What role will technology play in providing a solution?

    Without a doubt, the greatest challenge that advisors face in the coming years is helping our clients to make their money last a lifetime. Unfortunately, our profession and the software vendors that serve us have yet to offer clients the solutions that they deserve.
    The industry has been slow to develop better software solutions for many reasons, but they fall into two broadly defined categories: industry dynamics and methodology.
    In the past, most financial advisors focused either on product sales or asset gathering. Until recently compensation was tied closely to either sales, assets under management or both, so there was little incentive to develop tools that helped clients deplete their assets. In addition, much of the training offered at financial institutions focused on sales rather than planning. Hence, there was little incentive for software companies to develop sophisticated withdrawal software.
    Over the last few years, much has changed. The profession is starting to mature. As we shift from a product/asset-driven model to an advice-centric one, the demand for better tools has increased. As the quality of training within the industry improves, we are producing more sophisticated advisors who are better prepared to deal with complex problems, such as withdrawal planning, on behalf of their clients.
    While our industry is evolving, so is our client base. The baby boom generation is aging, and as a result, they will be transitioning from the "savings" mode to the "spending" mode. Soon, the most common question you are likely to hear will change from "How much do I need to save for retirement?" to "If I spend $100,000 per year, will my assets expire first or will I?"
    According to Purna Pareek, CEO of AdviceAmerica, "Seventy-seven million baby boomers will retire over the next two decades. It is estimated that retirees will control a significant asset base, in the neighborhood of $20 trillion."
    For readers with a shorter time horizon, David McClellan, vice president of advisor business development at Morningstar, says, "In 2006, $10.9 trillion in retirement assets will be held by 60-plus-year-olds. These assets represent a tremendous opportunity for financial advisors because many of these assets are up for grabs, and once an advisor captures these assets, they tend to be sticky."
    Linda Strachan, Ph.D., CFP and vice president of product marketing at EISI, the developers of NaviPlan software, also senses a huge opportunity for advisors: "Near-retirees lack comprehensive retirement plans. Market fluctuations, coupled with the current national debate on Social Security, have exacerbated fears of outliving one's savings. Often, the conversion of assets at retirement creates an opportunity for advisors to establish a relationship and capture those assets."
    Methodology within the industry is advancing as well. With the exception of Bill Bengen's excellent work ("Determining Withdrawal Rates Using Historical Data," Journal of Financial Planning, October 1994, and subsequent works), little was written in the profession's periodicals regarding withdrawal strategies until the late 1990s. More recently, however, new studies have tackled various aspects of the withdrawal planning puzzle. Examples include "Making Retirement Income Last a Lifetime" by Ameriks, Veres and Warshawsky (Journal of Financial Planning, December 2001), which dealt with annuitizing a portion of a client's retirement portfolio; "Sustainable Retirement Withdrawals" by Ahmet Tezel (Journal of Financial Planning, July 2004), which dealt with asset allocation/asset allocation; and "Decision Rules and Portfolio Management for Retirees: Is the Safe Initial Withdrawal Rate Too Safe" by Jonathan Guyton (Journal of Financial Planning, October 2004). While the above list is far from exhaustive, it demonstrates that more intellectual currency has been expended recently to solve the withdrawal puzzle.
    Clearly, all indications are that advisors require better software tools to help clients create realistic plans during the retirement years, and vendors are about to respond with a number of new products to meet the need.
    According to Joseph Weiss, CFA, FSA, MAAA, of Ernst & Young, "The ideal software package would help clients understand the risks, face reality, understand their options and present potential solutions; however, this is easier said than done. Clients must be educated, and many advisors require further training in this area as well."
    The factors an advisor must examine are numerous, and often random. Factors Weiss cites include: market risk, liquidation risk, health risk, mortality risk and inflation risk. Each of these risks can be further broken down into subclasses of risk. For example, when dealing with market risk, advisors must look at equity market risk, bond market risk, real estate market risk and interest rate risk. Liquidation risks include timing risk (the risk that a client will be forced to sell at a market bottom), tax risk (the risk of paying too much tax through poor tax planning, as well as the risk that tax rates will be higher at retirement) and wealth transfer risk. Illness risk includes planning for "normal" illnesses as well as catastrophic ones. Mortality-related risks include overconsumption, underconsumption, death related events and the order in which the spouses die. Inflation risks include CPI risk, as well as medical, nursing home and LTC premium inflation.
    Unfortunately, the distribution puzzle is complex. Says Weiss: "Something must be simplified, but it can't be the problem, it can't be the plan, it can't be the tools and it can't be the solution. What is needed is a way to simplify the message to clients."
    Apparently, a number of software vendors agree. EISI, which licenses its NaviPlan software to more than 70,000 financial professionals, is currently working to incorporate retirement distribution planning into its NaviPlan Standard product. (NaviPlan Extended currently supports distribution planning, but the program is designed for advanced planners only.) According to Strachan, in the initial release the focus is on whether or not existing assets will provide a lifetime income given certain risks and income options. The idea is to provide the functionality that advisors and their clients require without making the software too complex.
