Like a doctor, a financial advisor's first responsibility is to do no harm. But, as in the medical profession, external forces often rear up to challenge a financial professional's commitment to that oath.
For advisors, one such force is now gathering momentum: the Social Security funding crisis. The American Enterprise Institute, a public policy research organization (www.aei.org), says current and past generations of Social Security recipients will take a combined $8.7 trillion more from the fund than they contributed to it.
By contrast, future generations are projected to get $1.7 trillion less than they contributed. It doesn't take an actuary to understand the implications of these numbers. Depending on whom you believe, the system might last another 35 years, or it might go belly-up much sooner. Regardless, it is something that financial advisors must address, for American seniors lean very heavily on the fund: Two-thirds of retirees derive over half their income from Social Security.
Here are some tips for financial vehicles that provide the best upside for various life stages:
Birth to Pre-Teen Years: Variable Annuities
Lower capital gains and dividend tax rates may have tempered current investor enthusiasm for VAs. But ask your clients, and they'll likely predict higher tax rates for their descendants. Other than the tax deduction on contributions, annuities offer the best of work-sponsored retirement plans, without requiring earned income on which to base a deposit (or the maturity necessary to put the money aside). The several-year head start on saving for retirement can yield astounding results. For example, $5,000 deposited at birth, earning 8 percent per year, will equal almost $750,000 when the child reaches 65. At the same annual rate of return, she would need to make a $5,000 contribution each year from age 32 to 65 to end up with the same dollar amount. In addition, many college financial aid offices don't count a student's annuity as a usable resource when calculating assistance packages. And although the taxes and penalties on early withdrawals from 529 plans are usually a negative, these “high hurdles” can prevent a spendthrift heir from liquidating the account for non-retirement purposes.
Teenage Years: Roth IRAs
Using a Roth IRA instead of a regular IRA will cost virtually nothing now, and could save Junior a six-figure tax bill during his golden years. Sound ridiculous? Three years of $3,000 contributions for a teenager would be worth almost a half-million dollars in retirement, if the money earns 8 percent annually. Best of all, the teen doesn't even need to part with his hard-earned dollars to contribute. Parents or grandparents can make deposits with their own money, although the money then becomes the child's for good.
Early Adulthood: 401(k)s
Charts and graphs showing the advantages of early-start savings can only do so much to convince a young adult to delay the gratification of spending the first “real” paycheck. A better solution is bribery — tell your clients to match a portion of their children's deposits to a work-sponsored retirement plan with cold, hard, spendable cash. This carrot may not only allow your clients' offspring to pick up money from an employer-matching contribution, but could also allow the next generation to qualify for the Saver's Credit. Joint filers with less than $50,000 of modified adjusted gross income ($25,000 for single) can get a tax credit of up to 50 percent of the first $2,000 contributed to an IRA or retirement plan. Act fast, though — this credit is scheduled to expire after 2006.
At the risk of sounding jaded, politicians can't be trusted to make the necessary tough decisions regarding Social Security (at least until five-year-olds get the right to vote). But the diligent advisor can take some steps now to help ensure the crisis doesn't catch clients — and their offspring — unawares.
No matter what the ages of the clients' loved ones, advisors can make a lasting emotional connection by showing them how to prepare for retirement in a way that doesn't rely too heavily on the future solvency of the Social Security fund.
Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future.