Begin at the End When It Comes to Saving for Retirement
When thinking about retirement, the goal for investors is to put as much money away now to be used later. But, do investors know how much they should be saving if they don’t have a desired outcome in mind? Once they have a desired outcome, do investors know how to invest to have the best chance of reaching that outcome?
There are several considerations for saving for retirement. How much to contribute, whether there is a company match, are contributions pre- or post-tax, whether to contribute to a Roth account, what are the fees, and what are the investment options are just a few. As investors approach retirement age there are additional questions to consider. What does the investor want their retirement to look like? Do they plan to move or downsize, travel, or help heirs with education costs? Living situations can change at any time, and so can priorities as well as desired retirement goals.
One major concern in retirement is rising health care costs. Health care expenses are one of, if not, the biggest potential liabilities retirees face. According to Fidelity Benefits Consulting, “a 65-year-old couple retiring this year will need an average of $275,0001 (in today’s dollars) to cover medical expenses throughout retirement, up from $260,000 in 2016”. And, unfortunately, costs continue to rise.
Another concern is the phase-out of traditional employer-funded pension plans. Over time, employers have shifted away from defined benefit plans to defined contribution plans, such as 401(k)s. Broadly speaking, defined benefit plans are designed to guarantee a stream of income to a retiree and possibly a beneficiary, based on actuarially determined formulas. Upon entering retirement, the retiree is promised lifetime income, as determined by a benefit formula and the retiree’s payment election. A defining characteristic of a defined benefit plan is that the employer assumes all the investment risk as well as the responsibility for ensuring the payment of benefits. A defined contribution plan shifts investment risk to the employee, thus making it more difficult to predict income levels in retirement.
Advisors and retirement investors should be concerned about whether they can accurately predict the amount of future income required. Certain products alleviate some of the pressure investors feel when picking their own investments, but it still may be difficult to predict earnings that will be generated by a defined contribution plan account. Target date funds, which have dominated the retirement plan space in recent years, were designed to invest according to an approximate retirement date, using a glidepath to determine the allocation of assets. One of the shortfalls of more traditional target date funds is that they fail to consider the personal needs of an investor by investing solely based on a retirement year and not the individual needs or retirement goals. Target date funds continue to evolve; however, there may still be income unpredictability.
Advisors can play a critical role in helping retirement investors get closer to their desired outcome. Rather than relying on products like target date funds alone, advisors may consider individual goals to create solutions that incorporate any number of variables, as opposed to only a retirement date.
In addition to pure performance and anticipated retirement date, advisors and their clients can also discuss outcome expectations. Thus, if an investor’s goals are too lofty or unattainable at current income and contribution levels, advisors may suggest, if suitable, increasing contributions, or placing less money in cash positions. Moreover, it may also help set a more realistic portrayal of what the investor may expect; and therefore, they may be able to build more attainable retirement goals.
There are no perfect solutions for achieving desired income levels. Advisors may offer aid by taking a more comprehensive look at an investor’s future goals and evaluating them against their current situation (portfolio makeup, performance, rate of savings, etc.). By creating a custom solution instead of relying on broad, non-individualized products, advisors may offer an opportunity for retirement investors that more accurately projects future income levels.
1 Source: https://www.fidelity.com/viewpoints/retirement/retiree-health-costs-rise
Target Date Funds – The “target date” in a target date fund is the approximate date an investor plans to start withdrawing money. Because target date funds are managed to specific retirement dates, investors may be taking on greater risk if the actual year of retirement differs dramatically from the original estimated date. Target date funds generally shift to a more conservative investment mix over time. While this may help to manage risk, it does not guarantee earnings growth, nor is the fund’s principal value guaranteed at any time, including at the target date. Investors do not have the ability to actively manage the investments within target date funds. The portfolio managers control security selection and asset allocation. Target date funds allocate their investments among multiple asset classes, which can include U.S. and foreign equity and fixed-income securities.
Glidepath – The glidepath refers to a formula that defines the asset allocation mix of a target date fund, based on the number of years to the target date. The glidepath creates an asset allocation that becomes more conservative (i.e., includes more fixed-income assets and fewer equities) the closer a fund gets to the target date.
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