Planning for Long Term

Retirees may well live to 100. Are your employees preparing to survive financially for such a lengthy retirement?

By Chris Taylor Mar 1, 2004

HR Magazine, March 2004 After three decades with ExxonMobil Corp. in Houston, systems analyst Dianna Green figured she was financially ready for retirement. She could count on her company pension and on the 401(k) plan she had been contributing to for years. She and her husband, Charles, would build on some farmland they own in Texas’ hill country.

But as she looked closer at her retirement prospects, she began to see her financial realities in a different light. For years she had been told to save, save, save. Then, as retirement neared, she realized she needed to start developing a strategy for how and when she would spend those savings.

Those are important considerations because the manner in which retirees tap their funds and manage their assets can have a big impact on their quality of life after leaving the workforce. In fact, a single percentage point could make a major difference, according to a Fidelity Investments calculation: A nest egg that totaled $500,000 in 1972 and was tapped at 4 percent per year would now be worth more than $1 million, but the same nest egg reduced at 5 percent annually would have been used up by 1995.

Green, who retired last December, says “the mind-set is so different” after one leaves the workforce. “You start to worry about how much income you’ll have to live on and making sure it lasts—because we’re retiring relatively young, and we hope to live a long time.”

At 57, Green is in the vanguard of the millions of baby boomers who will be departing the full-time workforce over the next 20 years. And they will enter retirement with arguably larger responsibilities than previous generations had for managing financial resources after leaving the workforce. In defined benefit retirement plans, which once dominated private pensions, employees have no asset management role, and retirees have virtually no influence on the size of the payouts they receive. But with 401(k) arrangements—the retirement plan structure that took off with baby boomers—the participant’s increased management responsibilities last not only throughout the working years but also into retirement.

Even for those who are used to managing their 401(k)s, the prospect of shifting from the asset-building phase to the draw-down phase of financial life can be challenging. It’s no longer a matter of just setting aside 10 percent for the future—a pretty straightforward formula that employees are encouraged to adopt. Near-retirees have to start thinking about preserving the assets they’ve accumulated, eventually changing their health-coverage arrangements, minimizing taxes on their retirement-plan withdrawals, providing for heirs and taking on various financial uncertainties.

“It’s only been in recent times that people have started to look at this aging population and say, ‘What are we doing to help them once they reach that age?’ ” says Julie Leclere, assistant director of retirement and investor services at Principal Financial Group, a financial products firm based in Des Moines, Iowa.

Cynthia Egan, executive vice president of Fidelity Retirement Income Services in Boston, says, “The financial-services industry has done a great job so far in helping people save for retirement, but now that the number of individuals approaching retirement is increasing every day, financial education is even more relevant.”

To help near-retirees set their sights on making the most of their financial resources over the long term, HR managers have begun offering educational programs that focus on the issues that retirees face—matters that employees in their 20s and 30s, even those in their 40s, may assume are too far off to merit their concern.

Providing financial education is not new for employers, of course. Generic education has long been offered to employees who take part in 401(k) plans to help them make informed decisions on their investments. And while some employers may be wary of offering specific financial advice to employees out of fear they’d be held liable if advice proved faulty, many do so through third-party vendors.

When To Begin 

One question is when to start preparing employees for the financial realities they’ll face in retirement. Presumably, such preparation should be offered to workers when they’re mature enough to understand the need for it yet still have enough earning years ahead of them to be able to plug the gaps in their savings plans.

If employees start thinking about such issues roughly five to 10 years before they retire, they can make catch-up contributions, maybe put more into a Roth IRA on the side, perform some timely asset allocation and so on. “If the average age of retirement is 59.5,” Egan says, “55 is when many individuals might do some financial modeling. They can look at what they have and get a realistic assessment of what they’ll need and work the two pieces together.”

Some say the earlier that employees consider their actual retirement needs, the better. Says Leclere: “We should start thinking of it 10 years away. If you’re only a couple years out from retirement, there’s not a lot you can do—except win the lottery.”

Brenda Franklin, an HR manager at a Midwestern bank who helps retirees and near-retirees deal with their health costs, says, “By the time [employees] become financially literate, it’s often too late.”

Leclere notes that every client over 50 who contacts Principal’s call centers is offered the option to do some calculations right then and there, to figure out where they are and if their projected income is enough to cover what they’ll need. A traditional rule of thumb, for instance, is that it takes 75 percent to 90 percent of your pre-retirement income to maintain your standard of living in retirement. If that calculation proves to be a jolt for some employees, it may be just what they need, says Leclere.

The reason that employees might need a little “shock therapy” about their retirement-income prospects is what’s called their “longevity risk.” People are living healthier and longer than they used to, which means they could outlast their savings. A person retiring at 55 these days still has about 27 very active years to go, according to Principal. That’s hardly the “couple of years in a nursing home” that people used to envision, says David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America.

Improving the Learning Curve

HR managers have a number of tools for helping employees boost their financial IQ and manage their long-term prospects. Some companies may have the internal resources and the know-how to formulate and deliver such education on their own. More typically, such services are delivered by the company’s outside 401(k) provider, which has the expertise and the programs already set up. Retirement plan vendors often provide financial education services as part of the overall relationship with the company.

