Thinking Past Savings: Research from TIAA-CREF Reinforces the Need to Focus Clients on Reliable Retirement Income

Traditionally, the financial services industry’s success measure for “retirement readiness” has been the achievement of a large nest egg. Clients and advisers alike have focused on growing savings over the course of a career. Retirement planning has addressed how much to save each year, what risks to assume in various investments, and how to maximize total return. This approach is helpful in getting clients to build their portfolio, but provides little guidance for converting those savings into reliable income throughout retirement. There has been a significant void in practical applications for turning assets into sustainable and steady retirement income to last for 25 or 30 years.

Instead of measuring retirement readiness by looking at accumulated savings alone, advisers must help clients focus on the ultimate outcome of their plans: their income-replacement ratio or the amount

of income clients will need to live comfortably each year throughout retirement. The ability to convert accumulated assets into sufficient, sustainable income that will last throughout their old age, the way pensions did in the heyday of defined benefit plans, is the mark of success in retirement-income planning today.

This paper will present the results of TIAA-CREF’s proprietary 2015 Lifetime Income Survey1_{and other}

relevant research, as well as review their implications for financial advisers working with clients to plan for retirement. Key findings about the mindset and actions of American workers suggest what actions advisers can take to help clients improve their approach to retirement planning.

Thinking Past Savings: Research from TIAA-CREF

Reinforces the Need to Focus Clients on

Reliable Retirement Income

BY

ED

VAN

DOLSEN

E

V

D

P

R

&

I

F

S

TIAA-CREF

Fundamental Planning Strategies

F

1 : P

R E S P O N D E N T S T H O U G H T T H E Y W O U L D N E E D I N O R D E R T O L I V E C O M F O R T A B LY I N R E T I R E M E N T

Those findings indicate three trends for American workers today:

I They continue to underestimate the amount of

income they will need in retirement – by a significant margin

I They are still not saving enough of their annual

income for retirement

I They are looking for safe, secure savings and

retirement income

In examining these trends and their implications for advisers, the necessity of several actions becomes clear:

I Creating a “floor” with sufficient guaranteed

income to cover all essential expenses as an effective income-planning strategy

I Saving in annuities during the accumulation phase

to drive better retirement income behavior and help savers meet their safety and income security goals

I Understanding that while middle-class households

may face an income shortfall, high-net worth households must address a very different set of concerns in creating income

A detailed analysis of the three key trends for American workers follows.

1. American workers continue to underestimate the

amount of income they will need in retirement – by a

significant margin

Most industry experts and retirement income advisers agree that Americans need 70% - 90% of their pre-retirement income to live comfortably during retirement. But only 33% of Americans over the age of 18 surveyed by TIAA-CREF believe they will need more than 75% of their pre-retirement income (Figure 1, page 55). In general, there is an unrealistic expectation about the amount needed to live comfortably in retirement. According to the Urban Institute, health care costs alone may consume 20% - 40% of a household’s retirement income.2

F

2 : T

-

The Income Conundrum

While middle-class households may face an income shortfall, high-net-worth house-holds must address a very different set of concerns in creating income.

Creating sufficient and sustainable retirement income for middle-income earners can be particularly challenging. When focused on building their portfolio, it often seems that clients are making solid forward progress. However, when converting those savings to an income stream for retirement, the results can expose a significant income gap. Analysis from McKinsey & Company suggests that, if middle-income households make $68,000 per year, they should plan to replace 90% of their pre-retirement income. But if they only have a $250,000 portfolio when they are 10 years from retiring, they will have a shortfall of $20,000 per year when they do retire.3_{Even though they may have saved}

diligently for years, it becomes clear that they are financially unprepared for retirement. Showing middle-income workers the detailed components and sources of their income for retirement, as McKinsey does in its analysis, can help them understand if there is a gap and get them started on saving strategies to close it before leaving employment. One strategy may be the purchase of a deferred annuity to make up for having a short-fall later. Because more companies are adding annuities as an option in the investment line up, checking a client’s workplace plan documents to see if an annuity is one of the investment options is a good first step.

On the other side of retirement readiness are clients who have amassed substantial nest eggs in tax-advantaged plans and taxable accounts. While financially solid, they may be ill-prepared in other ways for the realities of turning their savings into income. The mere idea of drawing down their hard-earned savings accounts can make for an uncomfortable discussion. For these wealthier clients, the conversations about retirement income may need to begin many years before retirement as part of an estate planning discussion about the needs of a surviving spouse and possibly the next generation. But it's also important for advisers to help clients understand the connection between their lifestyle and their withdrawal rates, to manage expectations around required minimum distributions, and to discuss optimal strategies for Social Security, Medicare and taxes.

Note: This analysis represents a household with $50k to $100k in annual income, where the head of household is a pre-retiree (40 to 59 years old).

