FINANCIAL PLANNING

FINANCIAL PLANNING

JUNE 2017

Reimagining Retirement Income for the Mass Affluent How New Collaborative Strategies Are Working Together to Dynamically Change Outcomes Don Graves, RICP

economic growth, a lot of debt, and muted inflation,

One doesn’t have to look too far into the retire-

“We are living in a world now of more subdued

ment income landscape to realize that we are in a

which we call ‘the new neutral.’ We expect this to

time of true challenge. For years, retirement planning

continue for the next 5 to 7 years.”

had focused nearly exclusively on getting to the top

of the mountain, planting our flags, and declaring

ultimately came to commonsense conclusions: retire

mission accomplished! This process was strategically

later, work longer.”

marked by having the right type of asset allocation to

maximize the accumulation.

ment income reminds me of the late 1990’s movie,

Armageddon.

Now that our clients have reached the top of the

“Even the roomful of economists and experts...

A present-day scenario for dealing with retire-

mountain, a different focus emerges—income alloca-

tion. The focus has shifted. It’s no longer the cash pile

arisen. An asteroid the size of Texas is hurling toward

as much as it is the strategic dispensing of cash flow

Earth with 18 days remaining before total world an-

at this stage of the game.

nihilation. As conventional measures have failed, the

conversation expands to think outside the box. This

Recently Olivia Mitchell, a well-known professor

In the movie, a crisis of biblical proportion has

of insurance, business economics, and policy at the

leads NASA to find Bruce Willis. He leads a ragtag

Wharton School of the University of Pennsylvania,

bunch of oil riggers who combine forces in a collabo-

hosted a conference at which other world-famous

rative effort to help avert the crisis.

economists, fiscal experts, and portfolio managers ex-

amined long-term trends in the marketplace and how

come crisis is on the horizon, and though convention-

they affect retirement. Here are a couple excerpts:

al financial measures have worked in the past, the im-

I think it’s fair to say that a global retirement in-

pact of this situation will require new conversations and outside-the-box thinking. Let’s unpack these four key concepts: crisis, conventionality, conversation,

INSIDE THIS ISSUE 6

“How Am I Doing?” and the Complexity of Returns

and collaboration.

The Crisis That Is Upon Us Now

Nobel Laureate and MIT professor, Dr. Robert C

Merton, called the current situation a “global retirecontinued on page 2

www.SocietyofFSP.org n 1

Reimagining Retirement Income continued from page 1

ment income crisis.” The professor is not alone in his

ing to be addressed and resolved, but the anxiety

thinking. Many financial futurist and thought leaders

that it produces in tense times is not helpful.

have rightly opined that “retirement Armageddon”

• The Uncertainty of the Markets. We no longer live

is fast approaching Earth and its impact could be

in a singular market silo. What happens in China,

catastrophic for many. There are many facets to this

France, and Greece affects the United States.

financial asteroid, but let’s unpack just a few.

Assets have grafted into a global system, leav-

• The Longevity of Baby Boomers and Beyond.

ing less control and heightened susceptibility to

The 78 million Americans born between 1946

market fluctuations.

and 1964 will have three bona fide challenges.

First, they will live longer than any previous

crisis is imminent and the asteroid is on the way.

generation! We could stop right here and un-

To say that we are living in times of global finan-

pack the implications. The American College has

cial uncertainty is an understatement. The pebble

identified 18 major risks of retirement income

that splashes in China will have ripples throughout

(www.18risks.com), but longevity risk stands

the world. At age 51, my wife and I may be able to

out because it is a risk multiplier. The longer you

recover; however the group that is most vulnerable

live, the more serious the other risks become.

to those ripples are those who are in the distribution

Planning for a 20-year retirement was considered

phase of their retirement. A market correction, “black

long, but today we need to plan for 30, 40, 50, and

swan” event, or financial crisis could leave them crip-

perhaps even 60 years for some retirees. This in

pled with no remedy for a quality retirement.

and of itself is huge, but today’s boomer has two

other issues as well. Second, they are carrying

million baby boomers and existing retirees to main-

more cash-flow-destroying debt than any prior

tain consistent purchasing power and quality of life

generation, and third, they have not saved nearly

over an ever-increasing length of time?”

enough to sustain a lengthy retirement. • The Demise of the Pension System. Though near-

There is much more that could be said, but the

So, the question persists: “How will we help 78

The Conventional Tools We All Use

ly obsolete for most current employees, there are

still many existing retirees who are receiving a

used in fighting the retirement Income crisis. They

pension. Recent reports tell us that nearly every

have proven both powerful and effective in times

major pension system in the country is in danger

past. These three buckets represent the primary ways

of failing in some measure. United Airlines, Del-

in which income is coming to retirees now or assets

phi, and Bethlehem Steel all failed their combined

will be converted to create it.

