Cannon Financial Institute

Someone Fried Your Nest Egg: Equity Investing for Older Clients

An exhilarating conversation with Executive Vice President and Retirement Plan Curriculum Chair Larry Divers.

“Your older clients have fewer years remaining than your younger clients,” Larry told me at our recent interview. While this is stating the obvious, he feels strongly about this.

“When you are advising your older clients on equity allocations in their retirement accounts, you as an FA must keep this issue top of mind. When it comes to investing in stocks time is your best friend if you have a lot of it and your worst enemy if you don’t.”

Unfortunately, the perfect example is right in front of us, Larry said. “Between 2000 and 2010, US equity markets experienced what is known as “the lost decade” when returns amounted to zero.  If you were 100% invested in US equities in that decade, then for ten long years you didn’t make one thin dime.” However, if you had a balanced portfolio and rebalanced it on a regular basis then you would have done much better.

We must accept some painful truths about life as we get older and one of those is: we aren’t getting younger.  “If you are thirty years old and experience a decade of zero percent return in the equity markets, you can ride out the storm. But if you are sixty-five or seventy, you aren’t investing in stocks for the ‘long run’. You’ve already run the race. To be as blunt as possible, I’ll turn to the economist John Maynard Keynes who said, ‘In the long run we are all dead.’

Please don’t get me wrong, but imagine the difficulty which would be faced by older clients who are over-weighted in equities in their retirement accounts and get caught in an ‘extended downturn.’  Not only will their financial capital decline, their human capital, that is their ability to work and make the money back, will have also declined.

Adding peril to this scenario for retirement accounts, are two different tax issues. Larry explained that the countdown clock for the first tax issue begins when a client reaches the age of 70 ½. “Under ERISA and the Internal Revenue code, your client must begin to take her RMD, required minimum distribution, from her retirement accounts commencing no later than April 1st of the year following the year she attained the age of 70 ½. If your client fails to do this, then she will pay an excise tax to the Federal government of 50% of the amount she should have withdrawn but did not.”

I asked Larry for an example of this.  “If you have a client who does not begin to withdraw their annual RMD beginning on April 1st of the year following the attainment of age 70 ½, that client will pay a 50% excise tax plus income tax on the amount they should have withdrawn, but did not. A client in a 40% income tax bracket who failed to take a distribution of $10,000 will pay $5,000 in excise tax and $4,000 in income tax. So, the IRS gets 90% and your client gets 10%.”

Unfortunately, if your clients are over-weighted in equities in their retirement accounts, they could easily face a second tax issue if they must sell stocks to take their RMD.  This second issue isn’t a tax but the opportunity cost of a forgone tax deduction.  If your client is forced to sell equities at a loss in her retirement accounts to withdraw their required minimum distributions, then she will take a capital loss which she cannot deduct.

The pitfalls of a secure retirement are many and your task is to ensure your clients avoid these.

 

To learn more about this topic, register for our Retirement Plan Services curriculum.

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Resources

1 A Tract on Monetary Reform (1923) by John Maynard Keynes

Contributing Writer: Subject Matter Expert Charles McCain

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