Ric Edelman, who runs Fairfax, Va.-based financial advisory firm Edelman Financial Services, received a call a while ago from a prospective client, who wanted to set up an appointment to talk about planning for his retirement. Fine, Edelman said, and asked the man when he planned to retire. “This Thursday,” the man replied.

Certainly, the average prospective retiree is not that grossly unprepared. Yet advisors and market analysts agree that as the baby boom generation begins to retire en masse later this decade and throughout the 2010s, many retirees remain dangerously uninformed about how much annual income they will need and about how to manage their investments.

Then there's the need to calculate such variables as health care costs; most haven't given it a thought. At the same time, pillars of traditional retirement plans — Social Security and pensions — are being shaken. Even as some once-comfortable pension programs are being gutted, few employers are now offering anything comparable to them. As for Social Security, few advisors believe the program will be allowed to go bust, but many are telling their clients not to expect too much from it upon retirement.

“The nation is going to face a retirement crisis in the next 10 to 30 years,” Edelman says. “A great many people are going to be unable to retire, or they will be forced to return to the workplace, or they are going to have to radically alter their lifestyle.”

For financial advisors, the crisis represents an important business opportunity (but not manna from heaven; see related story on page 34). Quite simply, advisors will increasingly need to serve as educators for people who have up until now considered retirement to simply be a blur on the horizon; some will have to serve as something like emergency room doctors for those aging workers who have neglected their retirement plans until the eleventh hour. “Our job as advisors is to spread the word, to give people the warning they need to hear,” Edelman says.

Actually, advisors will have to spread the word with the vigor of St. Paul. “The average person at age 50 has saved less than $50,000 for retirement and they still think they can retire,” says Tom Gau, with Oregon Pacific Financial Advisors in Ashland, Ore.

A survey of 1,000 Americans over the age of 30 conducted by ING U.S. Financial Services in July showed the depth of this unpreparedness. According to the survey, two-thirds of respondents do not know what their monthly budget should be in retirement. Two in five say they are building up a nest egg for retirement, but they also have not thought of how to convert that nest egg into an annual income stream. And 20 percent haven't even begun retirement planning. At the same time, however, 51 percent of respondents gave themselves an “A” or “B” grade on their preparation efforts.

This overly optimistic self-grading indicates how many prospective retirees still haven't grasped the hard realities of retirement, says John Wheat, chief marketing officer for ING Financial Horizons. “It's like, ‘See teacher, I've been saving more than I used to,’” he says. “But the bad news we have to break to them is that you need to take a different course now — turning your money into an ongoing income stream.”

Retirees' blithe attitudes will soon strike against hard demographic facts. By 2010, the number of Americans older than 65 should increase nearly 30 percent from 2000, according to a recent AARP survey, and the numbers will grow every year in the 2010s. Simply put, this will be the largest generation of retirees in American history, and one which will live far longer, and far costlier, than its predecessors. This has the potential to overwhelm the Social Security and Medicare systems and could send repercussions throughout the financial markets, as millions of retirees fumble with the delicate alchemy of turning savings plans into annual income.

What are financial advisors seeing on the ground right now? Not surprisingly, longtime clients are the best prepared, advisors say. It is the great Middle American mass that needs education and, at times, intervention (and, some fear, it is a mass that is ripe for the plucking by unscrupulous advisors). There are a few basic steps to introduce the topic. First and foremost, advisors must disabuse retirees from the notion that the government will provide enough income for them, or that variables like inheritances will solve any cash-flow problems. Secondly, they must provide clients with a solid grasp of how much they will need to live on per year, and how to contend with rising costs like health care premiums. Lastly, advisors should set up clients with the investment programs and products that will sustain them for the long term.

End of the Pension Era

Let's face it: The classic post-war retirement plan — which consisted mainly of Social Security payments and generous employer pension plans — is rare today, and few prospective retirees expect anything of its ilk when they retire. Current forecasts predict that Social Security, under current fiscal conditions, could run out of money to pay full benefits by 2030 — when many people retiring in the next decade will likely still be alive. Disillusionment with the system is already running amuck. According to the ING survey, two-thirds of respondents do not have high levels of confidence they will receive retirement income from Social Security.

Advisors generally believe that Social Security will be there in some form for the next generation of retirees, but whether full benefits will be paid — or whether there will be income caps, or whether the benefit age could get moved up to 70 — are all concerns. Some advisors fear that the most aggressive free-market scenario — supplementing or even replacing Social Security accounts with private savings plans — has its own pitfalls.

“That's a good idea for people who have the intelligence to deal with money,” says Bob Burke, an advisor in Morgan Stanley's Walnut Creek, Calif. office. “It could be a disaster, however, because most people will not manage their money correctly and will effectively have a net loss of their Social Security benefits.”

