Retirement Planning Implications of COVID-19
As trusted advisors to clients and constituents, there have been very few CPAs who have not felt the impact of COVID-19. From situations involving afflictions and deaths from the coronavirus, to furloughs, layoffs, business interruptions and financial disruptions in households throughout many communities, the reach of the global pandemic has been far and wide.
While we are not out of the woods yet, it’s important to make sure clients understand the implications of the pandemic on their finances — especially with respect to retirement planning. Here are three observations and considerations to keep in mind:
- This is a wake-up call. The pandemic has created a systemic disruption to the economy in ways that many financial advisors never imagined. Many of the tenets of financial planning — a fully funded and accessible emergency fund, proper and adequate insurance, and a properly drafted and executed estate plan — came into focus during the pandemic’s initial wave and remind us that individuals need these items in place just as much as a robust retirement plan.
- COVID-19 is not a black swan. Author Nicholas Taleb defines a “black swan” as an event that is unpredictable and rare, but when it occurs, its results are catastrophic. The Great Recession of 2008-09 is an example of a black swan. While it can be tempting to look at the COVID-19 pandemic as a black swan, history tells us differently. Global pandemics and epidemics from the recent past such as SARS, MERS, swine flu, ebola and HIV/AIDs are all recognized as adverse events that are “baked into” the patterns and pricing of the market. Financial discipline mechanisms such as staying invested in risk- and goal-oriented portfolio allocations, staying diversified and rebalancing are all defensive tools that help to mitigate the effects of negative market events like COVID-19.
- Rethink “risk management” in retirement plans. Unconventional investment vehicles like self-directed IRAs and familiar (but hotly debated) vehicles like annuities deserve a second look as a part of a retirement plan strategy to mitigate risks.
Risk in retirement planning has generally been perceived as the likelihood of a person outliving their retirement assets. That also includes the chances of an adverse event — like a health event that leads to the need for long-term care — that can significantly reduce the assets for a client’s remaining life. However, with COVID-19, the timing of such market downturns can profoundly impact an individual currently taking distributions from a retirement portfolio, as too many losses on the front-end could lead to irreparable damage to what was considered “safe withdrawal percentages” for the duration of one’s retirement. This phenomenon is known as the “sequence of returns.” Couple the COVID event with a low-interest environment and the real prospect of a prolonged U.S. recession, and this risk becomes very real.
To mitigate such risks, one can look to (1) unconventional alternative investments (i.e., private equity, hedge funds, specialized real estate investment trusts (REITs), (2) invest a portion of retirement assets via a self-directed IRA focused on uncorrelated investments to the market (e.g., hard money lending), and (3) annuities.
Getting Financial Houses in Order
Just as the pandemic exposed many shortcomings in the healthcare system, specifically our shortages in personal protective equipment and ventilators, many families had their share of experiences with financial shortfalls. Common scenarios included the following:
- Not having adequate emergency funds to bridge disruptions in income
- Becoming ill or facing disability without the appropriate or adequate insurance
- Not having the appropriate estate planning documentation in place to properly handle the affairs of a person who fell ill, became incapacitated for a prolonged period or died.
What creates challenges for investors, especially pre-retirees and retirees who see significant drops in value of their holdings, is an unprecedented shut down of the economy. This leads to panic, where investors irrationally pull funds out of the market (while values are dropping) and place them into cash. This exacerbates the level of disruption in clients’ financial plans which lends to the axiom that financial performance is more of a function of investor behavior than it is actual asset selection.
If there is any time for reaching out to clients, it is now. CPAs can be a guiding light for their clients, since they need assistance now more than ever.
Sharif A. Muhammad
Sharif Muhammad, CPA, MBA, MST, CFP, is the founder and chief executive officer of Unlimited Financial Group Inc. He is a member of numerous NJCPA committees and interest groups.
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This article appeared in the January/February 2021 issue of New Jersey CPA magazine. Read the full issue.