How Wealth Management Firms Can Help Investors Avoid the Pitfalls of Asset Accumulation

About 15 years ago, I was in a bar having a debate on defined benefit (DB) retirement plans versus defined contribution (DC) plans. The person I was speaking with worked for an association that promoted the idea of companies and agencies continuing to offer DB plans. I was dumbfounded. My parents and their friends were just reaching retirement age, and several of my parents’ friends were set back (some devastatingly so) when their pensions collapsed from large financial events, such as the downfall of Arthur Anderson and Enron.

From my perspective, DC plans—such as 401(k)s—cut the risk associated with employers’ plans being hurt by the business itself. Pension failure poses a double risk because it happens along with the loss of present income when employees lose their jobs if the company goes out of business.

Contribution-based forms of retirement savings other than 401(k)s include IRAs and variable annuities, with each offering portability and fungibility. Investors can move money between plans, custodians and within the plan itself, and the allocation of investments can be changed, with limited or no transaction fees and no impact on taxes. Contribution-based plans also offer a range of investment vehicles that cater to those who need the simplicity of age-based funds or require the ability to invest in sophisticated investments, such as stock options, plus everything in between.

As I think back when I defended DC plans, there is one aspect that didn’t come to mind at the time, yet we see happening with more frequency today. A trend that often gets ignored is the risk of not enjoying your money as much as you should. David B. Loeper, the former chairman CEO of Wealthcare Capital and a pioneer in goal-based financial planning, called this phenomenon “unnecessary sacrifice.” He believed that traditional planning encouraged planners to recommend their clients continually forgo enjoyment in the present for a supposed brighter future. That behavior would continue into retirement years with an avoidance of spending assets, again, even with sufficient reserves and no need to add to savings.

While DC plans may provide more stability for investors in the future, wealth management firms should help their clients avoid falling victim to the unnecessary sacrifice paradigm. Below, I’ll outline the consequences of this philosophy, share how people slip into this mindset in the first place, and explore how wealth managers can help their clients create an appropriate spend-down strategy.

The Consequences of Investors Not Having a Proper Spend-down Strategy

When retirees lack an appropriate spend-down strategy, they not only harm their own overall life satisfaction but can create problems for society at large. Listed below are just some of the ways over-saving can be detrimental:

• Less Fulfilling Retirement: The most obviously impacted in this scenario are the retirees themselves. Though they have the comfort of seeing large balances in their accounts, they may be able to do more in retirement than they are allowing themselves. For instance, they could be traveling, eating out more, taking up new hobbies or participating in a variety of lifestyle-boosting activities.
• Larger Estates: Many savers don’t prioritize leaving an estate as a top priority but end up doing so anyway out of an abundance of caution. This, in turn, creates issues for surviving family members left to divide up assets appropriately.
• Slower Economy: Just about every industry that caters to retirees (other than the financial industry) suffers from less demand. If retirees spent more, there would be increased travel, more or pricier restaurant meals and more intergenerational wealth transfer—boosting the economy.
• Less Charitable Giving: While many think larger estates will help charities, that’s not necessarily the case. People who “give while living” tend to get more benefits than those who wait to give through their estate. The most obvious benefit is that donors get to see how their chosen charity benefits from their donations. Living donors also get more tax benefits, including the extra benefit of donating accumulated shares. On the other side of the spectrum, charities would receive help from the time value of money by getting donations earlier.

How Can Wealth Management Firms Help their Advisors Change Client Behaviors?

Despite a long history of retirees over-saving at the advice of their advisors, wealth management firms have a role to play in reversing course.

• Goal-based Planning: Offering an integrated, goal-based planning tool to advisors will enable them to create and manage plans efficiently. When firms choose a financial planning application tool that fuses nicely with investment selection and the investment proposal and rebalancing parts of the job, it creates a time saver for the advisors and a coherent conversation.
• Annuitizing: Buying an annuity—or annuitizing while still in accumulation—creates an income stream like a pension. This strategy could provide added long-term tax benefits but may also provide higher investment expenses. Withdrawing assets from a taxable account with a low-cost basis, compared to their current price, could result in immediate tax consequences. Like a pension, the annuity option also supplies insurance that clients don’t outlive their assets. Firms need to prioritize educating their clients on this, so they can reap the benefits.
• Setting Up Systematic Withdrawals: This approach requires no change in the investment strategy or asset allocation. Simply help your clients set up appropriate systematic withdrawals from mutual funds and have the proceeds deposited into a checking account on a regular basis. Most order entry systems accommodate this feature and firms should encourage using it.
• Managed Withdrawals: As firms well know, not all investments offer systematic withdrawals. Whether they are semi-automatic or manually managed by the investor or advisor, advisors can help investors set up a reminder every month to sell enough assets to supplement their fixed income from social security.
• Laddered Fixed Income: By encouraging their clients to implement a strategy of having bonds, certificates of deposit and preferred stocks, all maturing or paying interest at various times, advisors can help their clients produce periodic cashflow to supplement intermittent expenses.
• Monitoring and Notifications: After a plan is created, advisors can monitor their clients’ progress through dashboards. Timely alerts can also allow for proactive adaptation when there are large deposits, withdrawals or market moves that impact the plan’s trajectory and warrant course correction.

Fifteen years after that barroom debate, I still prefer defined contribution plans to pensions, especially when the employer matches the contributions. However, I now recognize the advice people get on how to manage their accumulated assets has some room for improvement. Advisors should educate their investors on the multiple ways they can drawdown assets and the risks, benefits and costs of each option. Wealth management firms can help their clients by appropriately using technology to make the best recommendations for their clients and their unique needs.