By: Erik C. Mizell CFP® CLU®
As you embark on the fresh start of a new year, there are often many objectives and resolutions we all set for ourselves to accomplish. We all have different goals and items we would like to check off to help us feel like we are making progress in our lives. They could be health oriented, maybe a promotion at work, or just simply to take time to enjoy the little things in life. However, if you are retired or debating on when is the right time to make that move, there could be a few things that would be very helpful to discuss as the new year begins. Most notable, would be the topic of how to distribute your hard-earned savings over the course of your life in a stress free manner. There are many methods that have been put into practice regarding the spend down of your assets in retirement, and we will address three of those in this piece. We will discuss the traditional systematic distribution method, the bucket/tranche method, and also the approach known as flooring. Our goal is to open the conversation between you and your planning team to help identify which method is the right choice for you and your family to fully enjoy your golden years in a stress-free manner.
The first method we will discuss is commonly referred to as the systematic withdrawal strategy. When this option is utilized, the client and their planning team determine what the optimal percentage of their total asset value should be liquidated annually in order to provide the desired income level for that year. Historically this has been the most popular method for managing income needs in retirement, and many will recognize the 4% level that has become somewhat a rule of thumb. This method is based on the premise that a client would be able to earn a rate of return that is higher than the percentage of funds being liquidated, thus never having the risk of running out of money in retirement. The advantages of this method include the simplistic approach to making the appropriate decision on a yearly basis. The disadvantages include the pressure being applied to the performance of the investments within the portfolio. If the account does not increase at a level that is at or above the liquidation percentage, then the client will eventually begin to dissolve the principal balance in the account and could run the risk of exhausting their portfolio. This method must be evaluated annually to ensure that the percentage is accurate based on the prior returns in the market, and also the current inflation rates.
The second method we will discuss is known as the bucket/tranche approach. The ultimate goal of this method is to help alleviate some of the emotional stress of managing an investment portfolio as it pertains to a client’s willingness to take risk. Most stock market investors try to balance less risk with more reward. However, there is an inherent draw for retirees to make a conservative shift earlier than they should. Those who are looking to retire within the next few years, may be tempted to put all of their money into safe places to combat the fear of a drastic correction in the stock market. This temptation can have unfortunate results for a retired family if it is done too early. The investment portfolio should be viewed as a 30+ year account. This method of income distribution combats the urge to go too conservative too fast. The portfolio is typically divided into three, 10 year segments. These segments will all be invested at different levels of risk, with the intention of creating an environment that the client will be able to spend as desired, regardless of what the stock market is doing at the time.
The final method we will discuss is known as, flooring. The goal of this method is to provide a guaranteed level of income with additional discretionary funds available if needed. This method is much different from the other two we have covered, because a retired person will need to make use of certain types of investment products. This option may involve the utilization of a; pension, annuity, bond ladders, permanent life insurance, cash accounts, social security, etc. The investment products that are chosen will need to have some type of a contractual guarantee in order to provide the fixed income level that is desired. The planning team will generally look to create a guaranteed level of income that is equal to a client’s minimum monthly need. If the client needs or wants to spend above that level, then they would liquidate from other investment accounts as needed. The goal of the investment portfolio would be to have an allocation that would allow for growth of those dollars above and beyond the predicted inflation levels. One disadvantage with this method is that the investment products that may be used typically will not have an option for the income stream to increase with inflation. If they do have that option, it may prove to be too costly to add the feature onto it.
Now what? So, for most people who are in or near retirement, their prior planning may dictate which method of income distribution they choose to use. For those who are still in the accumulation phase of life, you have a fleeting opportunity to adjust your planning to ensure you will have the desired distribution option in the future. There is one thing to keep in perspective: No two clients are the same when it comes down the management of a retirement income. That being said, there may be times that we will look to blend these methods to fit our client’s situation appropriately. If you are curious about what options you have, we would love to help you analyze your current strategy to make sure that it is as efficient as it can be. With our planning approach, you can be certain that we will exhaust all available options to create an income level that is suitable for your golden years. Let us help you take the stress away so that you can treat every day as Saturday for the next 30 years.