Tag: sustainable income

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Make Sustainable Income a Cornerstone of Your Portfolio Beginning at 45

Dollar bills falling in or flying out of a pink piggy bank in a fantasy landscape

A common theme I hear when I talk to retirees is “I wish I would have started saving sooner for retirement.”

There’s an underlying feeling of guilt that’s expressed each time this statement is uttered. The implication is that the individual had the ability to save more for retirement but chose not to do so.

While it’s ultimately the responsibility of each of us to make sure that we have sufficient funds to pay for our needs for the duration of retirement, it’s extremely difficult, if not impossible in many cases, to achieve this goal without proper guidance. Saving for retirement requires a totally different mindset than saving for any other financial goal.

It’s All about Income Replacement

Most financial goals require planning for the availability of a lump sum at a future date that will either be spent (a) one time, e.g., a down payment on a house or (b) over a specified number of years, e.g., college education. Retirement, on the other hand, typically requires you to replace one source of income, i.e., salary, or draw in the case of self-employed individuals, with multiple sources of income. Furthermore, the replacement income sources must be sustainable for the duration of retirement which is unknown.

You need to use the right tools for the job at hand if you want to achieve a successful result. Retirement is no exception. Given the fact that sustainable income is the name of the game, it makes sense that investments that are allocated for retirement are designed to provide you with a targeted amount of after-tax income that will meet your needs after other sources of sustainable income, e.g., Social Security, are taken into consideration.

Timing is Key

Fixed income annuities are well-suited for this purpose since they’re designed to provide sustainable income for the duration of retirement. Deferred fixed income annuities, including fixed index annuities (FIAs) with income riders and deferred income annuities (DIAs) make the most sense due to the fact that they require the least amount of funds to generate future known income amounts compared to other types of investments.

Even though FIAs with income riders and DIAs allow you to minimize initial and ongoing investment amounts compared to other types of investments, the potential length of retirement requires you to start early if you want to generate enough income to meet your needs.

You simply can’t begin saving a relatively small portion of your salary ten years before you plan to retire and expect your savings to provide you with adequate retirement income for 25 or more years. Age 45 isn’t too early to start in most cases.

FIAs with Income Riders vs. DIAs

If you establish a sustainable income plan before age 55, I generally recommend investing in one or more FIAs with income riders vs. DIAs to provide you with the most flexibility. For starters, unlike DIAs which generally have fixed income start dates, FIAs don’t require you to begin income withdrawals at a specified date. This is a distinct advantage when you don’t know if you’re going to retire at 60, 65, or 70 and you don’t necessarily know all of your potential sources, timing, and amounts of other retirement income.

Additional funds can periodically be added to flexible premium FIAs that generally isn’t possible with DIAs. Care must be taken, however, when researching these types of FIAs since some limit the number of years that additional premiums can be added or subsequent purchase amounts. See How Flexible are Flexible Premium Deferred Annuities?

Another benefit of FIAs is their accumulation value which can increase over time and provide a pre- and post-income withdrawal death benefit. In addition to the lack of an accumulation value, a death benefit with DIAs is generally optional and is limited to the amount of premium invested in exchange for a reduced income payout.

Finally, in addition to generating sustainable retirement income, investment in FIAs with income riders and DIAs reduces portfolio risk to the extent that funds from equity investments, e.g., stocks and equity exchange-traded and mutual funds, are used.

In conclusion, it’s not only about minimizing regrets regarding how soon you started saving for retirement when you’re retired. Making sustainable income a cornerstone of your portfolio using investments that are suited for this purpose, i.e., fixed income annuities, will help you sleep better at night – before and after you retire.

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Retirement Asset Planning Retirement Income Planning

Do You Want to RAP or Do You Prefer to RIP?

Retirement planning is unquestionably the most difficult type of goal-oriented financial planning. Most goal-based planning is straight-forward, solving for the amount, and frequency, of payments that need to be made to accumulate a sum of money at a future date using two assumptions: rate of return and inflation rate.

College education planning is a good example of the use of this methodology with a twist. Unlike other planning where the future value will be withdrawn in one lump sum, college costs are generally paid for over a series of four or five years. This complicates the planning since it requires the calculation of the present value of the future annual costs of college at the beginning of college, which in turn becomes the future value that must be accumulated.