Implications for Advisers

By focusing on income-replacement rates as the appropriate retirement goal, advisers can help clients determine how much they need to save based on their expected income needs in retirement. That means using insight about each client based on age, account balances, earnings potential and retirement funding status to estimate how prepared he or she may be in the future to meet anticipated expenses in retirement – both for essential and discretionary spending. The TIAA-CREF retirement-income philosophy aligns with the best practices in the industry that retirees should cover their necessities – food, shelter, clothing and health care – with guaranteed income sources. And, because it is rare that Social Security is sufficient to meet all essential expenses, a combination of annuitized income from Social Security plus fixed annuities and pension benefits, when available, typically serves as the retirement income “floor” to cover essential living expenses for clients and help set up their surviving spouse or partner for financial security.

This is why we advocate that advisers go beyond an emphasis on risk tolerance, performance, fees, investment style and account balances and focus on ensuringsufficientincometomaintainadesiredstandard of living in retirement. Put more simply, solutions for saving should target income as the outcome.

2. Americans are still not saving enough of their

annual income for retirement

Experts recommend that Americans save at least 10% - 15% of their annual income for retirement (including contributions from their employers, IRAs, taxable accounts, etc.). However, the TIAA-CREF survey found that 41% of workers are saving 10% or less of their annual income (Figure 2, previous page). Even more alarming is that 29% aren’t saving for retirement at all.

Thirty-eight percent of respondents who plan to retire before age 60 are saving 10% or less of their income and 24% are saving nothing at all. If they continue to save at this rate, early retirement will be an unlikely aspiration.

Implications for Advisers

Many factors play a role in determining the actual amount that someone should save: income levels, portfolio returns, number of years until retirement, and current and past savings rates, among others. The reality is that each individual may have a different retirement-income replacement rate and will save a different amount. But, if the client doesn’t understand the outcome he or she is trying to accomplish, implementing changes to savings rates and behaviors becomes nearly impossible.

In addition, advisers need to recognize that their

F

3 : P

G

R

P

clients may be unemployed for periods of time throughout their careers. Whether it’s to take time off to care for children or elderly parents, return to school, or deal with a job elimination, these periods can wreak havoc on the best-laid plans and affect clients’ ability to maintain their target savings rate. Advisers might recommend a fluctuating savings strategy, where clients save more aggressively in better earnings years to offset periods when they may have to save less. This is especially true for women, who are more likely to take time out from their careers to care for children or elderly parents.

3. American workers are looking for safe, secure

savings and retirement income

TIAA-CREF’s research found that 48% of

Americans who participate in a retirement plan at work say the primary goal for their retirement savings plan should be guaranteed income every month to cover living costs. Another 23% want to ensure their savings are safe regardless of what happens in the market. Very few are interested in saving a specific amount of money as their main goal. (See Figure 3, previous page)

In addition, 46% of the TIAA-CREF survey respondents say they are somewhat concerned (21%) or very concerned (25%) that they may run out of money in retirement. But just 16% expect to receive income from annuities. This is at odds with their desire for safety, as annuitizing guarantees a consistent income stream in retirement that clients cannot outlive.4

Implication for Advisers

Not having enough money to live comfortably in retirement is a very real concern for Americans today. They recognize that they will be entering a period with no paycheck, yet plenty of bills to pay. Leading retirement practitioners recognize and deal directly with this uncertainty—whether the client can verbalize it or not. They take time to have in-depth discussions about the risks that may be at the root of a client’s uncertainty to motivate the client to take specific actions that can reduce those risks. (See Figure 4, above)

F

4 : R

A

C

’ R

S

I

P

I Longevity. Most clients have not considered that they may need to plan for

income well into their 90s and manage their portfolios to ensure that their money lasts that long.

I Market volatility. There is always the risk that the underlying investments

won’t perform as well as expected – an especially big problem if a sharp downturn happens during the first few years of retirement.

I Cognitive decline. The risk of losing mental acuity can inhibit a client’s ability

to make appropriate financial decisions. Some clients will begin to falter as early as their late 50s.

I Health care costs. The need for additional healthcare services is a virtual

certainty in retirement. The average retired man will need $124,000 and the average retired woman $152,000, to cover these costs alone.5

F

5 : A

R

I

C

T I A A - C R E F R

P

Source: Paul J. Yakoboski, Retirees, Annuitization and Defined Contribution Plans, Trends and Issues, TIAA-CREF Institute, April 2010.

But in advising clients who are still in a saving mode, advisers may also want to introduce an element of more certainty to allay their fears. And that includes saving in an annuity throughout the working years.

