It's Triage Time

Baby boomers are hurtling toward a retirement crisis. How to play doctor with boomer nest eggs and keep your business growing

A well-known Los Angeles-based news anchor in his 50s dropped into the office of financial advisor Louis Barajas in early September looking for some advice on how to get ready for retirement. He left a couple of hours later in shock. Although his annual income is over $300,000, he had never opened a 401(k) account and hadn't saved a nickel in 30 years on the job. He and his wife do not have a savings account, much less an IRA.

“I was floored,” says Barajas, 45, who runs Louis Barajas & Associates, a retirement-based RIA practice in Santa Fe Springs, Calif., with $40 million under management. Barajas is starting from the beginning: maxing out the newscaster's 401(k), teaching him about investments, drawing up a drastically scaled-back spending plan, recommending the client take on additional side projects for extra income and exploring alternative zip codes for post-retirement living. His stay-at-home wife is considering going to work.

Barajas does not mince words when confronting such clients: “Either they emotionally have to accept that their lives will have to change dramatically, or they will have to go into bankruptcy,” he says. “Their change is going to be extremely dramatic.”

Where Were You?

The anchor may be an extreme case, but he's in very good company: There are millions of baby boomers zooming toward retirement who have vastly underestimated their future financial needs. In other words, for financial advisors and their clients, it's triage time. The first wave of 77 million baby boomers turned 60 this year, and the rest of the Me Generation is set to retire over the next 30 years. That means advisors have a lot of bad news to deliver. To serve such clients — and keep their own businesses growing — many advisors will find themselves performing the equivalent of financial open-heart surgery on clients' nest eggs.

That is, if the client will still trust you to do the emergency work. While clients were skimping on retirement-plan contributions and plowing money into fun toys (or even into college savings), where were you? In a McKinsey & Co. survey of 3,000 retirees and pre-retirees aged 40 to 75, only 31 percent said their financial advisors had even spoken to them about their financial goals in retirement. Respondents told McKinsey that they found financial advisors more interested in “pushing products” than providing unbiased retirement advice, and said that advisors put their own compensation interests above the interests of their customers. Meanwhile, a third of “affluent” retirees — those with $100,000 or more in liquid assets — say their advisors haven't created a retirement-income plan for them, and yet they have already begun tapping their nest eggs, according to a recent study by MFS Asset Management.

It's a problem advisors can't continue to ignore. Those who don't address retirement needs risk losing current boomer clients and stand little chance of gaining new ones. That's a huge risk. For better or worse, boomers are the dominant force in the investment business — until their children, the even larger Gen-X cohort, can accumulate sufficient assets (by which time most advisors working today will be facing their own retirements). Boomers, now aged 42 to 60, represent $8.5 trillion in investable assets and stand to inherit another $7 trillion over the next 40 years, according to estimates by Boston-based research firm Cerulli Associates.

Even assuming you already manage a lot of boomer clients, that doesn't mean that you will keep them. Clients are more likely to switch advisors as they approach or begin to plan for retirement, according to a study by the VIP Forum, Coming of Age: Best Practices for Serving Affluent Pre-Retirees and Retirees, 2005. Although just 2 percent of pre-retirees aged 50 to 60 said they were more likely to listen to competitors offers, that rose to 18 percent for pre-retirees over 60 and to 23 percent for retirees over 60 “For people approaching retirement — that's when they get this wake-up and they look at their financial picture more critically,” agrees Stephen Cunha, director of retirement services at Wakefield, Mass.-based Baystate Financial Services. Certainly, there's no shortage of competition for their assets. Consider the ever-expanding array of firms anxious to serve this demographic, including other full-service brokers, independent advisors, discount brokers, retail banks, private banks and money managers, insurance companies, CPAs and even some law firms.

There are a couple of reasons advisors and their clients have gotten themselves into this mess. First, neither advisors nor clients are inclined to talk about bad news. Some advisors say they fear that laying out a gloomy scenario will only alienate the client. And sometimes that does, in fact, happen. Cunha, 36, says he has lost more than one potential client who just didn't want to hear that their financial goals were beyond their means. To get one of these clients where he wanted to be, he would have had to average 12 percent returns. “It was almost impossible for us to reasonably project those rates of return,” he says, but the client didn't like the alternatives — sell the house, delay retirement, take on part-time work or go broke in your 70s. (Still, these clients are the exception rather than the rule. Cunha runs a successful practice with $90 million in client assets.)

Beyond the psychological blocks, there is the sheer complexity of retirement planning. Compared to creating an asset allocation or picking some stocks and mutual funds, measuring the different retirement risks a particular client may face, plotting retirement income spending and figuring out the most tax-efficient way to take withdrawals, is much more difficult and time-consuming. Advisors also see that managing retiree accounts can be a game of diminishing returns — literally: As the investor ages and draws down assets, fees and commissions trail off.