Retirement Asset vs. Retirement Income Planning

Retirement planning is a whole other world. For starters, there are two stages of retirement planning, i.e., retirement asset planning (RAP) and retirement income planning (RIP). Until recent years, RAP was the only type of retirement planning and, as such, is what’s considered to be traditional retirement planning. RAP’s focus is the accumulation and “spending down” of assets. Although it’s more complicated, much of the methodology used is similar to other types of goal-oriented financial planning.

While RAP works well in the accumulation stage, it isn’t designed for calculating, and planning for, projected retirement income amounts that need to be available to pay for projected retirement expenses during various stages of retirement with unknown durations. As a result of the uncertainty of traditional RAP as a solution for providing a predictable income stream to match one’s financial needs in retirement, RIP was born.

Retirement Income Planning Issues

In addition to possessing the knowledge and experience of financial planners who specialize in RAP (RAPers?), retirement income planners (RIPers?) require an expanded skill set and associated knowledge to assist their clients with issues that are unique to RIP before and throughout a client’s retirement years. Planning issues extend well beyond asset accumulation and include, but aren’t limited to, the following:

  • Medicare
  • Long-term care
  • Social Security claiming strategies
  • Conversion of assets into sustainable income
  • Income tax minimization
  • Choosing strategies to address gaps in income
  • Retirement plan distribution options
  • Retirement housing decisions
  • Philanthropic
  • Estate transfer

Recommended Timeframe

Retirement planning is a time-sensitive and arduous task that requires a high level of discipline and commitment over the duration of one’s adult years, not to mention specialized expertise. Given the relatively short accumulation period compared to the potential duration of retirement complicated by an unknown escalating cost of living, the RAP phase should begin as soon as possible.

There are always competing goals, including saving for one’s first house and education planning, to mention a couple. All financial goals must be balanced against one another, keeping in mind that the ability to provide for your support – before and throughout retirement – supersedes all other goals.

RIP works best when it’s initiated long before you plan to retire. In addition to the nature and complexity of the various planning issues, this is very important given the fact that historically approximately 50% of all retirees retire before they plan on doing so. Given this reality, a 20-year pre-retirement RIP timeframe is recommended.

Finally, it’s important to keep in mind that RIP doesn’t end the day you retire. The success of your retirement years is dependent upon your ability to employ and adjust RIP strategies for the duration of your, and your spouse’s, if applicable, retirement years.

Do you want to RAP or do you prefer to RIP? As I hope you can appreciate, you need to do both at the appropriate time in your life in order to enjoy your retirement years on your terms.

See Planning to retire? Start with the right question

Categories
Annuities Fixed Index Annuities Retirement Income Planning

How Flexible are Flexible Premium Deferred Annuities?

When planning for retirement, you need to generate sustainable income that will meet your projected inflation-adjusted financial needs during various stages. This often requires multiple income-generating sources that ideally start, and potentially stop, to match your projected needs at different stages of retirement.

A diversified portfolio of fixed income investments that’s part of your overall portfolio generally needs to be designed to provide the desired after-tax income amounts and timing of same. The planning is complicated, should begin well in advance of retirement, and needs to be monitored and updated on a regular basis.

One popular investment that’s designed for the fixed income portion of a retirement income plan is a fixed index annuity (“FIA”) with an income rider. When you invest in a FIA, you’re purchasing a deferred annuity. As defined in the Glossary, a deferred annuity is an annuity that doesn’t mature or begin making payments until some future date.

Deferred Annuity Types

There are two types of deferred annuities, both of which are suitable for inclusion in a retirement income plan: (a) single premium deferred annuity (“SPDA”) and (b) flexible premium deferred annuity (“FPDA”). The basic difference between the two is the allowable investment frequency. A SPDA is a one-time investment whereas a FPDA provides for multiple investments in the same annuity.

The key to understanding FPDA’s, including how they will fit into a particular retirement income plan, is that flexibility is in the eye of the beholder, or, in this case, the insurance carrier that issues a particular product. While a FPDA by definition allows for multiple premiums, the number of years the additional premiums may be added and/or the premium amounts are often limited by the terms of an annuity contract. This can be problematic where ongoing investments of specific amounts are required to achieve a targeted level of retirement income.

