Time to Break the 80% Retirement Income Rule
by Kevin Hart

Most of us rely on the tried and true retirement-income formula – 80% of pre-retirement income. It’s easy, straightforward, and outdated. Previous generations of pre-retirees had simple needs and lived modestly. But, for the millions of up-and-coming Baby Boomers, it simply won’t compute. Baby Boomers have broken all the spending and lifestyle rules and now they’re about to break free of the 80% income rule, too.
A cursory Web search finds dozens of retirement-planning sites still suggesting pre-retirees shoot for somewhere between 70% to 85% of pre-retirement income as a way of estimating future needs. Many online calculators have an 80% factor built right in.
      But the 80% no longer adds up. The reasoning used to be that people would spend less when they stopped working. For example, they’d no longer be shelling out for business expenses or paying off debts. However, many retirees will face unexpected and unavoidable costs, like healthcare and inflation, which will severely affect retirement plans. Also, today’s retirees are expected to live longer than past generations. Because of these variables, it’s vital that advisors don’t hesitate to engage clients about preparing for retirement. By starting such conversations early, there’s a good chance you’ll discover that, along with your clients, the 80% rule is ready to retire.
      The 80% rule makes several faulty assumptions:
• No retirees will spend beyond the essentials.
• All retirees want to function on a fixed income or can do so.
• All retirees will never have a big emergency expense and never want to splurge on a big-ticket item.
• All external factors, such as inflation, healthcare costs, and investment returns will remain static.

Living large in Retirement

When retirement rolls around, Baby Boomers will be heading into exciting new adventures. A 2006 AARP survey of 60-year-olds revealed that this group is excited about the future and raring to do more and spend more. The 60-somethings are optimistic about an even better future and they are making many plans to bring it about.
Large segments of AARP survey respondents have the following big plans for the next few years:
• 70% want to spend more time on interests and hobbies.
• 72% want to “do the things I’ve always wanted to do.”
• 57% want to do more traveling.
• 30% plan to move.
It is apparent that Baby Boomers will retire from work, but not from life. It’s also obvious that, while they may be shedding work-related expenses, they’ll be replacing them with new ones and possibly many more.

Expenses May Climb, Too

Fast forward to Baby Boomers’ mid to late retirement years and they’ll be up against external factors that also threaten more financial upheaval.

Longer Lives

While past generations of retirees expected to live 10 or maybe 15 years in retirement, for Baby Boomers it can be decades. According to the Centers for Disease Control project, it will be quite common for 65-year-olds today to live well into their 80s. That’s a lot more years they’ll need income.

Inflation

Since the 1980s, retirees have had a relatively easy ride with inflation averaging about three percent annually. But Baby Boomers, who are expected to live much longer, will contend with many more years of cost unknowns and price increases.

Investment Risk

Historical stock market returns were fairly flat until the late 1980s and the average retiree was not an investor. Today, markets swing much more widely and many retirees will seek ways to moderate downside risk in equity investments.

Healthcare Costs

This is perhaps the greatest unknown and biggest risk. Annual double-digit cost increases for healthcare are now the norm. As Baby Boomers age, they can expect this expense to significantly climb.
With so much pressure on retirement finances, where will Baby Boomers get their retirement income? It turns out they’re breaking with tradition here, too.

More Financial Resources

In the past, Baby Boomers’ parents and grandparents relied largely on Social Security and pensions when it was time to draw retirement income. Since then, Baby Boomers have greatly expanded the pool of possible retirement resources.
According to Pew Research, 82% of surveyed workers 50 and over plan to earn money from work after retirement. Another Pew survey reveals that 49% of Baby Boomers expected personal savings from a 401(k) or IRA to be their largest source of retirement income. If the 80% rule is no longer workable, how will Baby Boomers’ current financial holdings support their future spending needs?

Changing Income Needs

Until now, advisors to Baby Boomers have focused on helping clients accumulate wealth in anticipation of retirement. With the oldest Baby Boomers entering their 60s, this focus is shifting. More and more Baby Boomers will want access to their wealth and will need guidance on the best way to support their retirement. While most financial resources promise a certain level of support, relatively few are set up to meet Baby Boomers’ changeable retirement income needs.
Social Security/pensions – These can be a good base of guaranteed lifetime income. But, in most cases, they can’t pay for everything or vary payment levels to accommodate Baby Boomers’ projected lifestyles.
      Taxable investments -- These will allow future retirees to keep investing for growth, but they come with the risk of loss of principal and they seriously limit retirees’ ability to manage drawing down income.
Annuities– Fixed annuities can produce guaranteed annual income, but they don’t allow investors to access principal in case of an emergency. While variable annuities have the potential to pay more (based on investment performance), they are subject to market risk, which implies a fluctuation in value. It seems that none of these present-day income solutions has what it takes to satisfy Baby Boomers’ high hopes and expectations.

An Opportunity for a New Kind of Income Benefit

Variable annuities’ living benefits can take Baby Boomers part of the way by combining guarantees and flexibility to meet income needs. But there needs to be a new category of variable annuity riders that capitalizes on the best of GMIBs and GMWBs, but with more flexibility, and a lower cost. Features might include the following:
• Guaranteed lifetime withdrawals
• The ability to lock in upside performance
• Freedom to stop, start, and save income payments as desired
• The option to take saved income as a lump sum or in installments
Such rider refinements may solve even more retiree demands for income flexibility. For instance, a couple that is getting along fine on Social Security and a pension may not need every annuity payments every year. Under this arrangement, they might be able to save one or more installments without incurring income tax on the payment. Yet, they’re always free to access that money as the need arises.
      Retirees who have rental or employment income may want to save income for later use, such as a lump sum down payment on a second home. Saved income may also be a handy source of money to defray unforeseen medical expenses later in life.
      Under another scenario, a retiree might begin annuity payments and receive an inheritance three years later. This person could stop and save income, if desired, to help manage their tax situation. In each of these cases, variable annuities would further extend a retiree’s ability to manage money as efficiently as possible.

Help Baby Boomers Close the Income Gap

With Baby Boomers just beginning to retire, creating income for this generation spells huge opportunity. How can you help your client?
1. Learn what’s available. There are many forms of variable annuity “living benefits.” New iterations are constantly entering the market. Know what’s out there and what’s hot.
2. Don’t just compare; look for the real benefits. Baby Boomers want the sun, the moon, and the stars. Be sure you can respond with living benefits that truly address the widest range of concerns including guarantees, flexibility, withdrawal options, and upside investment potential.
3. Help Baby Boomers fund their lifestyle. Start talking to Baby Boomers about the opportunity to live their life their way, and you’ll find they’re more willing to talk.
4. Educate, don’t sell. Boomers are mavericks at heart; they’ll listen, but they won’t be pushed. So, be informative and ready with more information when you’re asked.
      The more ways you can help Baby Boomers plan their income today and flexibly pay it out tomorrow, the more they’ll seek you out.
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Kevin Hart is President of Sun Life Financial Distributors, Inc. Prior to joining Sun Life Financial, Mr. Hart served as Chief Executive Officer & President of Sun America Financial Network Inc. For more information, call 800-SUN-LIFE or visit http://www.sunlife-usa.com.