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Income Planning


​​Income planning is becoming critical for people in or nearing retirement and you may want to work backwards to figure out your primary income need. When you add your Social Security payments, pension (if you are one of the lucky few) and investment income, there may be a gap in your primary income need. One solution that has been getting a lot of support lately is the use of fixed Indexing as part of your asset allocation strategy that will cover the gap and protect against longevity. The income stream may also be adjusted for inflation if desired.
By implementing an allocation strategy combining traditional asset allocation with fixed indexing, you vastly increase the chances of having sustainable income in retirement no matter if live to be 85 or 105 years old.
Let’s look at the example above of a retired 62 year old with a million dollars. If you use the new proposed safe withdrawal rate of a 2.8% and increase that distribution by 3% every year for inflation, you could supplement your retirement as follows:
 
Year 1       $28,000
Year 5       $31,514
Year 10     $36,533
Year 20     $49,098
Year 30     $65,983
Total withdrawals at age 92 equal $1,332,112
 
Now, let’s look at what we could achieve with an income planning strategy that includes Indexing with a guaranteed income for life rider and the conservative traditional retirement strategy. Let’s assume we put $500,000 in a Indexing strategy with a lifetime income rider and planned to turn on that rider at age 70 to start taking income. The other $500,000 we are going to place in a money market account with zero growth for this example. You could take $62,500 out of the money market for the first 8 years and spend down that account to zero and then, in the ninth year, you turn on the income rider from the annuity. From the annuity, you would be guaranteed an income stream of $61,884 for the rest of your life.
 
Year 1 – 8             $62,500
Year 9 - ?              $61,884         
Total withdrawals at age 92 equal $1,861,448
 
Two more things you may want to ask yourself. First, who is taking on all the risk? Second, what will happen if you live past life expectancy?  With the traditional asset allocation model, the investor has 100% of the risk. By diversifying a portion of your asset to the insurance company, you are transferring some of the risk and can sleep well at night knowing you have a sustainable income stream for life.

Risks in Retirement

Inflation Risk

From 1926 to 2009, inflation has averaged 3%. While history does not always dictate future, it is important to plan on this trend continuing. Consider the inflation chart to the left. This graph depicts the purchasing power decline of $50,000 assuming inflation rates of 2%, 3%, and 4%.

Sequence Risk

Portfolio A

Portfolio B

 
The two hypothetical portfolios, A and B, each begin with $100,000. Each investor aims to withdraw $5,000 per year, and it is assumed that both portfolios experience exactly the same compound annual returns over a 25-year period, only in inverse order, or “sequence.” Portfolio A has the bad luck of having a sequence of negative returns in its early years and is completely depleted by year 20. Portfolio B, in contrast, scores a few positive returns in its early years and ends up 25 years later with more than double the amount of assets it started with.

Withdraw  Risk

Source: Fidelity Investments. Hypothetical value of assets held in an untaxed account of $500,000 invested in a portfolio of 50% stock, 40% bonds, and 10% short-term investments with inflation-adjusted withdraw rates as specified. The char’s hypothetical illustration uses historical monthly performance from January 1972 through December 2008 from Ibbotson Associates; stocks, bonds, and short-term investments are represented by S&P 500, U.S. Intermediate-Term Government Bonds, and U.S. 30-day T-bills, respectively. This chart is for illustrative purposes only and is not indicative of any investments. Past performance is no guarantee of future results.**Probability of a couple surviving to various ages is based on Annuity 2000 Mortality Table, Society of Actuaries. Figures assume a person is in good health.