By Michael J. Prestwich
April 11, 2011 -- The “evil day” means a future time characterized by misfortune, distress or suffering. EVIL is also an acronym for the challenges that retirees must overcome to maintain their future living standard:
Entitlements. Your clients are “entitled” to certain retirement benefits such as Social Security, their pension and Medicare. Most of them contributed to these programs for their entire working career. Unfortunately, many of these programs are no longer economically sound. All one has to do is turn on the news to see riots in France, Spain, Italy and Ireland because these governments are changing their state-funded retirement programs to keep them economically sound. In the United States, the Social Security Administration has been posting insolvency warnings for years. On the final page of the Social Security and Medicare 2010 Annual Report you will find the phrase, “Social Security expenditures are expected to exceed tax receipts this year for the first time since 1983. The projected deficit of $41 billion this year . . .”
Social Security and Medicare trustees in their 2007 Annual Report stated, “Social Security could be brought into actuarial balance over the next 75 years in various ways, including an immediate increase of 16 percent in payroll tax revenues or an immediate reduction in benefits of 13 percent or some combination of the two.” Congress has ignored these warnings for years. In fact, instead of increasing payroll taxes by 16 percent to keep Social Security solvent, the irresponsible 2010 Congress reduced payroll taxes from 6.2 percent to 4.2
percent for 2011. This is not to suggest that Social Security or Medicare will go broke, but that financial advisors should help their clients prepare for any future changes that may reduce their benefits.
Volatility. Markets always fluctuate, often with dramatic corrections. Retirees may find themselves in trouble when they calculate an income based on an average rate of return. For example, it may sound logical to withdraw $10,000 per year from a $100,000 fund that has consistently earned a 10 percent average return, but there is a historical reason why investment disclosures include a phrase similar to “past performance is not a guarantee or projection of future results.”
During the “lost decade,” the S&P 500 index lost about 10 percent in 2000, 13 percent in 2001, and 23 percent in 2002. A $100,000 account that took an annual $10,000 withdrawal in this environment would have only been worth about $35,000 after three years. Even though the market had positive gains for the next five years, and came back to its previous levels, the withdrawals in the three negative
years would have caused this account to be entirely depleted after eight years.
Here’s why: Let’s suppose a $100,000 account loses 10 percent. It is worth $90,000 at the end of the year. Now withdraw $10,000. It is now worth $80,000. It takes a 25 percent return on the remaining $80,000 to bring it back to the original $100,000. If the account loses 13 percent in year two, then 23% in year three, it is down to about $35,000. It now takes nearly a 300 percnet return to bring it back to the original $100,000.
Inflation. The US Department of Labor publishes monthly inflation data that goes back to 1913. For the past 98 years, inflation has averaged 3.23 percent. In order to maintain their living standard your clients must have about 50 percent more income in 10 years, double their current income in 20 years, and triple their current income in 30 years. The costs of medical treatment and long term care are accelerating at roughly double this rate.>
Longevity. Diabetes, polio,
measles and small pox were once fatal, but are now under control or completely
eliminated. Heart disease has decreased about 26 percent since 1975. Many
cancers are under control and new treatments are available almost daily. The
number of centenarians has increased 400 percent in past 30 years and is
expected to grow by 700 percent by 2034. The bad news is that many people will
outlive their money.
The primary objective of a retirement specialist is to guide their clients in their financial choices and to provide an effective strategy. Retirement decisions should be based on client goals, time horizon, life expectancy and tolerance for risk. There are risks associated with all financial strategies and there is no guarantee that any particular strategy will be successful. Although the use of a professional financial advisor does not guarantee future success, retirees who have accumulated substantial assets are generally smart enough to know when a financial advisor is putting his interests ahead of those of his or her clients.
Financial advisors who sell only annuities should explain to their clients exactly what their role is in helping them solve the above problems. One retirement specialist, who only has an insurance license, tells his clients, "I am in the safety business. I build financial ‘basements’ that will survive any future financial storm. If a tornado destroys your ‘financial house,’ I will help you design a plan so that you will always have at least a basement to live in." He spends at least an hour in the initial interview asking questions about their financial goals, assets, income sources, their life expectancy, where they want their remaining assets to go after they die, and their risk tolerance. He discusses the challenges presented by the EVIL acronym above and then asks them how much income they want in their "financial basement." After gathering all the information required by the 2010 NAIC Annuity Suitability Model Regulation, he shows them the following illustration of how having a safe foundation may protect a person's future assets:
In summary, this annuity producer knows that the key to making annuity sales is to propose products that meet the current and future needs of his clients. He emphasizes that annuities provide safety, tax-deferral, guaranteed values, and guaranteed income. As shown in the above example, he sells annuity products that complement the client’s investment portfolio by providing a safety net to allow the investments the time they may need to recover from any market down cycles.
Michael J. Prestwich sold his first annuity in 1975. After seven years he started ImagiSOFT, Inc. which develops life insurance and annuity illustration,marketing, and compliance software.
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