The duration of a client’s modeled financial plan – or of the client’s life for purposes of that planning – is a factor that often receives little thought or consideration when we are putting together a financial plan. After all, the software automatically calculates a life expectancy based on the client’s date of birth and gender or, if married, based on the dates of birth and gender of both primary persons. That life expectancy is set at or near the eightieth percentile of the mortality tables, meaning that using the default would mean that the client would be expected to outlive eighty percent of his or her peers.
Since one of a client’s or planner’s greatest fears is a client outliving their assets, using the default would seem to provide some protection and make good sense in most cases. Although this is conclusion is basically true, a more finely tuned approach would include an assessment of the client’s current state of health, the family history of longevity and health, as well as any information regarding the client’s lifestyle, employment, recreational activities, place of residence, education and wealth levels and more. It might turn out that the eightieth percentile age likely is too low and a longer life expectancy should be used. Alternatively, when the client clearly has a shortened life expectancy based on an assessment of the same factors, it must be considered in setting the actual life expectancy for the client in their financial plan. Even if the client is older than his or her spouse, life expectancy should be adjusted where indicated and that adjustment may affect the overall plan duration.
One factor that should NEVER drive the selection of life expectancy in a financial plan is the client’s retirement spending goal. One actual case that stands out here as an example is that of a retired client who did not have significant resources and whose spending needs were not insubstantial. In order to obtain a plan result in the comfort zone, the advisor set the client’s life expectancy to her age 80, despite her general good health and longer life expectancy based on available factors. Balancing the desire to create a plan that reaches the hoped for result (the end justifies the means?) with the need for a plan to be real and achievable based on the client’s actual situation should not mean recommending that the client spend what they want now and die early to ensure the plan works. Instead, the advisor needs to tell the client what the results really are and seek a way to help the client improve their situation.
What the advisor usually faces then is a balancing act where the duration of the plan must be neither too long nor too short but “just right”. Too long a period of time may leave a client in unknowing sacrifice for years during retirement and dying with money left over that the client would gladly have spent on lifestyle. Too short a term and we face that real fear of running out of money if things do not go well in the markets or with changing needs. In either situation, a client will not be happy with the advisor and the expectations set in the presented plan. Of course, one could consider modeling both shorter and longer life expectancies for comparison purposes but faces the almost inevitable client request for the spending level of the shorter term plan coupled with the longer life…something that is not logical and cannot be a basis for planning.
One other trap to avoid in planning for married clients is to not overlook tying the plan duration to the person with the longest life expectancy. On many occasions, advisors have omitted this step which typically means that the plan stops with the death of the first to die, usually the older of the couple and the one with the greater earnings history, larger retirement benefits and the like. A failure to plan for the survivor – which can be made automatic simply by checking which life and expectancy is to set the plan duration – not only hurts the client but can lead to potentially significant liability on the part of the advisor who overlooked this step.
Time frames other than a client’s life expectancy may be appropriate for certain plans and planning situations. An advisor might want to isolate planning for education of a client’s children over an appropriate time period or may want to show a client what may transpire between the current date and his or her planned future retirement, to get an idea of the potential range of portfolio values available at that time. This approach may also be useful in weighing options with a variety of non-qualified executive compensation, working within the framework of employment as opposed to including the full retirement period.
Independent modeling of a variety of trusts often focuses on a particular time frame as where a charitable trust has a fixed twenty year term or a grantor trust is set to expire at a particular client age. Modeling business activity of various sorts may best use a stated time frame that is unrelated to a life but is instead targeted to a particular ending date, anticipated event or other known time limitation.
A different question involving plan duration arises when a client concern is for survivor needs planning. Most often this involves a marriage or other long term relationship where the client with more substantial or significant assets wants to ensure that his or her spouse/partner is provided for in the event of the client’s early demise. Because survivor needs vary over time, this planning may use several different modeled durations of the client’s life to better understand what resources need to be available for the survivor since the client’s death may occur at almost any time with different impacts.
Clearly, an early client death followed by a long spousal survivorship likely requires more resources to ensure the survivor is adequately provided for by the client. In a particularly complex case for one high net worth client, this required modeling the impact of client death in each year over a twenty year span to get a handle on what it would take to provide for the survivor depending on when the client died. Think here, for example, about the concept of declining term insurance used in the real estate mortgage situation where one purchases insurance coverage that covers/pays less each year as the amount needed to pay off the remaining obligation falls due to continuing payments of principal.
As we have seen, setting the duration of a financial plan may not be as simple a step as one might believe. Relying on a standard approach for all your clients may mean that the plan is not tied closely enough to a particular client’s own personal situation and needs. Understanding the variations and why one might change either life expectancy or plan duration (or both) can be an important part of the planning process that may have a real impact on both plan results and actual client confidence.
George Chamberlin has been working in the legal and financial industry for over thirty years, including working at Wealthcare Capital Management from 2002-2009. George practiced law for several years before focusing on writing, planning and software development in the estate planning and financial planning areas. During his time at Wealthcare, George wrote weekly e-mails for advisors and their clients, engaged in basic and advanced financial planning and estate planning as well as working on a variety of other Wealthcare projects. Since 2009, George has worked as a registered investment adviser representative in his own firm, meeting and planning with clients, and more recently as a consultant to financial advisors, including Wealthcare advisors, on a variety of matters including advanced financial and estate planning.
George Chamberlin & Mentor RIA Consulting © 2015