the children still may not see any money if they die before the new spouse dies. “This is tragic if this is accidental and not intentional,” D’Ordine says.

Individuals should sit down with an adviser or estate planning attorney to make accommodations for older children as well as the new spouse or children, he suggests. For example, they can divide up assets 40/60, or use life insurance estate equalization, taking out a policy that leaves a lump-sum for older children and the rest to the new spouse.

D’Ordine observes that there’s a real do-it-yourself crowd out there, but using a financial adviser or estate planning attorney can really help individuals make the right decisions.

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