Buy Income and Invest the DifferenceIt seems there will always be a difference of opinion when it comes to income planning and which method provides the optimal level of income in retirement. Insurance licensed advisors may try and convince you that you should put all your money into annuities, touting guarantees and payout rates. Stock brokers and mutual fund salesmen paid on a fee-only basis or commission basis will try and convince you that you must put all your money in a “balanced portfolio” of stocks and bonds and take out the safe withdrawal rate of 4% (this withdrawal rate is pretty safe if you only live to 85 or 90) It may fail if you live past 90. With 10,000 people in America already at age 100, your plan should be designed to last until you live to age 100. The best solution actually involves a little of both using a math and science proven combination of securities and insurance products.
I compared the 2 most common methods to see which one had a higher chance of success. Forget about the “bond ladder”. Interest rates are too low at the time of this article to achieve high level of success to age 100.
Option 1 : Balanced portfolio of 60% stock funds and 40% bond funds or fixed income with 4% systematic withdrawals. Sometimes called the “bucket approach”
Option 2: Buy income and invest the difference in a growth focused portfolio.
Here are the results:
Case study: Female client age 70 with $500,000 IRA
Current income: $40,000 comprised of:
$25,000 Social Security
$15,000 pension
Expenses $65,000
This means she needs to generate $25,000 from her $500,000 IRA. This is a 5% withdrawal rate. (500,000 X .05) Based on the hypothetical 4% rule, she may run out of money for withdrawing too much if she lives long enough. Also, if 100% of her money is in a balanced portfolio that loses money, she could run out even faster.
This approach would allocate the following way.
Year 1-2: $50,000 to money market to be spent down to $0.
Year 3-7 $125,000 to Fixed income (short to intermediate bond funds or short term bonds) to be spent down to $0
Year 8-10 – Harvested gains from the balanced portfolio with $325,000 initial value earning 5% annually (no losses hypothetically shown in any years… which is may not happen)
Over 7 years, the balanced portfolio hypothetically grows at 5% a year which is $81,250. Every year, the annual growth is added to the cash account. This could provide income until the end of year 10.
In year 11- Repeat the above steps. Note: Your account balance should be somewhere around $150,000 principle left of your $500,000 unless the portfolio performed better than 5%.
At beginning of year 21, repeat the process. At 93, you stand the chance of being out of money…unless you earn more than 5%, and the market goes up every year by at least 5%… and you spend no more than your original budget set up at inception and you don’t need long term care at some point.
OPTION 2 Buy income and invest the difference in Growth Portfolio.
Countless studies have been done at the PhD level (Mechem Yaari, Moshe Milevsky, David Babel) proving there is an OPTIMAL way to achieve lifetime retirement income using math and science. Notice I did not say “best”. We don’t know how long you or your surviving spouse will live if married, so “best” is difficult to plan for.
Here is how the strategy works.
Buy guaranteed lifetime income with the same product institutions use to provide a lifetime pension…an insurance contract known as an immediate annuity. This strategy requires less money to achieve the same income target because it is age based and not “rate of return” based. With income covered with guarantees, you are more free to invest the remaining dollars for growth (80/20 or 100% equity portfolio) or to buy products designed to create a larger inheritance for your heirs or favorite charities.
Year 1-2 $50,000 -money market
Year 3-7 – $120,000 – deferred income annuity 1* -This provides a 70 year old female with almost $26,000 income for life
Year 8-Life $120,000 – deferred income annuity 2*- This provides $32,016 more income beginning in year 8 and pays until the death of the annuitant
Growth portfolio- $210,000 – At an 8% return (less than 20 year S&P average annual return) which is achievable using basic index funds with very low fees over time, (no recommendation being made) this amount could potentially have grown back to $420,000. You could buy more income or not if needed. The choice is yours.
By separating assets that provide income from assets that provide growth, you generally get a more efficient retirement income plan. Since your income shortfall can be guaranteed with Lifetime income insurance contracts, you may not have to watch what the stock market does every day. What would that mean for you?
To see if our OPTIMAL approach would work for you. visit us at www.robertscottwealth.com and book a complimentary appointment. Don’t take our word for it, let us prove it to you.
notes: payout rates are based on the age, and gender of the annuitant and the date issued and are subject to change. Investing in securities involves risk and past performance is no guarantee of future performance. Any guarantees mentioned refer in no way to investments or investment advisory services. Guarantees are provided by the claims paying ability and financial strength of the insuring company.
*life with 5 year guarantee payout used, female age 70. Cash refund design would work as well but would require more money at inception. No investment, tax, or legal advice being given with this post.