Preparing for the retirement wave

Timing is everything. This is especially true when it involves clients and our business. For instance, we all know the benefits of having clients who invested with us at just the right time. Those clients who started with you in the first quarter of 2009 likely think you’re pretty smart, regardless of whether you put them into stocks or bonds. Conversely, those who signed on in the first quarter of 2008 are likely less pleased.

This is an example of a short-term trend you may have gotten right, but what’s the potential benefit of catching a longer-term phenomenon? With the baby boomers’ transition into retirement, it’s possible we’re entering one of those phases. And the success of advisors’ businesses could vary widely, depending on whether they take advantage of this opportunity or decide they simply don’t have the time.

The aging of profitability

The upcoming baby boomer/zoomer wave could significantly impact advisors’ profitability, and should change the way we do business. For starters, we’ll see a greater focus on fixed-income products. That’s because as the baby boomers move into retirement, they’ll start to decumulate instead of growing their assets. Advisors will have to adjust to this trend, since fixed-income products have traditionally generated less revenue.

We can start this adjustment process by asking if the current best practices in the industry will be the right ones for retiring clients, once the retirement wave hits over the next few years. At Russell Investments, we recently did a survey of some of our advisor partners in which we asked, “What percentage of your revenue is generated from clients aged 40 and under, 40-50, 50-60, 60-70, and 70 years of age and older?” What we found was not surprising.

The under-40 age group represented less than 3.5% of advisors’ revenue streams. The greatest concentration of revenue, on the other hand, was in the 50-60 years of age category, at 32.5%. Even more compelling, the 50+ group represented a staggering 85% of revenue, on average, in these advisors’ businesses.

What a boomer wants

Not surprisingly, the 50+ group’s main concern is their retirement nest egg. These clients want to ensure they’ll have a reliable source of income to allow them to live in the style they’ve grown accustomed to.

Retirees also want limited volatility from their portfolio or source of income. This fact, along with the recent market gyrations, resulted in a mass migration to fixed-income assets in portfolios. I believe this trend will continue to grow as the baby boomers get deeper into retirement.

And if this does continue to occur, either the cost of fixed-income products will need to go up, or the revenue that advisors earn will have to come down. The trend towards the former is not likely; in fact there’s a significant trend towards reduced costs and revenue on fixed-income products. The average equity mutual fund, for example, provides an annual trailer of 1%, versus 50 basis points for the average bond fund.

Depending on your bond pricing strategy, a laddered portfolio could pay even less. Today, some advisors opt to essentially build a bond portfolio for free and subsidize the revenue with the fee on the equity portion. But this is going to have to change, no doubt, especially in a more yield-hungry environment.

Prepare for the retirement wave

It wasn’t always about fixed income for the baby boomers, though.

I’m fortunate to have experienced the full benefit of the baby boomers’ rise to prominence within financial services. I entered the business in 1993 — just in time to witness the rapid growth in the mutual fund business, as well as the corresponding rise in equity markets. At this point in time, the early baby boomers were starting the transition to empty nests and mortgage-free living; and they had the ability to aggressively contribute to their savings as their income grew.

Fast-forward to today, and it’s now estimated that more people will be retiring in 2015 than at any time in the history of Canada. The bad news is most of your best clients are likely at — or have already passed — their point of maximum wealth.

They will, slowly at first and then more rapidly, start to eat into their principal as they draw down income, which will make growth for your business more difficult. I don’t think anyone has a viable solution on how to stop this from happening and ensuring the associated revenue you earn from your business doesn’t also go down.

I do have one suggestion, though: Get them to withdraw less. Looking at the percentage of revenue the 50-plus crowd provides for most advisory businesses, I became interested in the use of corporate-class funds in Canada. And I was shocked to discover that these funds only represented 6.4% of all mutual fund assets. If you add stock and bond portfolios into the total, the percentage of assets in corporate-class funds is probably under 3%.

In the past, the advantage of this structure was touted as the ability to buy and sell equity portfolios that were under the corporate-class umbrella, without triggering a capital gain. Well, the focus has now shifted to the ability to re-classify interest income into capital gains. The tax savings are significant, and allow your clients to take out less money because they’re retaining more, if not all, of the distribution.

So, if your client needs $50,000 in after-tax dollars and doesn’t need to take out $70,000 before tax, multiply that by the number of clients in your business who’ve reached retirement, and you can hold on to a lot of assets for a longer period of time.

Do the math

As some of your best clients start to retire and put more money into fixed income and dividend-paying investments to satisfy their need for security, they could potentially decrease the amount they received in pension benefits. Old Age Security pays qualified Canadian citizens a maximum of $6,203.52 per year. However, this gets clawed back by 15% on income over $66,335, and is completely eliminated for income over $107,692.

Let’s just say, for argument’s sake, that your client is currently earning $66,335 in pension and other sources of income. In addition, he or she also has a sizable portfolio that’s paying $45,000 in interest income or $35,000 in dividend income.

Under either of those scenarios, the amount he or she receives in OAS benefits would drop to zero — so he or she is giving up $6,203 per year due to bad planning. But, by putting their fixed-income investments into a corporate-class structure, which converts interest income into capital gains, you could help them avoid the clawback on their benefits. And the impact with dividends is even greater, as the government uses the grossed-up amount of dividend income declared when calculating the clawback.

Time is money

Compounding the loss of revenue due to a greater concentration on fixed income will be the challenge advisors have to prepare for in the next few years. However, the baby-boomer wave also represents an unprecedented opportunity for advisors to exponentially grow their businesses as retirees come in search of innovative advice that can provide them with a reliable income source, reduce taxes and ensure that they don’t outlive their savings.

Advisors should address these client needs sooner rather than later, since the demand for sustainable retirement income is something that simply can’t be ignored from a business standpoint. In other words, the old adage rings true when figuring out when to start preparing your business to meet the needs of the 50-plus crowd: Time is money.