Some say Social Security anxiety is a good thing, since it helps focus clients' attention on actual income. John Young, a financial advisor with UBS Financial Services in Houston, says he tells his clients, when arranging their retirement income streams, to regard Social Security payments simply “as the icing on the cake.”

Corporate pensions are in worse shape. Many once-strong pension programs, such as that of bankrupt United Airlines, could be terminated. The Center on Federal Financial Institutions recently predicted the Pension Benefit Guaranty Corporation, the federal agency that insures pensions, will deplete its assets by the early 2020s. Even municipal government pension plans are in trouble. San Diego, for example, recently posted a $1.2 billion shortfall in its pension fund because the city government had been tapping the program for other expenses. And while these traditional plans founder, few will take their place, as most employers are moving to defined-contribution plans (which put more of the burden on the employee) instead of traditional defined-benefit plans.

To be sure, there are traditionalist holdouts. Morgan Stanley's Burke, for example, has found a niche advising prospective retirees from Chevron Products Co., having used strategies like paging through Chevron's in-house magazine to find employee anniversary dates, and contacting those near retirement. Chevron, like most other major oil companies, still has generous pension programs, which makes advising its retirees a less daunting task. “Even a refinery worker who has been at the company for 30 years has anywhere from $500,000 to $700,000 — compared to other companies, that's a lot,” Burke says.

Tempering Expectations

We should all be in such good shape. The average prospective retiree, those who are five to 10 years away from retirement, is still generally in a perilous fiscal situation, most advisors agree. The problem facing retirees first and foremost is one of perception — many people are not aware of how long, statistically, they may live after retirement; how much health care costs will eat into their budget; and how to convert savings plans like IRAs into viable monthly or yearly payment streams.

“The amount of money needed to retire seems so unrealistic to them that they throw in the towel,” says Scott Hanson, with Hanson McClain, in Sacramento. Calif. “If you tell someone who earns $60,000 a year that they'll need $2 million for retirement, it's such an abstract sum they kind of ignore it.”

Getting clients to grasp long-term budgeting is tough work for advisors. Oregon Pacific's Gau once asked a client how much she spent on groceries per year, and the client wouldn't even concede that she spent at least $5,000 a year — that is, $100 per week — on groceries. That's just a microcosm of how hard it is for people to grasp big-picture costs, he adds.

Several advisors have made retirement education a way to both improve their clients' knowledge of the market as well as to find new avenues of business. Bob Harris, an advisor with Colonial Heights, Va.-based Harris Financial Group, which is affiliated with Mutual Service Corp., regularly organizes seminars along the East Coast. The goal, he says, is not to push products like annuities or insurance, but to give people basic facts to make informed decisions. Some advisors, Harris says, “are making mistakes — they should be relationship builders and not salespeople.”

To be sure, not all prospective retirees are without resources. About 45.2 million U.S. households own IRAs, roughly $3 trillion worth, compared with 29 million households in 1996, according to the Investment Company Institute. Yet even prospective retirees who have saved will need some form of re-education, advisors said. Steve Eulian, with Scudder Retirement Services, (the U.S. retail name for Deutsche Asset Management), says retirement will require a different mindset, and adds that advisors need to change their thinking as well. “We've been in an accumulation phase for so long, but I think now that the baby boomers are getting older we have to help with the decumulation phase.”

Risk vs. Safety

A central question for advisors planning a client's retirement is how to construct an adequate risk profile. As the baby boom generation retirement wave increases, the nature of retirement savings is going to have to change, advisors say. Rather than focusing mainly on wealth preservation and low-risk savings plans, many retirees who were not aggressive investors during their productive years may be just that now.

“It used to be that people were retiring at 65 and dying at 75,” Morgan Stanley's Burke says. “Now people want to retire at 55 and they're living to 85 — that's 30 years, that's stock market territory.”

Gau agrees that many retirees will need to be steered toward more income-producing investments. For example, someone with $1 million in savings, who needs $30,000 a year in annual income, would need to make a 3 percent return, while someone with a lesser nest egg will need a more aggressive return to match that. “People don't realize they can't have the most conservative strategy — they need to take some risk.”

To be sure, many prospective retirees were all too aggressive during the 1990s, and paid the price. The bear market has shattered expectations of living well off of sizzling annual returns and, in some cases, retiring early. “Most people are woefully underprepared, and many have lost faith in the financial markets,” Hanson says. “They have cut back on 401(k) [contributions] because they do not have faith in 401(k)s.”

One crucial problem was that many prospective retirees, enticed by the tech bubble, were anticipating far-too-high returns on their portfolios. “People thought it was conservative to have a 12 percent career growth rate,” Hanson says. “But not only did they not get 12 percent, now their portfolio is half of what it was.”

