The Great Recession Creates a New Retirement Reality

Quoted in Journal of Financial Planning (Dec. ’09)
The Great Recession Creates a New Retirement Reality
By Amy E. Buttell

The stock market is recovering, and the economy may not be far behind as the Great Recession begins to recede into history. But for retirees, the newly retired and everyone else contemplating retirement, the events of the last 15 months are not going to be forgotten anytime soon.

In fact, for the baby boomer generation, the Great Recession may be a defining moment in a similar way to what the Great Depression was for an earlier generation. Many Americans are not just cutting back and sticking to a budget, they’re extending their working years beyond planned retirement dates and becoming more sensitive to risk, say experienced planners.

Scars from the recent economic turmoil are still evident, even for those who haven’t been hardest hit by job losses or foreclosure. Declining home values, lower retirement plan values and a large dose of economic uncertainty have incited even the wealthy to be more cautious about spending and more disciplined about paying down debt.

Earlier in the decade, things couldn’t have been more different. Many Americans counted on the rising equity in their homes not only to pay for luxuries now, but also to fund a comfortable retirement in the future. Retirement plans and stock portfolios were also up, so more people were comfortable taking on more debt in the belief that the bull market in both housing and stocks would go on indefinitely. Link those shattered beliefs with the growing expenses involved in healthcare, longer life spans and the expenses of caring for parents and children, and it’s evident that a new retirement reality is literally taking hold.

“I think this really is going to have a generational impact on people,” says David Twibell, president of Private Wealth Management at Colorado Capital Bank in Colorado Springs, Colo. “At some point, we’ll all forget and go back and make the same mistakes again, but I think there will be some lasting impact over what we’ve seen in the past couple of years.”

Here’s where the financial crisis has impacted retirement:

Working Longer May Become a Necessity: The new retirement reality is particularly evident when it comes to retirement dates. Retiring early or even at the traditional ages of 62 or 65 is increasingly untenable for many.

“Many people who spent heavily and thought that everything would work out and they could still afford to retire early are either postponing retirement or, in many cases, are working part-time,” says Lewis Altfest, Ph.D., CEO of Altfest Personal Wealth Management in New York, N.Y., and an associate professor of Finance at Pace University’s Lubin School of Business. “Working longer will become fashionable because of a practical consideration—people will work part time, and at least some of them won’t say they are working because they need the money, but to stay active.”

Lynn Ballou, EA, CFP®, founder of Ballou Plum Wealth Advisors, LLC in Lafayette, Calif., is seeing many of her clients who may have retired full-stop in the past are now making career changes into part-time employment, or less stressful full-time employment, to bridge the gap to retirement.

“I have talked to a lot of clients lately who are thinking about their lives, who want to live differently,” she says. “So now they are doing something, whether it is quitting a job to substitute teach or whatever.”

By working part-time, Ballou says clients can avoid drawing down their retirement savings for a few more years, helping to preserve their assets.

Higher Expenses, Longer Life Spans Fuel Health Care Concerns: The baby boomer generation, sandwiched between their children and their aging parents who are living longer, are particularly cognizant of the toll that a longer lifespan and health care expenses can take on a retirement portfolio.

“I think a lot of people are realizing that they’ve got a limited window to save enough money to get them through the rest of their lives,” says Twibell. “We don’t know how long the rest of their lives are going to be. With medical advances, it may be a lot longer than people expect now.”

According to AARP, seniors spend an average of 30 percent of their income on health care costs. And federal officials are predicting that basic Medicare premiums will increase 15 percent in 2010 to $110.50 a month—topping $100 a month for the first time.

A 2009 study by First Command Financial Services found that Americans grossly underestimate the amount of money needed for health care expense in retirement. The study showed that Americans expect to need about $33,000 above general retirement savings to cover health care costs; a mere fraction of the estimated $166,000 in out-of-pocket expenses estimated for someone retiring in 2009 and living to 100.

Meanwhile, life expectancies continue to increase, according to data from the Centers for Disease Control and Prevention.

Back in 1950, the average 65 year old could expect to live another 13.9 years. In 2005, the average 65 year old could expect to live another 18.7 years.

Longer life spans not only mean that clients will potentially need to save more so that they have the power to spend over a longer period of time, but also can mean higher medical expenses. With a health care plan being debated in Washington, there are more questions than ever about what funds are available to pay for medical care and how the system will be able to handle the health care expenses of millions of aging baby boomers over the next half century. With government budget deficits escalating, more of the spending burden may be eventually pushed onto consumers, resulting in even higher health care expenses in retirement.

Altfest sees clients trying to save more in case their medical expenses are higher.

“It’s a major concern, and people in general tend to be conservative about their spending to keep some in reserve for this possibility,” he says. “But the most likely hedge against medical expenses is going to be the home. If things get bad, they’ll sell their home and use that to pay for medical or nursing home expenses.”

Changing Market Conditions Add Risk: The recent severe market downturn and volatility have caused clients to become much more sensitive to risk in their portfolios and in their lives, says Clint Edgington, CFA, a principal at Beacon Hill Investment Advisory in Columbus, Ohio.

“We obviously focus on portfolio risk, but there is an appreciation for risk across all aspects of a client’s life that wasn’t there two years ago,” he says. “We’ve seen an increased willingness to listen to discussions focused on risk and the insurance area.”

Not only are clients more sensitive to risk, they are also reigning in their expectations on the return side, says Dan West, CPA, PFS, CFP®, a family CFO with Moneta Group in St. Louis.

“People are setting their expectations much lower for rates of return,” says West. “They are also reducing their expectations about what they will be able to do in retirement. They’re more cautious about things like acquiring a second home.”

Twibell is concerned about the havoc that rising interest rates could wreak on the portfolios of retirees, because an increase in inflation of even 1 percentage point—from 2.5 percent to 3.5 percent— results in an amazing amount of extra money people have to save to make it through retirement.

“We’ve gotten very spoiled with very low inflation for a long time, but seeing core inflation of 3.5 to 4 percent is really, historically not that unusual,” says Twibell.

Budgeting, Paying Down Debt in Vogue: West is seeing not only a reluctance to spend, but also a newly found aversion to debt.

“Clients are asking themselves more often whether they should spend money now on something like a car or wait a few years,” he says. “We are also seeing that they are not only cautious about taking on debt to the point that it is a bad word. People want to pay down as much debt as they can.”

Budgeting can be a challenge for baby boomers, many of who have been used to spending up to their income limits and beyond, says Ballou.

“When we finally got our clients to open their statements—and it was surprising how many didn’t want to open their statements when the market was down—we talked to them about how much their lifestyle was costing them and where they can make some changes,” she says. “It’s kind of like negotiating; it’s helping them negotiate with themselves about where they are willing to make changes … that old-fashioned needs versus- wants conversation.”