408,268 employees with nearly $17.2 billion in claims to Pension Benefit Guaranty Corporation. And that is just the top three!

There are three traditional financial weapons

• The Income Bucket: Employment, pension, Social Security, income annuities, bond ladders, and other resources used to create income.

• The Angst over Social Security. The system needs

• The Investment Bucket: Qualified and nonquali-

to be tweaked and though we keep kicking the

fied plans, as well as other investment vehicles

can down the road, the editing of the program is

that are used primarily to create growth in the al-

needed by either pushing the full retirement age

location phase but now must be managed wisely

back or reducing benefits to a certain income

in planning for withdrawals needed to sustain a

class or age group. Hopefully, the dilemma is go-

long retirement.

2 n Financial Planning | June 2017

annuities, a personal business, rental property,

An Expanding Conversation We Must Have

and other similar resources that are backed by an

insurance firm or that represent something that

vices had an article that elucidated this very subject. It

can be converted to income in the future.

was called “Making a Case for Reverse Mortgages in

From these three conventional financial buckets,

Retirement Income Conversations.” It featured Dr. Rob-

• The Insurance Bucket: Life insurance, deferred

Recently The American College of Financial Ser-

advisors must create sustainable lifetime income

ert C. Merton, Dr. Wade Pfau, myself, and a few other

through whatever primary philosophical distribution

financial thought leaders speaking about the changing

strategy they gravitate: systematic withdrawal, time

role of housing wealth in retirement income plans.

segmentation, flooring, or any combination or hybrid.

It doesn’t matter since they all revolve around and

ry, Investment News “Retirement Income Summit”

draw from the same three buckets.

had a presentation on reverse mortgages. Here is an

excerpt from the website:

My good friend, Dr. Wade Pfau, wrote an article

on www.retirementresearcher.com outlining “39

Just the other week, for the first time in its histo-

Despite home equity being the largest asset

Hybrid Retirement Income Planning Techniques.”

of many retirees, financial advisors have long

dismissed reverse mortgages as not applicable

One of the hybrid strategies Dr. Pfau mentions

has been pioneered by Thrive Income founder and

for their clients or merely a tool of last resort.

American College Adjunct Professor, Curtis Cloke.

However, the tide has been changing as recent

This past weekend I was invited to a Wall Street firm

research incorporating reverse mortgages into

to present with other thought leaders and was again

retirement income planning has demonstrated

privileged to hear Curtis share his “Divide and Con-

that the strategic uses of reverse mortgages are

quer Income Allocation Strategy.”

far more reaching than previously understood.

Reverse mortgages can be used effectively for

His plan has garnered a lot of attention and praise

and is closely aligned with Tom Hegna’s “Paychecks and

Roth conversions, tax efficient withdrawals, in-

Playchecks” strategy. It consists of two simple steps:

creasing a client’s withdrawal rate, and improving

the longevity of a retirement income portfolio….

Step 1—Create lifetime, inflation-adjusted, guar-

anteed, predictable income using insurance-related

products with mortality credits to provide income for

monly called a reverse mortgage, is an equity release

A home equity conversion mortgage (HECM), com-

the essentials in retirement.

continued on page 4

Step 2—Create a more aggressive asset alloca-

tion with dollars remaining in the market to provide for additional inflation protection and money for discretionary items.

The math and science behind this approach are

solid, and the “psychonomics” are profound. But is this enough to meet the goal of helping retirees to maintain consistent purchasing power and quality of life over an ever-increasing length of time? The reason I bring up Curtis and Tom specifically is that both men have said, “no,” it is not enough. They have expanded their retirement income conversations, models, books, and even software to now include another critical element, that is, the one we are discussing next.

Financial Planning | June 2017 n 3


tool sponsored by the federal government since 1988.

people. The conventional strategies have been great

It allows seniors aged 62 or older to convert a portion

and effective, but are they enough to prevent the new

of their home value and turn it into tax-free dollars,

crisis and challenges faced? The financial thought

without the requirement of a mandatory mortgage pay-

leaders have expanded the conversation to consider

ment. It’s really just that simple. (For more advisor-fo-

the HECM. Now let’s welcome them into the planning

cused information go to www.housingwealth.net.)

family and see what they can really do.