A study by the TIAA-CREF Institute found that individuals who contribute to annuities during their accumulation years are more likely to annuitize a portion of their retirement savings when they retire, creating a guaranteed stream of income for themselves and their spouse. A full 40% of individuals covered by TIAA-CREF retirement plans — in which annuities are both an investment and a distribution option — annuitize a portion of their accumulated savings when they retire. Individuals used less than half of their assets in an annuity stream, suggesting that they were filling a specific gap for essential expense coverage. (See Figure 5, previous page, bottom)

Nineteen percent of individuals who retired with significant balances in defined contribution plans and IRAs, but little defined benefit pension income, annuitized some of their retirement savings. The top three reasons these retirees cited for annuitizing any of their retirement savings were:

I for regular monthly income (27%)

I seemed like a good, safe investment for retirement

(22%)

I an adviser said to purchase an annuity (21%)

These statistics clearly show that the advice clients receive from advisers matters greatly when they are deciding how to manage savings and create a sustainable income stream during retirement.

Forward-thinking financial advisers are committed to

helping their clients reach a secure retirement

All of this research points to a single, powerful conclusion: Forward-thinking advisers have an opportunity right now to be trailblazers.

Clients are quickly coming to recognize that accumulating a large chunk of savings for retirement may not be enough. In the end, what matters most is not how much they have saved, but how their accumulated savings can translate into a lifetime of income. This outcome-oriented approach can help accelerate individuals’ savings at critical decision

F

6 : A

C

Top 10 adjustments to make when re-focusing on income as the outcome

With a backdrop of challenges and the need to present clients with a complete view of their retirement portfolio – a portfolio that will effectively generate income – what ac-tions can an adviser take to help clients see their full retirement picture?

1. Change the measure of success from how large the portfolio is to how sustainable a client’s expected retirement income amount will be.

2. Focus on income replacement rates as the appropriate retirement goal to help clients determine how much they need to save based on their expected income needs in retirement.

3. Start the income conversation early – from the first meeting and with even the youngest clients. Making the connection between the projected value of the portfolio and the amount of monthly income that portfolio might deliver upon retirement is the foundation to success.

4. Educate clients on what an income plan is designed to do – generate appropriate levels of income, navigate the inherent risks and provide options for lifetime income. 5. Challenge clients to save at the correct rate from the outset. Target 10% - 15% of

gross income, including contributions from employers plus their own contributions and IRAs.

6. Address the implications on future retirement income of moving in and out of the workforce. Help clients save more during high-earnings years and make adjustments in leaner years. This is especially important for women who may take time off to care for children or parents.

7. Recognize clients’ level of uncertainty and concern about making their money last and show them how their financial habits are on track (or not) to deliver improved income results.

8. Expand investment solutions for income to include enough guaranteed income to cover all essential expenses for clients.

9. Recommend that clients consider investing in annuities throughout their savings years. Investing small amounts over time lessens the impact of taking $100,000 or $300,000 out of the portfolio all at once as they set up their guaranteed sources of income.

10. Check clients’ workplace plan documents to see if an annuity is one of the investment options. More companies are adding annuities as an option in the investment line-up.

points, prevent common investor-driven errors tied to market timing, give them a new focus on the importance of guaranteed income sources, and keep clients on track to meet their goals.

Advisers have a pivotal role to play in ensuring their

clients' retirement income success. By reframing the conversations to focus on retirement income as the outcome rather than on building a big "nest egg," advisers can expand their business model to include discussions of "income outcomes" for all clients, not just those closest to retirement.I

Footnotes:

1 The TIAA-CREF 2015 Lifetime Income Survey was conducted by KRC Research by phone among a national random sample of 1,000 adults, age 18 years and older, from Jan. 7–13, 2015, using a combination of landline and cell phone interviews. The margin of error for the entire sample is plus or minus 3.1 percentage points.

2 Johnson, Richard W., and Mommaerts, Corina, Will Health Care Costs Bankrupt Aging Boomers? Urban Institute, February 2010. 3 Why Are We Not There Yet? An Update on U.S. Retirement Readiness, McKinsey & Company, April 2013.

4 Guaranteed lifetime income is subject to the claims paying ability of the issuing insurance company.

5 Fronstin, Paul, Dallas Salisbury and Jack VanDerhei, Funding Savings Needed for Health Expenses for Persons Eligible for Medicare, EBRI Issue Brief no. 351, May 2010.

Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, are not bank deposits, are not insured by any federal government agency, are not a condition to any banking service or activity and may lose value. TIAA-CREF products may be subject to market and other risk factors. See the applicable product literature, or visit tiaa-cref.org for details.

You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877 518-9161 for a current product and fund prospectuses that contain this and other information. Please read the prospectuses carefully before investing.

The material is for informational purposes only and should not be

regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Past performance does not guarantee future results. TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services, Inc., members, FINRA, distribute securities products. Annuity contracts and certificates are issued by Teachers Insurance and Annuity Association of America (TIAA) and College Retirement Equities Fund (CREF), New York, NY. Each is solely responsible for its own financial condition and contractual obligations.

©2015 Teachers Insurance and Annuity Association of America-College Retirement Equities Fund, New York, NY 10017