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RIAs are about to become the nation’s defined benefit pension enablers. What? I know what you’re thinking: Defined benefit pensions are yesterday’s news.
And you’re absolutely right, as far as employer-sponsored defined benefit plans are concerned. However, we are about to enter a new era – the era of the personal defined benefit pension. And I predict that over the next few years, it will be RIAs that deliver these personal plans to millions of Americans. Before I explain how this transformation will unfold, let me first explain why it must unfold.
Robert C. Merton, winner of the Nobel prize in economics, reminds us that in retirement, it is your income, not your wealth, that creates your standard-of-living. The truth of this can be seen in recent economic history. In 2000, a risk averse retiree with savings of $ 1million could have generated interest income of $6,000 per month. By 2020, that $6,000 had plummeted to less than $100. Over 20 years, income declined by 99%. However, the retiree’s wealth never changed.
Meanwhile, the U.S. has witnessed the termination of 56,000 employer-sponsored defined benefit pension plans. This loss is equivalent to eliminating a pension plan for every resident of Saginaw, MI, or Chapel Hill, NC. The transition to 401(k) plans has significantly weakened retirement security for millions. BlackRock CEO Larry Fink captured the problem succinctly: “The shift from defined benefit to defined contribution has for most people been a shift from certainty to uncertainty.”
The vital importance of income, especially guaranteed income, has driven the many insurance company efforts to convince RIAs to embrace annuities. I applaud these endeavors. They have, however, generated only marginal advancements. I believe there is a better path, a new approach with less inherent “friction,” a strategy blessed with incentives that line up with the RIA’s core mission and objectives.
The fresh approach I will describe is likely to scale in the RIA channel because it does not ask RIAs to change what they do. Rather, it encourages them to be the best that they can be at the jobs they love to do. Therefore, you can forget about becoming an annuity expert to effectively address your clients’ retirement income needs. There’s a whole new path.
Describing the new strategy
Imagine technology that “wrapped” any investment that accepts ongoing investments. Using this technology, advisors can transform managed accounts, mutual funds, individual investment portfolios, 401(k), and even life insurance policies, making any of these the funding vehicle for a personal defined benefit plan. How would this work?
The process begins by the investor making some key choices that define the parameters of a personal pension:
- Define the amount of retirement income;
- Choose the age at which income payments begin;
- Select how many years to invest;
- Select a payment option at retirement; and,
- Choose a baseline growth assumption.
For instance, imagine the hypothetical example of Julie, age 35. Julie makes these five decisions to construct her personal defined benefit plan:
- $100,000;
- Age 65;
- 30 years;
- Life only; and
- 5%.
As you can imagine, number five, the assumed baseline growth rate, is critically important. At the inception of the plan, assume that, based upon a 5% return, the application calculates that Julie must invest $1,500 per month to reach age 65 with enough capital accumulated to purchase an annuity guaranteeing income in the amount of $100,000 for as long as she lives. Of course, future investment performance is unknowable. Therefore, at the annual anniversary of Julie’s plan, the application recalculates how her $1,500 planned investment must be changed – upward or downward over the next year – to keep Julie on track for her desired $100,000 retirement income.
Assume that in year two, actual performance was 3.5%, falling short of the baseline assumption. The application would generate an annual report advising Julie that to remain on track for the $100,0000 targeted retirement income, her monthly investment over the following year must be increased to $1,565. Julie decides to increase her investment to the suggested amount.
Now, assume that in year three, actual investment performance was 7%, exceeding the baseline. Julie’s annual report would indicate that Julie’s monthly investment over the next year can be reduced to $1,480. The report also illustrates that if Juile wishes to keep her year three investment consistent at $1,565, she is now on track for a higher income, $101,560.
This dynamic assessment-advice procedure continues in this fashion all the way to retirement. In the process, we have created what Julie might have enjoyed had she been a worker a generation ago: a defined benefit pension.
The ongoing monitoring of actual investment performance merged with dynamic advice on investment level modifications combine to deliver a new level of transparency and investor empowerment.
Moreover, I believe this technology does more than create a personal defined benefit pension. Rather, it changes the very nature and ownership experience of investments, adding an income context to vehicles that otherwise have none. The investment becomes objectively more important to the investor, as it takes on the properties of a lifelong answer for retirement income security.
What about inflation?
The application incorporates investor education on key financial topics, including the vital topic of inflation’s impact on future purchasing power. In our example, Julie has access to tools that enable her to easily model the impact of inflation at rates she selects. This combination of educational content and modeling capability helps Julie understand the long-term impact of inflation and creates an incentive to systematically increase contributions to maintain continuity of purchasing power in retirement. This incentive for clients like Julie to continually increase systematic investments builds long-term AUM for the RIA’s practice.
Why demand for guaranteed income persists
People want retirement income that is guaranteed. This is borne out by research which shows that 401(k) plan participants want their plans to look more like pensions. The persistence of this demand for financial certainty underscores a fundamental truth: Financial stability in retirement hinges on reliable income streams. Many individuals, faced with the challenge of managing their savings over an uncertain lifespan, seek the reassurance of predictable income.
The technology behind the solution
Perhaps you’re wondering if the technology I’ve described exists. It does, in the form of a patent-pending invention called Defined Benefit Investor™ that is being introduced by the company I founded. The platform’s user-friendly interface and robust reporting capabilities make it an invaluable tool for RIAs to better serve their clients. By streamlining the retirement planning process and offering actionable insights, this technology empowers individuals to take control of their financial futures, while fostering greater collaboration with their advisors.
Why RIAs should be enthusiastic about this innovation
The reality is clear: Most clients require some guaranteed income. Prudent fiduciaries should welcome a solution that addresses this need without disrupting their business models.
RIAs who recognize the benefits of helping clients invest larger sums, year over year, toward increasing retirement income targets will see significant AUM growth. While some assets will eventually convert into annuities, the overall adoption of this income-focused model will boost topline revenue.
More importantly, it is the right thing to do. If we could turn back time and prevent the loss of 56,000 defined benefit plans, the RIA’s role today would be less critical. But we cannot. Instead, RIAs can take decisive steps to replace uncertainty with certainty – positioning themselves as key players in solving America’s retirement crisis.
Wealth2k/Persuazo Founder, David Macchia, is an entrepreneur, retirement income thought leader, author, and public speaker whose work involves improving the processes used in retirement-income planning. Macchia is the developer of The Income for Life Model® retirement planning solution and the Constrained Investor® retirement planning framework. You can learn more about Defined Benefit Investor™ by visiting Persuazo.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