Types of Flexibility Restrictions

While many FPDA’s provide for indefinite additional investments, several have a limited defined window of opportunity. To give you an idea of the possibilities, let’s take a look at the FIA offerings available through the life insurance agency with which I’m associated.

Of the 52 FIA’s currently offered by 14 carriers, all of which are highly rated, 25 are SPDA’s and 27, or 52%, are FPDA’s. 16 of the 27, or 59%, of the FPDA’s have no restrictions regarding the number of years additional premiums may be added or the amounts of same.

That leaves 11 FPDA’s with restrictions, seven of which limit the number of years that additional premiums may be added and four limit the additional premium amount. The seven FPDA’s that limit the number of years uses either one or three years as the limitation. The four that limit the premium amount are all offered by the same carrier which limits additional premiums to $25,000 per year.

Retirement income planning requires flexibility. The ability to make unlimited additional investments after the first contract year without restriction as to dollar amount is an important consideration in many cases when evaluating FIA’s with income riders. In summary, the type of fixed income annuity and product that you’re evaluating needs to dovetail with your projected financial needs to increase your opportunity for success.

Categories
Annuities Fixed Index Annuities Social Security

Delayed Gratification is the Key to Maximizing Income with Fixed Index Annuities

When you’re planning for retirement, income is the name of the game. The more sustainable income that you can generate, the less you need to worry about things like sequence of returns and major stock market downturns – before and during retirement.

The idea is to build a base, or floor, of predictable income that will cover your day-to-day expenses. For most people doing retirement income planning, Social Security is the core element of an income floor. Although pre-retirees today can plan to receive a full Social Security benefit beginning somewhere between age 66 and 67 depending upon their year of birth, the benefit that they, and potentially their spouse, will receive will increase by 8% per year for each year that they defer their start date up until age 70. This equates to as much as a 24% – 32% greater benefit depending upon your year of birth and how long you defer your start date.

Assuming that your goal is to build a solid base of sustainable income with the ability to increase your lifetime income amount similar to Social Security, one of the best ways to do this is to invest in a flexible fixed index annuity (“FIA”) with an income rider. The reason that you want to use a flexible, vs. a single, premium FIA is to provide you with the ability to add to your investment should you choose to do so. In addition, you need to purchase an income rider, which is optional with most FIA’s, in order to receive guaranteed (subject to the claims-paying ability of individual insurance companies) income.

Like Social Security, the longer you wait to begin receiving your income, the greater it will be. Unlike Social Security benefits which are increased by cost of living adjustments (“COLA’s”), the lifetime income from the majority of FIA’s available today will remain unchanged once it’s started.

To demonstrate the benefit of deferring the start date of FIA income withdrawals, let’s use one of the contracts purchased by my wife and me two years ago when we were 55 and 48, respectively. I will use my wife’s age as a point of reference for the remainder of this post since income withdrawal amounts are always calculated using the younger spouse’s age.

Per our annuity contract, my wife and I are eligible to begin income withdrawals at least 12 months after our contract was issued provided that both of us are at least age 50. It generally doesn’t make sense to take withdrawals from a FIA income rider before age 60 since the formula used to calculate the withdrawal amount is less favorable and the withdrawals will be subject to a 10% IRS premature distribution penalty and potentially a state penalty. Assuming that we plan on retiring after my wife is 60, there would be no need to begin income withdrawals before this age.

I have prepared a spreadsheet with various starting ages in increments of five years beginning at 55 through 75. The spreadsheet shows the projected percentage increase in our annual income withdrawal amount that we will realize by deferring our income start age compared to ages that are 5, 10, 15, 20, and 25 years younger, depending upon the starting age chosen.

Using an example that’s comparable to the Social Security starting age decision, suppose that we decide to defer our income start age from 65 to 70. This would result in a 31.2% annual increase in lifetime income. We will receive 120.3% more income if we begin our income withdrawals at age 70 instead of at 60. The percentage increases are significant in many cases depending upon the chosen withdrawal starting age compared to another potential starting age.

Similar to the Social Security starting age decision, there are numerous factors that need to be considered when determining the optimal age to begin income withdrawals from a FIA with an income rider, a discussion of which is beyond the scope of this post. Like Social Security, when possible and it makes sense, delayed gratification is the key to maximizing lifetime income.