No longer the maligned red-headed stepchild of

Today’s HECM, when integrated with conven-

retirement income planning, the reverse mortgage

tional strategies, forms a powerful catalyst that helps

has come front and center in retirement income

clients increase cash flow, preserve assets, mitigate

planning. Why?

risk, and ensure/enhance liquidity throughout retire-

ment. Let’s look at three examples of how to imple-

The simple reason is that nearly 87 percent of baby

boomers and existing retirees own their homes. There is currently $3 trillion dollars in retirement home equity that exists. The U.S. Census Bureau has stated that the

ment them with the existing buckets. Collaborating with the Income Bucket—

average person retiring today will have more than 60

Social Security Deferral

percent of his or her total wealth in housing wealth. A

recent CNBC article said, “Retirees cannot continue to ig-

particularly the married clients’ primary wage earner,

nore home equity and still reach their retirement income

defer Social Security withdrawals until age 70 is a solid

goals.” Housing wealth is simply too large to ignore!

conventional strategy. Now watch what happens when we combine that approach with a HECM. This normally

The Power of Collaboration to Avert Armageddon

Most advisors would agree that having our clients,

occurs when the client sees the wisdom of deferring Social Security but also needs the money prior to age 70

Just as in the movie Armageddon, the crisis

to live. One of the ways we can solve that problem is to

was real and the global impact undeniable, so it is

establish a HECM and use a monthly tenure payment for

with retirement income sustainability for millions of

the 3, 5, 7 years of deferral to meet the income required.


When the client reaches the deferral time, we

published in the January 2017 issue of Risk Manage-

turn off the HECM payment and turn on the Social Se-

ment, I shared a very powerful and overlooked tactic.

curity. This of course results in about an 8 percent in-

It is simply to have a noncorrelated buffer asset set

crease in benefits for each year of deferral. But some

up so that our clients can draw from that source ver-

other benefits of the collaborative strategy could be:

sus their portfolio in the year following a down mar-

1. Keeping them in a lower tax bracket due to pro-

ket. Life insurance can be used as that buffer asset,

ceeds from a HECM being nontaxable.

but not all clients have that in place, have enough, or

2. Giving their other assets and annuities time to

even want to use it.

grow and/or be vested for a higher payout.

3. A shortened retirement draw period by the years

access to is housing wealth. By simply converting the

of deferral.

home into a HECM line of credit (growing at about 6

4. Creating a greater probability of sustainability of

percent today), they can draw from this during the

assets.

recovery years. This strategy alone resulted in nearly $1 million more to the estate, a better retirement

Collaborating with the Investment Bucket—

experience for the client, and three times the fees for

Mitigating Sequence and Withdrawal Risk

The other asset that 87 percent of clients have

the advisor—a true win-win-win for all.

In my article, “Can Reverse Mortgages Hedge the

Most Important Retirement Income Risks,” which was

$100,316

Line of Property Credit Value $106,324 $206,000 $112,693 $216,320 $119,442 $224,973 $126,596 $233,972 $134,178 $243,331 $142,215 $253,064 $150,733 $263,186 $159,761 $273,714 $169,329 $284,662 $179,471 $296,049 $190,220 $307,891 $201,613 $320,206 $213,689 $333,015 $226,487 $346,335 $240,052 $360,189 $254,430 $374,596 $269,669 $389,580 $285,820 $405,163 $302,939 $421,370 $321,084 $438,225 $340,315 $455,754 $360,697 $473,964 $382,301 $492,943

$608,842

$204,716 Line of Property Credit Value $216,977 $416,000 $229,973 $432,640 $243,747 $449,946 $258,346 $467,943 $273,819 $486,666 $290,219 $506,128 $307,602 $526,373 $326,025 $547,428 $345,552 $569,325 $366,248 $592,098 $388,184 $615,782 $411,434 $640,413 $436,077 $666,029 $462,195 $692,671 $489,878 $720,377 $519,218 $749,192 $550,316 $779,160 $583,277 $810,327 $618,212 $842,740 $655,239 $876,449 $694,484 $911,507 $736,079 $947,968 $780,165 $985,886

$1,242,470


continued on page 8

$311,116 Line of Property Credit Value $329,750 $624,000 $349,500 $648,960 $370,433 $674,918 $392,620 $701,915 $416,135 $729,992 $441,059 $759,191 $467,476 $789,559 $495,475 $821,141 $525,151 $853,987 $556,604 $888,147 $589,941 $923,672 $625,275 $960,619 $662,725 $999,044 $702,418 $1,039,006 $744,489 $1,080,566 $789,079 $1,123,789 $836,340 $1,168,740 $886,432 $1,215,490 $939,524 $1,264,110 $995,795 $1,314,674 $1,055,437 $1,137,261 $1,118,652 $1,421,951 $1,185,652 $1,478,829

$1,888,236

“How Am I Doing?” and the Complexity of Returns Eric Sontag, CFA

choices—which is correct?