One approach is for the plan provider to hold seminars for groups of employees who are at a particular stage in their working lives. ExxonMobil’s Green says a two-day seminar put on by an outside consulting firm brought in by the company touched on all the issues facing those nearing or in retirement; sometimes retirees come back for a refresher. In fact, she found the seminar so helpful that she took it twice—first at age 50, then again last year. “They educate you on all the options to think about,” says Green, who also brought her husband to the seminar. Topics included options for pension payments (lump sum or annuity), health insurance and 401(k) investments.

Although large-group sessions are cost-effective and useful in getting general messages across, they may fall short for employees who want answers for specific questions. Because personal finances are private matters, many employees are loath to talk about details in public. “When people really want to talk about their own situation, they won’t do that in a group setting,” says Leclere. For those employees, experts say, the solution could be access to a call center where they can get information on particular matters, or even one-on-one meetings with financial advisers.

It’s in one-on-one sessions that employees often are more willing to crunch numbers and look at exactly how much income they’ll be bringing in from disparate sources such as investments, part-time work, Social Security and defined-benefit retirement plans. Then they can look at financial products that might be appropriate for their situation.

Of course, employees who take advantage of employer-provided retirement-planning sessions can also get help from outside sources. They can turn to their own financial planners or the brokerages they’ve chosen for their personal investments apart from their 401(k) plans. And those with a do-it-yourself bent can use advanced financial-modeling and retirement-planning software packages now on the market, says Wray.

The Core Concepts

In choosing an outside provider to convey the financial facts of retirement to employees, HR should make sure that certain basic guidelines would be covered. For example, experts generally recommend that retirees minimize the percentage of their assets that they draw down for expenses. Making overly large withdrawals in the early years of retirement can scuttle prospects for the later years.

According to a Fidelity Investments white paper, retirees should withdraw no more than 4 percent of their assets per year. Withdrawals capped at that level provide income without reducing assets too fast, Egan says.

Another broad-scale recommendation by retirement-planning experts is to maintain the right mix of stocks, bonds and cash in one’s investment portfolio. It’s a practice known as asset allocation, and financial experts say it should become a familiar concept to employees from the time they start a 401(k) plan. It becomes crucial for employees as they near retirement, however, because it can help insulate their 401(k)s against the effects of an economic downturn. An employee who is close to retirement may not have time to let a stock-heavy 401(k) account recover from a bear market before having to start tapping it for living expenses.

The traditional philosophy of investment management has been to stay diversified and gradually shift from risk to safety as one nears retirement age—moving from less-predictable but potentially more-profitable equities to more-certain but probably less-profitable bonds in keeping with the employee’s increasing need to preserve assets for retirement.

For the most part, such advice still holds true, but, as life expectancies increase, some experts say, portfolio growth becomes increasingly important. “You might be more conservative” as you approach retirement, says Leclere, “but you shouldn’t shift completely out of equities. If you’re in retirement for 30 years, you need a little growth potential.”

Another recommendation is that retirees draw on their 401(k)s and IRAs last, not first. Dip into such accounts “only after other, nonsheltered savings are exhausted,” according to a Fidelity white paper. A hypothetical $500,000 in tax-favored retirement accounts, for instance, would provide five more years of living expenses if it’s tapped last rather than first. The later the withdrawals, the longer the account accumulates interest and, presumably, the lower the tax rate that is applied to the funds when they are removed.

Of course, it’s not smart to wait too long. A retiree who doesn’t start making annual withdrawals by 70 1/2 faces stiff federal penalties.

A comprehensive education program for retirement-minded employees should include a few other asset-managing tactics apart from managing invested funds. For instance, near-retirees should be reminded that annuities, purchased with a lump sum, provide a guaranteed stream of income for life. While an annuity might not provide as much income as a managed portfolio, it’s a safe source of income (assuming the issuer is in good financial health) and offers peace of mind. Among the many types of annuities are those that offer some participation in stock-market gains.

Another asset that should be included in manageable sources of retirement income is real estate. Employees need to be reminded that their homes, which may be their largest investment, fit into their financial futures. Downsizing to a smaller home may produce enough leftover cash to help with daily living expenses. Or an employee may want to consider the pluses and minuses of a “reverse mortgage,” which is a loan against a house that need not be repaid until the owner sells it or dies.

Dealing with Unknowns

Health care appears certain to be the wild card in even the most carefully drawn plans for retirement. A 2002 Fidelity study on retiree health costs found that a couple retiring at age 65 this year will chew up $175,000 in out-of-pocket health costs and Medicare-supplement premiums (based on average retirement longevity of 15 years for men and 20 years for women). But as companies continue to pass more retiree health benefit costs to beneficiaries through higher premiums, higher deductibles and similar increases, retirees could face huge unforeseen cash needs. That’s why educational programs for near-retirees should include “how to cover prescription costs, Medicare supplements, insurance needs—the whole gamut,” says Leclere. “You can’t just talk about retirement funds,” she says. “Programs should provide guidance on all issues.”

Ideally, though, financial education isn’t just about numbers and formulas. Employees nearing the end of their working lives may need more than hard equations; they may need emotional support, talking through issues that can be very troubling, even frightening. That’s why Wray sees financial education for retirement as a “holistic, life-planning process.”

So it has been for ExxonMobil’s Green. She now feels confident that her newfound education has equipped her to deal with anything that might come her way. “My husband and I both feel like we don’t want to turn it all over to someone else,” she says. “We want to be involved, and educated, about all the financial choices we make.”

Chris Taylor is a staff writer for SmartMoney magazine.

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