For decades, financial planners helped baby boomers build their nest eggs. Now, as those same folks age, advisers are increasingly preoccupied with plotting how to distribute that wealth in retirement.
That’s a whole new ball game. “Managing distribution is much harder than managing accumulation,” says Todd Rustman, founder of Newport Beach Calif.-based GR Capital Management. For one thing, he says, there are more variables, primarily the addition of mortality to infamous unknowables such as market conditions.
“Longevity risk is the new buzzword,” says Rustman, referring to the problem of clients outliving their money.
As more Americans head into their sunset years, Rustman believes the job skills for managing wealth need to adjust significantly. “What I’ve seen in 16 years in this business is that a lot of advisers take all the [retiree's] money, assume a 3% or 4% return rate, and invest it all that way.”
But 2008 showed how badly that calculation can fail. To mitigate that potential, Rustman divides a retiree’s money into five-year buckets, and invests each bucket as a separate nest egg based on analytics that factor in longevity, gains and average inflation. “We end up with very little risk for the next five or 10 years, and more exposure to equities over the long term,” he says.
To demonstrate, he cites the example of a 63-year-old client with a wife and two grown children. “He was an executive who is now worth about $7 million,” says Rustman. “He’s not living high on the hog, but he also has a pension of about $6,000 a month. He’s super-healthy and a non-smoker.” Actuarial tables say that, on average, he’ll live another 17.5 years, and his wife two years longer. Of course, no one is average. They could both live to be 100.
So first, Rustman set aside about $1.5 million of the estate plus a paid-for home, which are earmarked as an inheritance for the children. Then he took the remaining money and divided it into five five-year buckets. Bucket One would contain 27% of the remaining nest egg and assumes just a 2% rate of return because 95% of the money is in fixed-income investments like laddered CDs. “We’re planning to deplete that bucket entirely,” says Rustman.
The next bucket holds another 26% of the total nest egg and is marked for a 4% return, with a bit more risk exposure. It now becomes the new Bucket One after five years, converting to the safer fixed-income funds. But over the first five years when it was Bucket Two it has presumably increased in value, so distributions will be notched up to counter inflation.
The third, fourth and fifth buckets have consecutively less in total funds and larger allocations of equities; each is expected to grow at faster rates as the time horizon expands. The total equity exposure comes to about half the portfolio, but it’s mostly loaded onto the back end, years away from now.
“The $1.5 million inheritance for his kids gives him a huge cushion,” says Rustman. “So even if I’m wrong on a lot of things, he has a lot of cash to chew through.”