But all is not lost if you follow a few simple steps. You've got to understand the facts — how retirement expectations and needs have changed over the past 20 to 30 years — and be able to explain them convincingly to clients. You need to acquire broad knowledge of qualified accounts, income products and insurance, tax laws and risk management. You should get a detailed picture of every client's risk tolerance, retirement-income sources and retirement goals. Finally, take a look at your costs and your clients' assets, and if it looks like you're going to face a profit gap, consider changing your client or product mix, and/or charging retainer and consulting fees to fill the gap.

Facing Reality

Whether your boomer clients are like the hapless Los Angeles anchorman or more responsible types, they are part of a generation that approaches retirement with a whole set of challenges that their parents never faced. For most of them, an employer-sponsored pension plan is a piece of vanished Americana (only 20 percent of Americans are eligible for a defined benefit plan, according to the Labor Department). Even if politicians can muster the guts to address Social Security's looming funding problems (see “Save or Else,” p. 47), the system won't provide more than a supplement to the kind of retirees who rely on professional financial advisors. Meanwhile, the average 401(k) account balance for a person in his or her 60s between 1999 and 2005 was just $140,957, according to a recent study from the Employee Benefit Research Institute and the Investment Company Institute.

To make things even more challenging, the financial needs of retirees continue to increase. Most significantly, life spans have risen (actuarial tables show that there is a 50 percent chance that one member of a healthy 65-year-old couple will live to age 92), even as companies scale back retiree health care plans. (Only 18 percent of Americans work for a company that provides retiree medical benefits, according to a 2006 Watson Wyatt report, The Changing Horizon of Retiree Medical Benefits.) Meanwhile, the cost of health care is going up: Fidelity estimates that a couple retiring at age 65 today should plan on spending at least $190,000 out of pocket during retirement to pay for expenses not covered by Medicare, not including the cost of nursing-home care or long-term care insurance.

And then there's this inconvenient fact: Conventional wisdom holds that retirees can work longer to make up for shortfalls. But a full 40 percent of retirees were forced to stop working earlier than they had planned — either because of health problems (47 percent), job loss (44 percent) or because they needed to care for a spouse or other family member (9 percent), says the McKinsey report. Only about 10 percent of retirees actually go back to work, either full time or part-time.

Playing the Benevolent Dictator

How do you convince your clients to plan around the realities — rather than the myths — of their impending retirement years? Be honest and talk about realistic goals. The clients will thank you, says Matthew Sliwa, 37, a partner with KSP Financial Consultants, a Waltham, Mass., financial advisory firm affiliated with Commonwealth Financial Network. Sliwa, who has been in the business for 15 years and has $250 million under management — about half of which are retirement-planning assets — says he has a 99 percent retention rate, thanks to his approach. “If you can't tell a client, ‘You can't retire this particular year,’ because you're afraid of what they're going to do, then you're really not connecting the way you should have,” he says. “They might not want to hear it, but when it gets right down to it, they know these things, and they want someone who will tell them what to do.”

Take the case of Sliwa's newly acquired client. The husband was in his early 60s and had retired with a $1.6 million nest egg. On the advice of his previous advisor, he had been taking an annual distribution of about 10 percent. When Sliwa got a peek at the client's accounts, he also saw that the advisor had sold the client variable annuities that were invested in very conservative funds, even though the high cost of annuities is supposed to buy the client downside guarantees. Also, Sliwa learned that the advisor told the client not to worry about long-term care. Yet the client really liked the previous advisor, who was always reassuring, even when the markets were in retreat. “Every time he went to the advisor, the advisor said, ‘It's fine,’” says Sliwa.

Sliwa signed the client and quickly instituted a recovery plan. But, he didn't want to cut the client's expenditures in half straight away. Instead, he scaled the monthly distribution rate back by about 15 percent, or $20,000 a year. “We'll meet again in six months to see how their cash flow is. I hope they will realize this first cut won't hurt as much as they think it will,” says Sliwa. “The next cut will hurt a little bit more. It will go into some of the things that they really want to do.”

Kacy Gott, a financial advisor with RIA firm Kochis Fitz in San Francisco, who deals with ultra-high-net-worth clients, says he gets around clients' resistance to having a difficult conversation about retirement by changing the focus from retirement planning to lifestyle planning: “The goal is to fund living expenses for every year they are alive. When they start thinking about it that way, it's not just one goal, it's 30 goals,” he says.

The Nuts and Bolts

Taking care of the emotional issues is only half the battle. The other half — the actual planning — requires that advisors acquire broad knowledge of qualified accounts, income products and insurance, tax planning and tax laws, risk management and wealth-transfer techniques. Advisors can set themselves apart if they are also able to offer health care advice, tax preparation and bill paying, says a Thornburg Investment Management white paper called Preparing for Tomorrow. The Wealth Explosion: The Effects of Baby Boomer Retirement on Independent Financial Advisory Practices.

“You really have to know tax law intimately,” says Sliwa, especially when you're considering when and how much to withdraw from qualified accounts. But you also need to know “whether you can access the client's insurance policy on a tax-favored basis or borrow against the insurance policy, which is a nontaxable event in its entirety. You have to consider the alternative minimum tax.”

