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7 Planning Steps for Middle-Income Retirements

Philip Moeller

Americans need more retirement planning and investment advice than ever before. We are increasingly responsible for our own retirement investments, courtesy of the move away from traditional pensions to self-directed retirement accounts. We are still trying to recover from the recession. Tax rates could change sharply as Congress wrestles with complex fiscal cliff issues. And according to survey after survey, we don't know enough about investments and personal finance to make good decisions on our own.

There are roughly 110 million middle-class households. According to financial planning research, at most two million, or a bit less than 2 percent, receive financial planning services. The Society of Actuaries (SOA) hardly sounds like the group that would be riding to the rescue of the other 108 million. Yet the SOA has assembled a wealth of research and practical advice aimed at middle-income retirement needs.

In terms of our attitudes about getting professional help, the SOA's research has reached some blunt conclusions:

1. Individuals don't trust financial advisers, don't understand the value of financial advice, and further, don't even have enough financial knowledge to seek and perhaps even understand professional advice.

[Read: How to Improve Your Finances at Every Age.]

2. Tradition drives non-affluent households to rely on family and friends for financial advice. Couples suffer from gender stereotypes that often prevent them from seeking help. Financial advisers don't know how to connect to the middle-class market, particularly recent immigrants.

3. The financial advisory industry thinks it can't make money advising middle-class households. Its business model emphasizes selling investment products and generating related fee income. This sets up conflicts of interest and may lead to actions that produce adviser fees but aren't in the best interest of a client. This, of course, provides yet more reasons not to trust advisers, which takes us back to item 1.

If people can get past these issues, there remains the significant matter of exactly what kind of planning and investment needs are appropriate for middle-market consumers. The SOA has developed a seven-step planning process. Many of the steps are complex, and make it clear why you may need outside advice.

1. Quantify assets and net worth. Tabulate current investments and savings, plus other tangible assets such as your home. Factor in future set-asides for retirement plus projections for how your holdings will appreciate by the time you want to retire. Split financial assets into different buckets based on their tax treatment, with tax-deferred investments such as 401(k)s going into one bucket and investments with different future tax liabilities into another. Housing is both an asset and a future expense, so think about whether you'll need your home to generate income and how you'd like to live in retirement.

[Read: 7 Signs You're Getting Bad Financial Advice.]

2. Quantify risk coverage. What kinds of insurance make sense and how will this protection affect your need for retirement income? For example, how much additional health insurance makes sense beyond basic Medicare, and can you afford to self-insure some health expenses with out-of-pocket spending? What about disability insurance? Long-term care? Life insurance?

3. Compare expenditure needs against anticipated income. Understand that retirement expenses will differ from preretirement needs. Separate retirement expenses into basics--food, housing, utilities, and insurance--and discretionary items such as travel, restaurant meals, and entertainment. Look at your retirement earnings the same way. How close does your guaranteed retirement income--Social Security, pensions, and annuities--come to matching your basic expenses? How much income is likely to come from investment accounts and other assets with uncertain returns? How does this discretionary income total compare with your discretionary expenses? Is there room left over to provide for an emergency reserve fund?

4. Compare amounts needed for retirement against total assets. This step is closely related to balancing retirement expenses and income. Determining how your assets can be converted into lifetime streams of retirement income can be a complex process. By using variables such as the date you retire, future investment gains, anticipated inflation, future tax rates, and even your life expectancy, you can build a model that produces realistic prospects for your retirement finances.

5. Categorize assets. Look at your retirement as a series of time periods, and try to group your assets so they produce the income streams appropriate to different periods. In the short run, for example, you want to avoid being forced to sell investments at bad prices. So you might want to use liquid assets, such as money-market funds or CDs, which can be sold without much risk of costing you big future investment gains. Many advisers also help clients put holdings into what are called "laddered" accounts, which are designed to throw off income at different stages of the retirement ladder.

[Read: Need Income From Your Retirement Fund? Try These.]

6. Relate investments to investing capabilities and portfolio size. Maybe you can properly oversee some mutual funds. But would you have the skills to self-direct more sophisticated investments? How much risk should you have in your portfolio? One of the reasons the rich get richer is that they have enough resources to tolerate some high-risk investments that will probably outperform more conservative portfolios. For most people, including many active investors, correctly assessing their risks and building an appropriate risk-adjusted portfolio is beyond their skills or even interests.

7. Keep the plan current. A financial plan is not a document to be filed away and forgotten. It should be looked at, perhaps at the end of each quarter of the year, to see if adjustments are needed. And there can be major life changes, the SOA notes, that could have equally big impacts on a retirement plan:

-- Health status or healthcare costs change

-- Life expectancy

-- Investment returns are differing greatly from what has been assumed

-- Inflation expectations change

-- Assumed employment income changes

-- Expected retirement date changes

-- Failure to fully realize expected benefits from employer's pension plan or other private pensions

-- Public policy changes

-- Death of a spouse

-- Other change in marital status

-- Loss of ability to live independently

-- Unexpected needs of dependents

-- Change in housing needs

-- Bequest objectives change

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