“How Am I Doing?”

So, how did Bob and Mary do? Here are three 1. Bob and Mary performed equally and poorly.

In today’s world, people want answers, and they

Over the course of 2 years, they each put in $1.1

expect incredible speed and simplicity. It now takes

million, and ended the year with only $1.017 mil-

10 seconds to get an Uber (assuming it doesn’t cancel

lion, a loss of $83,000.

on you), a few minutes to book a flight, and no time

2. Mutual Fund ABC had positive returns for the

at all to self-diagnose our minor aches and pains into

two-year period. It was up 30 percent for a year,

WebMD-induced nightmares. So it is understandable

then down 10 percent the following year. This is

that investors want answers to the question, “How

a net return of approximately 17 percent ($100 up

am I doing?” with the same speed.

30 percent = $130, then 10 percent decline = $117),

or ~8.1 percent annualized. The fact that Mary and

Returns are often considered the answer. In the-

ory, a net-of-fees return figure is the great equalizer:

Bob picked Mutual Fund ABC means they did a

reported on every site at the click of a button, simple

good job of picking a fund that increased in value.

and easily comparable to other firms or benchmarks.

3. Bob performed poorly but Mary performed well.

“My portfolio is up 5 percent, and the benchmark is

Because Bob is a trader and could have invested

up 2 percent? Great! I am winning.”

the $1.1 million from the start, he could have earned

17 percent on all his money, but because he timed

However, understanding investment returns can

actually be a pretty complicated task at times. Con-

the market, and invested the bulk of his assets after

sider the following example:

the fund’s hot streak, he ended with an investment loss of $83,000. Using an internal rate of return

Bob, trader

(IRR) calculation, this is a negative return of -4.55

• Bob has $1.1 million in investable cash, and wants

percent annualized. On the other hand, Mary didn’t

to invest. He is feeling very uncertain about the

have a choice. She fully invested from the start, and

market and so he only invests $100,000 in Mutual

it was just bad luck that her bonus came in right be-

Fund ABC. Over the next year, the fund returns

fore the market went down. Ultimately she picked

30 percent. Bob feels increasingly confident in

a fund that did well for the two year timespan, but

his fund selection and decides to add the other

her $83,000 loss was out of her control.

$1 million from his bank account. The fund then

Which answer is correct? All of the above and none

decreases by 10 percent over the following year.

of the above at the same time. All of the above, because each answer is factually correct with respect to their

Mary, long-term investor

calculations. However, none of the above is also true be-

• Mary has $100,000 in investable cash. She is

cause while each answer may be factually correct, we

a long-term investor who does not try to time

would contend that, viewed in isolation, each is missing

the market, so she invests her full $100,000 in

the point. We dive into more detail on this below.

Mutual Fund ABC. Over the next year, the fund

investment. The fund decreases by 10 percent

Investment Gain vs. Time-Weighted Return (TWR) vs. Internal Rate of Return (IRR)

over the following year.

returns 30 percent. Mary then earns a bonus of $1 million on Jan 1 and adds this in full to her

Answer 1 references the concept of investment


gain. In this case, the investment gain is -$83K. You

multiple metrics to get a complete picture of your

invested X, ended with Y, and take the difference.

investment return. Investment gain helps you un-

End of story. This is useful for someone who wants

derstand how much you have earned/lost in dollars.

to know, “Do I have more dollars in my pocket today

TWR provides insight into the performance of the

than if I had kept cash under the mattress?”

selected investment managers/funds. IRR gives you

a sense of how your money has worked for you in

Answer 2 describes time weighted return (TWR).

Time weighted return removes the effects of cash

percentage terms (and will share the same direction-

flowing into or out of a particular investment. Mutual

ality of the investment gain/loss). In other words, all

Fund ABC has no control over when its investors add

of these are valid measures of return depending on

or remove money, and therefore its stated perfor-

which question you are trying to answer.

mance should not be driven by the fact that new

cash came in just before the market turned south, or

be sure to know what your underlying goal is: do you

vice versa. The benchmark indexes (S&P 500, etc.)

want to know if you are still on track to meet your

used as tracking mechanisms do not experience any

financial goals, whether you have earned or lost mon-

cash flows; as a result, TWR is necessary to perform

ey, or how well your investments have performed?

an apples-apples comparison. So answer 2 proper-

From there, you can select which return metric most

ly answers the question “how has the mutual fund

directly answers your question. n

performed?” Note in particular that in this scenario,

the TWR is positive while the investment gain is

and is intended to provide a brief overview about the

negative! For asset managers and RIAs that do not at-

subjects described. It was created with the intention

tempt to time markets, TWR is the industry standard

to provide accurate and reliable information on the

measurement for the reasons described above.

