Financial professionals prepared to help retiring clients develop a strategy for turning savings into lifetime income stand to tap a huge market.
Cerulli Associates Inc. projects that IRA assets will increase 37% over the next four years to $22 trillion, fueled mainly by retiring baby boomers' rolling over account balances from their employer retirement plans.
More than three-quarters of pre-retirees don't have a written retirement plan, but half plan to work with a financial planner to develop one, according to The Principal Financial Group.
“There is no one-size-fits-all approach to retirement income, but evaluating which is the right strategy can be complex and time-consuming,” said Jerry Patterson, senior vice president of retirement and investor services at The Principal. To help advisers determine which approach is right for their clients, The Principal released a new white paper comparing and analyzing the two most popular retirement income strategies: systematic withdrawals and the bucket strategy.
SYSTEMATIC WITHDRAWAL
About half of all financial advisers use a systematic-withdrawal strategy — usually 4% to 5% a year — from a diversified portfolio to provide retirement income, according to a 2010 Financial Planning Association survey. (See Q&A with Jonathan Guyton of Cornerstone Wealth Advisors Inc., Page 14.)
The second-most-common strategy is a time-segmented bucket approach, which is used by more than a quarter of advisers, according to the FPA survey.
Typically, the bucket strategy assigns a separate pot of money to defined time periods in retirement, based upon the retiree's risk tolerance and time horizon. The first bucket contains cash and cash equivalents intended to fund spending needs during the first five years in retirement. The second bucket contains a conservative mix of fixed-income investments designed to meet the spending needs in years six through 15. The third bucket holds a more aggressive mix of equities intended to provide growth to fund the later years in retirement. The buckets are redistributed as necessary.
The Principal's analysis found that a bucket strategy might be more of a psychological benefit to the client if he or she feels it is easier to maintain smaller amounts of money directly linked to special goals. It also might help extremely risk-averse clients take a more long-term approach to investing if they know their riskiest investments are tied to their furthest time horizon.
By contrast, a systematic-withdrawal approach, while easier for financial advisers to execute, may feel overwhelming to some retirees. Viewing the total account balance may lead to more dramatic overreaction when that balance dips due to market volatility.
Despite the psychological benefits, according to the white paper, a bucket strategy does not provide financial benefits beyond what likely would be accomplished with a less complicated strategic-withdrawal approach.
ANNUITIES KEY TO STRATEGY
But Phil Lubinski, a certified financial planner who heads the Strategic Distribution Institute LLC, stands by his Income for Life model, which he has been using for more than two decades. His signature strategy includes five buckets, each five years long. For a $1 million portfolio, he would typically use 29% of assets to buy a five-year immediate annuity with a 1%-2% internal rate of return (depending on current rates) and allocate another 27% of the initial account balance to a deferred fixed annuity with a 3% to 5% return to fund years six through 10.
In Mr. Lubinski's model, the third through fifth buckets consist of managed accounts with decreasing amounts of money allocated to increasingly riskier asset classes, as follows: Bucket 3, $217,000, split 60/40 among bonds and stocks; Bucket 4, $142,000, 40/60: and Bucket 5, $77,000, split 20/80.
“After one of the worst decades in history, the model held up very well,” he told me recently. He used an example of a client who retired in 2002, a year in which the S&P 500 declined dramatically. During the first 10 years (2002-10) of retirement, which also included the worst loss of the S&P 500 since the Great Recession in 2008, the bucket model performed exactly as projected, due to the guaranteed rates of the immediate and deferred annuities. The other three investment segments netted (after 1.5% fees) just slightly less than the assumed rates of return of 6%, 7% and 8%, respectively.
The results demonstrate that the poor performance of the S&P 500 over the past decade is not representative of the entire investment universe.
“Our portfolios are comprised of index funds and ETFs that represent 12 asset classes around the world and include alternative investments such as commodities and real estate,” Mr. Lubinski said.
He also noted that unlike those who use static academic models, he reviews retirement income plans every year. When certain buckets outperform the assumption, he sweeps the excess into a less volatile asset class. If, on the other hand, certain accounts are underperforming the assumptions, the impact on future income is discussed well in advance with the retiree.
“You have to build a strategy that is dynamic and as liquid as possible so you can adapt,” he said. “It proves that passive investing is not dead and diversification still works.”
Mary Beth Franklin (mbfranklin@ investmentnews.com) welcomes your comments and suggestions for column topics.
