GuidePost

The GRABot BAG
by Sherrie E. Grabot, CEO

December 2009
Looking Forward — Very Far Forward

This is not a New Year’s edition of GuidePost. Regardless of the impending milestone, and despite the strange spectacle of an equities rally during a lingering recession, I will resist the temptation to look back at the events of the past year. Nor will I prognosticate about the coming one. I leave that to the pundits, knowing that they are usually wrong.

Instead, I’d like to gaze out for a decade or three toward the investment horizon. Or more accurately, I’d like to discuss how most people think about planning for the time after retirement, note how that might be changing, and earnestly hope that a more realistic perspective on retirement savings may be on the rise.

I Am Not a Number
You’ve seen them on television: confident-looking people walking around with giant cartoon numbers tucked under their arms. A recent financial ad campaign plays on the idea of “your number.” This is the dollar amount each individual needs to retire comfortably, or maybe their net worth, it’s hard to tell. Either way, it’s usually a tidy sum in the mid-seven figures (this is TV, after all).

It’s a clever concept. But somehow it misses a larger point. When you retire you don’t really need a number, or even a well-balanced portfolio. What you need is a regular, predictable income.

There Is a Difference
This distinction isn’t as trivial as it might seem. Of course, many options are available for converting assets into an income stream. However, there’s an important psychological aspect to how people think about their money. It can be comforting to look at a large number that’s waiting for you somewhere in the future. It’s quite another thing to look at a projected monthly or yearly income, and compare it to your income today.

For many investors, income projection creates a significant “uh-oh” moment that doesn’t happen otherwise. We’ve found that this kind of apples-to-apples comparison is a good way to get people thinking realistically about retirement planning: “How would I live? What could I cut? How can I make it bigger?”

For this reason, we’ve always focused on projected income at retirement as the most relevant participant outcome. That’s how our advice engine has forecast likely results scenarios. And recently, we’ve seen some signs that this approach is becoming more common, or at least that its importance is recognized.

An Annual Reality Check?
The first is a new Senate bill that would require plan providers to make income-in-retirement projections annually as part of their regular account communications. The bill’s sponsors note that while perhaps half of American households are in danger of not being able to maintain their standard of living when they retire, many don’t know it. It’s unclear how much a projection of their monthly income will help, but as one commentator points out, “sometimes a simple common sense change has the biggest effect.”

On the face of it the proposal seems like a fine idea. The DOL would even help out by providing standardized tables for calculating a hypothetical annuity. However, projecting future investment earnings is a much more complex and inexact business than the annual Social Security projections that the bill emulates. The underlying assumptions are critical, and communication is tricky.

So like many good ideas that come from the Senate, it just might be more trouble than it’s worth, at least in this incarnation.

Pay Now, Benefit Later
Another recent sign of interest in income projection is the discussion surrounding a change in the rules for Roth IRAs. (Yes, this is a bit outside our usual focus, but since Roth 401(k)s do exist, please bear with me.) As of January 1, 2010, the $100,000 income limit on Roth conversions will be eliminated, allowing all those who hold IRAs to swap them for Roth accounts.

Considering that you must pay all the applicable taxes up front, it’s hard to believe that anyone would want to do so, unless they happen to be sitting on a pile of cash. But according to a Wall Street Journal article some advisors actually recommend using funds from the IRA itself to cover the tax liability.

The reasons vary, from avoiding mandatory withdrawals to tax and estate planning issues. What they have in common is a concern for predicting and fine-tuning income during retirement, rather than simply aiming to accumulate the largest possible nest egg by the time you retire.

It’s Complicated
Of course, another element the Roth-conversion scenarios have in common is that they’re pretty complex, involving customized Monte Carlo simulations and a keen understanding of tax law. Making the decision to convert is a job for a professional investment advisor. People who would even consider this approach are likely to be rather more sophisticated than the average plan participant, and may not need a reminder about their retirement income. So I’m cautious not to read too much into these particular tea leaves.

However, it’s important to consider that estimating retirement income from any plan, Roth or otherwise, requires sophisticated calculations. The average participant won’t be doing the projected-income math. We’d rather not have the federal government do it. So the responsibility falls to those of us in the industry who deal with participant communications. But since experience shows that this is an uphill battle anyway, any proposal or publicity that sheds a little light on the subject will always be welcome.

~~ Sherrie