subjects covered. It is not intended to provide specific

legal, tax or other professional advice for any partic-

Answer 3 discusses the differences between

The next time you evaluate “how you are doing,”

This material was created by Sontag Advisory LLC

an IRR and TWR. An IRR calculation (also known as

ular client or prospective client. Past performance is

money-weighted calculation) is essentially the return

not indicative of future results and does not guarantee

the investor receives on his/her money. This return is

future positive returns. The services of an appropriate

heavily impacted by the timing of cash flows. Be-

professional should be sought regarding your individ-

cause Bob had the opportunity to invest more dollars

ual situation. It is reprinted here with permission.

earlier, and chose to time his entry/exit into the

market, IRR is appropriate for evaluating his personal

managing director of Sontag Advisory. Eric manages

investment strategy success (as opposed to the suc-

the general business practices and processes of the

cess of the mutual fund).

firm, including internal and client reporting, opera-

tions, client administration, and investment process-

Ultimately, it is our view that for individual inves-

Eric Sontag, CFA, is chief operation officer and

tors, looking at any one of these types of return mea-

es. Eric is also a member of the firm’s Investment

surements—in isolation—provides an incomplete

Committee. Prior to joining Sontag Advisory, Eric

picture. For starters, none of these concepts takes

worked at BlackRock in two different roles. He began

risk into account, and we strongly believe that any

in the Portfolio Analytics Group in New York and later

judgment of returns must be accompanied by risk

moved to the Transition Management team in Lon-

analysis. Second, investors might be asking about

don, where he devised implementation and hedging

investments when their primary concern is whether

strategies for institutional clients. Eric received his BA

they can still reach their financial goals. In that case,

from Cornell University, with distinction, in economics

investment returns must be incorporated into a finan-

and sociology. He holds a Chartered Financial Ana-

cial plan and a goals-based approach.

lyst® designation from the CFA Institute.

Consequently, it may be necessary to consider



Collaborating with the Insurance Bucket— Equity Insurance for Spending Shocks

The majority of our clients have homeowners and

auto insurance but will fortunately never experience a catastrophic loss. Wise financial stewardship says that it is prudent to still have this in place for a small price to share the risk—just in case. However, there is another insurance that the majority of boomers will absolutely use over a long retirement. It’s called

FINANCIAL PLANNING is published four times a year by and for Financial Planning Section members. This newsletter is designed to provide a forum for ideas and topics pertinent to financial planning. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of committee members, officers, individuals, or staff of the Society of Financial Service Professionals.

equity insurance. Equity insurance is access to the appreciating equity in your home regardless of your home’s future value, your income, or credit. It cannot be frozen, cancelled, or reduced as long as the client maintains the terms of the loan. It has been deemed the eighth financial wonder of the world.

The what ifs of retirement will come. Out-of-pock-

et health care costs for today’s retirees are predicted to be well over $250,000, not including the 70 percent who will need some sort of long-term care stay and the expenses associated with it. When these spending shocks happen (and they will), the client who has a collaborative strategy will not have to meet those challenges with gloom and despair, but will have a backup source to meet the challenges.

Editor Mark Jones, MBA, CFP NorthLanding Financial Partners 90 Linden Oaks Rochester, NY 14625 585-497-5013 [email protected]

The retirement income asteroid crisis is on the way.

The earliest fragments have already hit and have sent

Chair Michael Kitces, MSFS, MTAX, CFP, CLU, ChFC, RHU, REBC, CASL Pinnacle Advisory Group 6345 Woodside Court, Ste. 100 Columbia, MD 21046 410-995-6630 [email protected] Staff Anne Rigney, JD, CLU, ChFC Liaison Society of FSP™ 610-526-2536 [email protected]

concerning ripples of what is to come. The conventional strategies are good and time tested, but may not be enough for the mass affluent baby boomer. There is no doubt that expanding the conversation and opening up the collaboration to include the HECM is making a world of difference and could possibly be just a first step in preparing for other surprises that lie ahead.

Copyright © 2017 Society of FSP 3803 West Chester Pike, Ste. 225 Newtown Square, PA 19073-2334 Tel: 610-526-2500 • Fax: 610-359-8115 E-mail: [email protected] Web Site: www.SocietyofFSP.org

Here’s to joining Bruce Willis and NASA to save the

planet (this time), but even more to learning the skills and strategies required for when the next crisis arises. n

Don Graves, RICP, is the president and founder of the

HECM Institute for Housing Wealth Studies and an adjunct professor of Retirement Income at The American College. He can be contacted at [email protected].
