Article Excerpt
The common vision for retirement has remained constant since its creation, but the social and economic landscape has changed dramatically in recent decades. Learn about 3 primary reasons why conventional retirement planning will be unsuccessful for the masses moving forward and what Baby Boomers and beyond can do about it.
Everybody has a different definition of success for retirement. Though preferences vary when it comes to lifestyle goals, personal values, and desired retirement age, some desires are universal. Everyone wants to maintain their health, live a long time, have meaningful relationships, and be unburdened by financial stress. Most people also hope to leave some sort of financial legacy to their children.
While personal goals may vary, no one wants to run out of money before they die. The common vision for retirement has remained constant since its creation, but the social and economic landscape has changed dramatically in recent decades. Unfortunately, the way we plan for retirement has not evolved to account for these external circumstances, and now many Baby Boomers approaching retirement are in for a rude awakening. Here are three reasons why conventional retirement planning will be unsuccessful for the masses moving forward.
1. Increased life expectancy.
Baby Boomers are still retiring at roughly the same age as their parents but can expect to live an extra five to ten years longer on average. Larry Fink, CEO of BlackRock recently said, “As a society, we focus a tremendous amount of energy on helping people live longer lives, but not even a fraction of that effort is spent helping people afford those extra years.”
What’s truly worrisome is that living ten years longer doesn’t simply cost ten years more money. That extra decade will likely cost exponentially more money due to inflation, the spending down of assets, decreased autonomy, and higher medical bills. Add in concerns about dramatic social security reform and the increased prevalence of senior divorce, and you will quickly realize the storybook ending previously described just isn’t in the cards for most Boomers.
2. Shift from Defined Benefit (DB) to Defined Contribution (DC) retirement plans.
If you’re not familiar with these terms, defined benefit is a pension and defined contribution refers to a retirement savings plan, most commonly a 401k. In 1980, roughly 60% of private-sector workers were covered by a defined benefit plan. As of 2019, over 80% have a defined contribution plan.
This shift is monumental. If you’ve spent your entire life working at a job and receiving a paycheck every month, living off a pension in retirement does not require any adaption. The shift from a paycheck to living off a nest egg is an entirely different story.
In his book Re-wirement, Jamie Hopkins makes the point that earning years are about saving, but retirement is about managing cashflow. The financial literacy required to take an (often inadequate) pile of money in a 401k and convert it to sustainable income is an entirely new skill which the average retiree simply does not possess. There are many challenges to living off a nest egg in retirement but the single biggest threat to this plan is sequence of returns risk (which might be referred to as "the evil twin of compound interest").
Sequence of returns risk does not come into play until you start withdrawing from your retirement portfolio, but it can have a tremendous impact on your portfolio longevity, particularly in the first five years of retirement. Its potential to wreak havoc on your retirement demands that you have a plan to combat it once you stop working.
3. Wealth composition.
Since World War II, homeownership has become increasingly more common, and Baby Boomers have more money stored in real estate equity than any generation before them. To paraphrase Dr. Barry Sacks, the greater the portion of a retiree’s net worth stored in home equity compared with their retirement accounts, the greater the benefit of synchronizing those two assets.
Over half of Baby Boomers have over half of their net worth represented by equity in their primary residence. It is a strategic blunder to neglect such a large portion of one’s net worth when constructing a financial plan. Real estate equity looks nice on the balance sheet, but it is ultimately an illiquid asset unless you have a tool to convert that money into cash on demand.
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The Evolution of Conventional Retirement Planning
These are just three reasons why retirement planning needs to evolve. The ability to adapt is critical to survival and that applies to financial planning as much as anything else. A complex problem typically will require a complex solution, so I encourage you to consult with an advisor to review your financial plan in its entirety.
Consider utilizing home equity as part of a holistic solution, as it is the most obvious tool that is both readily available to the masses and currently being ignored. A Home Equity Conversion Mortgage is an FHA insured loan for homeowners (or homebuyers) over the age of 62, and it is specifically designed to complement a retirement plan by increasing liquidity and cash flow while also providing protections for surviving spouses and heirs. This tool has the potential to improve most retirement plans in America. A HECM unlocks what is often an individual’s largest source of funds, it can be used as a buffer asset to counter sequence of returns risk, and it can help prolong your portfolio’s lifespan to help sustain a longer retirement.
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We live in a dynamic world that is constantly changing, and so are the circumstances around retirement planning. Winning does not happen by accident. If you want to win in retirement, you need to start planning today. Don’t put it off, and don’t copy what your parents did. Spend the time to build a robust, redundant, and resilient financial plan that is customized to you. Keep in mind that the strongest plan possible must account for your largest asset. It’s always better to have something and not need it than to need it and not have it. If you prepare now, your future self will be grateful!