You typically want to defer withdrawals from qualified accounts for as long as possible, taking income from other sources while allowing the qualified assets to continue compounding before taxes. But if you wait too long, “That could blow up in your face,” says Josh Willard, vice president of the Colghan Financial Group in California. “At 70, you have to start taking a minimum required withdrawal each year. If you have too much, the minimum withdrawal could push [your client] into a higher tax bracket, maybe more than he could have afforded.”

Sometimes qualified account planning can get quite complex. Cunha salvaged one small business owner client's retirement by structuring a series of qualified and nonqualified retirement plans and using some term-life insurance. The 50-year-old client owned a small construction business and wanted to retire at 65. But when he came to Cunha, he had no retirement assets — he had spent most of his money on his business and on college educations for his kids — and no business succession plan. So Cunha created a 401(k) profit sharing plan for the construction company that excluded certain highly paid individuals in order to maximize benefits to the owner; another 401(k) plan for a realty trust the client held, so that he could maximize the client's pretax contributions; and another for a small bookkeeping company that his wife had recently expanded on Cunha's advice.

Then he created a separate nonqualified retirement plan for three key employees at the business, which stipulated that they would use the funds to buy the business in 15 years. In addition, because his wife wasn't in a position to take over the business if something happened to him, Cunha took out a 15-year term insurance policy on the business owner that would be paid to the three partners, and he structured a buy-sell agreement, by which the three partners would use that insurance to buy the business from the wife. Today, the client stands to accumulate a $4 million nest egg by the time he is 65, and he's on track for his retirement, Cunha says.

For risk-management planning, Willard and other advisors tend to rely on Monte Carlo simulations and efficient-frontier modeling. The latter helps an advisor determine what amount of risk is right for a certain level of return: You want to be certain that your clients are getting compensated for the risk they are assuming in any portfolio. For most baby boomer clients — who have to make their retirement funds last 25 to 30 years — fixed-income and insurance products are not enough. The money for later needs to be put into investments that can grow over time. For certain portions of the portfolio, that means taking on as much risk as possible while taking the client's risk tolerance into account.

For clients who are really on edge about their retirement and want to make sure they'll get their check every month, Cunha says he sometimes uses single premium immediate annuities, which look and feel like a pension payment. “That can be used in the first phase to provide a base of income for a few years,” he says. The rest of the client's income is then more variable, based on the performance of their other equity and bond accounts.

Another good thing to have in your emergency retirement toolkit is the reverse mortgage. “I think in the right scenario people are going to have to do that,” says Sliwa. “The average baby boomer may not have saved enough, but they do usually own their house,” he says. Obviously, it's something you have to engineer carefully, because of potential fluctuations in the housing market.

But for the truly desperate, bankruptcy may be the best last resort. Willard recounts the story of one particularly unfortunate client who recently came to him. The client retired in 1996 when he was 47 with $500,000 in qualified accounts, and began taking income distributions. Then he got hit by the bear market. Not long afterwards, he became severely ill and had to get a liver transplant. During that process, his insurance company dropped him. Though he has regained his physical health, his assets have dropped to $200,000 and his financial picture is a mess. “They have medical bills that they don't know how they're going to pay. He's on permanent disability and is relying on that as an alternative income stream,” says Willard. “From an investment-related product standpoint, there is nothing that can stop the depletion of assets given a certain amount of withdrawal. We just have to change the withdrawal levels by reducing expenses if possible to take the strain off of the asset that's providing the income. We've talked about some extremes such as Chapter 11, which would be the last resort.”

Of course, these strategies and tools barely scratch the surface. And for you, the advisor, the challenge doesn't end with squaring away your clients' retirements. There is still a profitability risk: The average senior household generates approximately 10 percent less in revenue than the average high-net-worth household, according to the VIP Forum study. These clients have significantly smaller demand for credit products and are slowly drawing down assets. And that could add up to an even bigger drop in profits if the costs of serving these more complex accounts go up.

But advisors who are catering to this market say there are a few ways to keep your profitability intact. One: retainer and consulting fees. Two: more commissioned insurance products. In addition, hopefully, not all of your clients will retire at the same time. And if everything goes well, it should take them at least 25 to 30 years to spend those assets.

Sliwa, for example, says he gets 20 percent of his revenues from retainer and consulting fees, another 55 percent to 60 percent from fees on assets and the rest from commissioned insurance work — annuities and life insurance. He made the move from commissions to fees, including retainers, in 1995, and said it was a hard shift to make, but worth it. “The best advice I got was to pick out the five clients you feel most comfortable with and have that conversation. And we were five for five. We told them we want to spend more time with fewer people. That if they were paying for it, they would be sure not to miss their appointments. And that we would make sure we were doing planning every single year.” He says he lost about 20 clients, or three percent of his total book. “But the people we didn't lose were the ones we really wanted to stay.”

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