    A new "Scenario Manager" will allow advisors to compare the current plan with predefined alternative scenarios. It will identify fixed needs vs. discretionary needs and illustrate the client's ability to meet each. The application's design makes it very easy for advisors to manipulate multiple scenarios. "What if" scenarios currently under development include: retire earlier/later, increase/decrease rate of return, increase/decrease inflation rate, increase/decrease fixed need, increase/decrease discretionary needs, annuitize to need, annuitize a percentage of assets, modify redemption order, modify life expectancy and incorporate Monte Carlo analysis.
    According to Strachan, the Scenario Manager is designed with the flexibility to meet the needs of EISI's diverse user base. "At the enterprise level, our clients can control how the tool is used. For example, less experienced advisors can be restricted to 'pre-canned' what-if scenarios, while experienced Level 3 Standard users can be permissioned to create their own scenarios." She emphasizes that this is just EISI's first iteration of the scenario builder, with more to follow. Possible future enhancements include incorporating reverse mortgages, alternative 72(t) distributions and long-term care costs into the analysis, as well as incorporating the Scenario Manager into NaviPlan Extended.
    Morningstar is also working on a Retirement Income Planning Tool. According to McClellan, the tool will be squarely targeted at the mass affluent, which he defines as $250,000 to $2 million in financial assets. While the product is still under development, McClellan envisions a stand-alone tool that can quickly zero in on some key variables and present clients with alternative scenarios upon which to base their decisions. For example, goals that a client might express are: generate a desired income (in real terms), limit volatility, avoid exhausting funds and leaving a bequest. The "levers" that the advisor will manipulate for the client include the withdrawal rate, the asset allocation, annuitization and product selection.
    Advisors will also, through the use of wizards, easily be able to model the impact of deferring retirement, taking early Social Security, working part time, accessing home equity and other scenarios. Morningstar's plan is to produce a client deliverable of no more than five to six pages that contains all information relevant to the desired scenario. Like the other programs discussed here, the Retirement Income Planning Tool will offer some sort of probability analysis to help gauge the probability of success.
    AdviceAmerica intends to incorporate Retirement Income Planning into its flagship products for advisors. One aspect of distribution planning that AdviceAmerica's CEO Purna Pareek emphasized is the "stages of retirement." He says that his software will allow users to create different age bands for the various stages of retirement, and to adjust assumptions within each band. Another area of emphasis for his firm appears to be execution. At the enterprise level, this program can not only create a plan but it can construct a portfolio, execute trades and rebalance to portfolio at regular intervals.
    While the development of software tools specifically targeted at distribution planning is a promising step in the right direction, much work remains to be done. Before the optimal distribution planning software can be developed, the industry must arrive at a consensus as to the methodology to be employed in generating solutions; as of now, no such consensus exists.
    "Safe" withdrawal rates are one area of uncertainty. While Bengen's original work indicated that a "safe" rate of withdrawal fell in the 4% range, more recent work by Guyton seems to indicate that, using his methodology, the maximum "safe" initial withdrawal rate could be 5.8% or higher. Weiss, however, urges caution: "If you lock your client into a higher withdrawal rate early on and the unexpected happens, you could have a problem."
    Most advisors currently use arbitrary, fixed life expectancies in their scenarios. However Weiss says: "Statistically, only 3.3% of people die when they are supposed to ... that means that our statistical projections are wrong 96.7% of the time." How, he asks rhetorically, can we base a plan upon numbers that are almost guaranteed to be wrong? How indeed.
    In the typical husband/wife planning scenario today, it is generally assumed that the male will die first; however, a percentage of the time the opposite will happen, often with disastrous financial consequences for the surviving spouse if that contingency is not planned for.
    Weiss fears that we as an industry are focusing too much attention today on withdrawal rates, and not enough on the other risk factors. What would happen to the plan of the typical 65-year-old today, he asks, if researchers discovered an affordable cure for cancer? "If you live too long, it's over, unless you have an inflation-adjusted annuity stream that can cover your fixed costs."
    Even assuming we get the methodology right, and assuming that the developers can integrate the methodology into easy-to-use software; further work will still be required. New, better products will be essential to meet the needs of boomers. For instance, while some studies have suggested that immediate variable annuities can play a role in providing an income stream plus an inflation hedge, Weiss claims that their high cost structure mitigates their advantages: "You'd be better off buying a combination of a fixed annuity and mutual funds," he says.
    Fixed annuities could play a part in the asset allocation of some clients, but there is little incentive on the part of advisors to sell them because compensation on the sale of such products is low.
    So, while we expect to see some major improvements in the field of distribution planning software in the coming months, the battle is far from over. Before we can develop the comprehensive retirement solutions our clients need, we'll need better methodology and better products, as well as better software.
    Designing better retirement distribution solutions is a challenge, but we, as an industry, must get it right. As Weiss correctly points out, this is your clients' final plan. "Your clients only get one shot at this," he says, "so they can't afford to get it wrong." Neither can we.

Joel P. Bruckenstein, publisher of Virtual Office News (www.virtualofficenews.com), is a leader in the field of applied technology for the financial service professional. He can be contacted at [email protected].