This is causing some advisors to be more cautious in their risk assessment, as some say clients have lashed out at them for their portfolio losses. Bruce Harrington, vice president and director of production and management for MFS Investment Management, says his advisors now quiz clients to determine their risk tolerance, have them sign the completed quiz and then file it as a written record of the client's risk tolerance.

While the stock market has been recovering in the past year, it still remains tricky to find the right tone between safety and solid returns. “Part of the job of the portfolio manager is not to become overly conservative. One of our big challenges is not to go too much into cash after a bear market,” says Carlette McMullan, principal/manager of William Blair & Co.'s private investor department.

And sometimes pure traditional conservatism still works. Harris regards a solid retirement investment plan as being a “stair-step” strategy, with the bottom (and largest) step being bond funds, then balance and growth funds, with high-risk funds being the highest (and smallest) step. The belief is that if you fell off the first step, that is if bonds go sour, “you would twist your ankle,” he says. “If you fell off the sixth step, you'd have to have surgery.”

Christopher O'Leary is a freelance journalist based in Sunnyside, Queens (N.Y.).

A Survey of Retirement Products / By Chris O'Leary

With a possible retirement crisis on the not-too-distant horizon, financial advisors are under the gun to provide answers to their clients. The question is whether some products now being touted as possible lifesavers, such as annuities, are addressing any compelling retirement need.

Yet as the retirement rolls grow with each year, advisors are going to be forced to decide, and decide soon, which products they think will be the best fit for their clients during what promises to be the longest sustained retirement periods in modern history.

Annuities

Annuities that provide a regular monthly payment to purchasers for the remainder of their life, in exchange for a down payment, are coming back into style. For much of the past few decades, annuities have typically been used more in the same manner as a certificate of deposit — that is, a way to essentially mandate saving money over a certain period. Now, however, retirement-geared annuities are being pushed as a way to offer risk-weary retirees an alternative to relying on stock or bond market returns for their income.

“Annuities used to have a bad name, but now they are going to be reborn as a product class,” says ING Financial's John Wheat. “Already we are seeing some ingenious ways of using annuities to help with retirees' monetization problems.”

Other advisors, however, see a case of the same stale wine in a new shiny bottle. “Some people are selling annuities to line their own pockets,” says Harris Financial's Bob Harris. “They're getting anywhere from 6 percent to 8 percent commissions while telling clients there is no charge whatever.” Many annuities, deep in their prospectuses, are stuffed with hidden charges, he says.

IRA Twists

IRAs have been an essential building block for most prospective retirees' plans, but few retirees have put much thought into how to best convert their retirement accounts into actual income streams.

Some advisors have found a niche guiding clients into the most lucrative strategies of tapping or converting their plans. MFS Investment Management's Bruce Harrington says the financial advisors his firm deals with have lately been asking clients to consider taking advantage of a current tax loophole. Internal Revenue Service Code Section 72(t) enables prospective retirees under age 59 to withdraw money from IRA accounts without the typical 10 percent federal tax penalty, while preserving the tax-deferred status of earnings “It's still an underutilized loophole,” he says.

“Stretch” IRAs, in which retirees can essentially turn their IRAs into legacy accounts for their children, are also growing in appeal. The “Stretch” IRA works by having the original investor name beneficiaries who are still years away from retirement age, such as children or grandchildren. These beneficiaries, in turn, take out distributions over their own life expectancy, which reduces taxes and keeps more assets in a tax-deferred account, according to MFS.

Setting up additional IRAs specifically designed for health care is also being considered by some retirees, advisors said.

Mortgages

Usually, advisors tell prospective retirees that as a first step, they need to eliminate all the debt they can. In some cases, however, adding on new debt in the form of mortgages or home-equity lines of credit could actually be a wiser move. In particular, reverse mortgages, in which homeowners borrow against their home equity in turn for monthly tax-free payments from a lender, make a lot of sense for retirees facing a situation in which tapping their IRA over a certain amount would push them into a higher tax bracket.
Chris O'Leary

The Retiring Mind

Which reflects your outlook on financial planning?
30+ 50-70
Employed Just Retired Employed Just Retired
Never planned 21% 22% 4% 4%
Building nest egg but no plan to convert it 41 20 43 25
Planning to convert it 35 56 44 66
Don't know 2 2 9 4
How do you want to receive the funds?
30+ 50-70
Employed Just retired employed Just retired
One lump sum upon retirement 4% 9% 8% 6%
Weekly/monthly paycheck 36 49 43 46
As needed basis 29 34 33 41
Don't know 30 5 16 1
Refused to answer 1 3 2 6

Source: ING U.S. Financial Services