The main objective of the Income Discovery software application is to find an income strategy for the client that will deliver the desired retirement income and legacy with the least amount of risk.
Retirees need to make many decisions while creating their income plan, including:
- selecting the method under which to claim Social Security (e.g., based on their own earnings or their spouse’s earning record);
- determining the best age at which to claim Social Security
- identifying the best time to make withdrawals from each tax-type investment account (e.g. Qualified, Roth, and Non-Qualified Accounts) and how to best combine withdrawals with the least amount of tax drain;
- the amount and type of annuities to purchase; whether to defer, annuitize some, all or in phases;
- and the model allocation for the investment portfolio.
The combination of these decisions defines an income strategy.
Income Discovery can help you find an optimal, personalized strategy for each client's unique situation. It allows you to compare the effectiveness of various strategies in achieving the client's objective. The comparison is based on an analysis framework that uses comprehensive metrics for evaluation. The risk-and-reward metrics that make up the framework are described in another article, which can be viewed here. Additionally, the risk-and-reward elements shown are based on insights of presenting them as a story of individuals rather than statistics – these insights are gained from decades of behavioral finance research (read more).
Social Security Claim Strategy
Accumulating and maintaining investment portfolios involves risks of many types, yet some risks become more critical to manage, mitigate or eliminate during retirement. Four key risks Social Security plays an important role in reducing include:
Market Risk – Social Security payments are not subject to market fluctuations.
Inflation Risk – Social Security payments provide inflation protection with Cost of Living Adjustments.
Longevity Risk – Unlike portfolio assets which may be subject to depletion over time, Social Security provides a steady stream of income you cannot outlive.
Survivor Risk – Social Security provides additional benefits for couples by continuing payments for the survivor based on the larger of the decedent’s or survivor’s record.
For financial advisors, Social Security provides the cornerstone (the “floor” income) upon which planning can begin using other sources of income to construct a cash flow strategy. Decisions regarding the method and timing of the Social Security benefits claim are a cornerstone of the income plan. Delaying the benefits until 70 years of age can significantly reduce the risk and also provide a much higher lifelong, inflation-adjusting source of cash flow. It can provide peace-of-mind to retirees knowing that if they were ever unfortunate enough to face catastrophic market conditions that deplete their portfolio, they will still have a higher floor of income that lasts for life. Income Discovery allows the configuration of multiple claiming strategies simultaneously so that different claiming options can be compared and the optimal strategy for the income plan can be determined.
Income Annuities and Fixed Annuities
Income annuities, whether immediate or deferred, are a reliable instrument for generating retirement income. Not only are they a stable source of cash flow, but also an endless one, so long as the retiree lives. Often referred to as longevity insurance, the opposite of life insurance, income annuities mitigate the risk of living too long. One school of thought recommends locking essential expenses from guaranteed lifelong sources, such as annuities and Social Security. A few advisors practice the strategy of gradual purchases of immediate annuities over a 10-15 year period. Other advisors prefer to lock the risk of living too long by buying deferred income annuities that will start making payments after 80 or 85 years of age. Many factors will determine which strategy is right for the client, including the client's risk profile, assets, health, the advisor's beliefs, etc. Income Discovery allows you to model various types of strategies to find the optimum one for the client.
Fixed annuities are of two types—Deferred and Indexed. Fixed-deferred annuities earn a fixed rate of return, which is how they behave during the growth phase, and an income annuity with lifetime payout after annuitization. During the growth phase, the annuity earns a fixed rate of return and the annuity balance grows. Many contracts also allow the owner to withdraw from the annuity before the balance has been annuitized, provided the owner reaches a specific age and has been invested in the annuity for a specific number of years. The owner can annuitize the balance in the annuity into a life-stream of payouts. The payout rate configured within the tool is the rate on the date of annuitization, based on the age of the annuitant on that date. Fixed-index annuities provide a guaranteed minimum rate of return plus additional percentage that may be credited from the performance of a specified stock market index, such as the S&P 500 Composite Stock Price Index.
Income annuities are simple and effective products for establishing stable retirement income. However, many retirees are not comfortable with the loss of access to the assets that are used to purchase the annuity and the lost opportunity to realize a good investment return on those assets. For such retirees, a Variable Annuity with guaranteed benefits provides an attractive alternative. The retirees can then enjoy the growth on those assets and by paying a periodic fee, they can lock in a guaranteed lifetime payment.
A Systematic Withdrawal Portfolio (SWP) is a conventional investment portfolio invested in stock and bond funds from which periodic withdrawals are made to generate the retirement income. The withdrawals may be more than the interest, dividend and other distributions from the portfolio, and so they may require liquidation of the principal. This is one of the most common strategies used to generate retirement income. An SWP accommodates flexibility to structure any type of withdrawal pattern, while allowing the retiree to maintain control of the assets and their investment direction, and also provides the opportunity to leave a legacy.
Each strategy and product has its pros and cons, and for most retirees a mix of two or more of these strategies will generate an income plan with risk and reward balanced to their profile. Income Discovery allows you to find an optimal income strategy for each client by mixing the aforementioned strategies and products.