If you’re building a house, you need the right tools. And, if you’re constructing an income plan, the same holds true, say financial advisors. Certain financial products and features make it more likely that an income plan will have a solid foundation, they say.
For example, a combination of immediate and variable annuities can be the right mix, says Darlene Simard, a certified financial planner in Manchester, N.H.
A portion of available funds would be used to set up an immediate annuity with another portion used to establish a variable annuity with a guaranteed minimum income benefit, says Simard, who represents MassMutual Financial. If the guaranteed minimum income benefit is at 5%, then the client’s balance would be growing at 5% or the market value, whichever is higher, Simard explains. Hopefully, the growth would be greater than the minimum guarantee, she continues.
The strategy is good for a client who has not saved a lot of money, she adds, because it protects the client from market declines such as the one in 2000-2002. “No one wants the market to drop when they need the money,” she says.
Experts are predicting that double-digit market growth of the 1990s will not continue going forward and that withdrawal rates will need to be in the 4% range, according to Simard. “That’s pretty low. It’s not what everyone is used to.”
Consequently, it is important to have both income and growth features in the income plan, she says.
Another tool Simard finds helpful is not a product feature but a detailed description of actual spending. “What do you pay for electric and in golf fees?” she will ask the client. Very specific information is needed “to know that the income plan is real.”
Single premium annuities and dividend paying stocks are among the tools that Neil McCarthy, a certified financial planner with N.J. McCarthy & Associates, Roswell, Ga., says he finds helpful when developing an income plan. The single premium annuity locks in yield. For instance, he says an annuity that provides income for life for a male age 65 can yield 8% compared with a fixed yield of 4.5%-5%.
Variable annuities are products that McCarthy says he tends to shy away from because of their fees.
With an SPIA, however, the upfront commission cost average is 3.5%; he says studies suggest the cost is less than 50 basis points, or a half percent a year, when amortized over the 15- to 20-year payout period.
Exchange traded funds (ETFs) provide a good way to participate in the market at a low cost, McCarthy adds, noting that cost is “really important” when designing a stream of income for a client. If an advisor is anticipating helping a client provide a 4%-5% withdrawal, then an eye to cost can help an advisor provide a cash flow nearer to 5%, he says. A typical income plan might consist of 40%-50% of assets in an immediate annuity for immediate cash flow and the remainder in a portfolio of ETFs or no-load index funds to provide asset and income growth over time, he suggests.
Because of the need to obtain yield and lower volatility, McCarthy says he focuses “more on value rather than on growth funds.”
A mix of dividend paying stocks and debt instruments are the income planning tools of choice for Grant Brown, a certified financial planner with Raymond James in Dallas. Debt instruments can include both government and corporate bonds, he adds.
If he did recommend an annuity for an income plan, Brown continues, it would more likely be a fixed annuity (to avoid the fees associated with variable annuities). In addition, Brown says, a Depression-era mentality makes many of his older clients more risk averse and more prone to favor features with guarantees. But with younger clients, this is less likely to be the case, he notes.