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Costs Do Count When Income Planning Is The Goal

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Costs do count when creating a retirement income plan for clients, planners say.

Whether the product used to implement an income plan is a bond portfolio or an annuity, financial advisors say costs can shave income that would otherwise be part of the client’s regular income stream. Consequently, to maximize regular income, financial advisors need to be diligent to minimize these costs.

For instance, if an advisor is using an outside bond manager to create an individual bond portfolio, “costs can vary widely,” says Elaine Scoggins, a certified financial planner with Scoggins Financial, LLC, Tampa, Fla. The same can apply when an advisor is selecting a bond fund, Scoggins says.

“The cost can vary widely and these costs, of course, lower returns. Many will be in retirement for 30, 40 or even 50 years. These costs, when multiplied over many years, can lower returns significantly.”

Another factor that can drive up costs is the possibility of whether individual bonds or bonds held within a fund will be subject to the alternative minimum tax, Scoggins notes.

The AMT calculates an individual’s tax using lower rates but also fewer deductions. If the AMT is larger than the ordinary income tax a client would pay with larger deductions, then the AMT amount is what an individual pays in tax. Some bonds generate income that is subject to AMT and therefore would reduce return.

Jim Holtzman, a certified financial planner with Legend Financial Advisors, Pittsburgh, agrees that cost is an important consideration in the development of any income plan. Rebalancing a client’s portfolio and appropriately selling a portion of that portfolio can keep cash available for a client, Holtzman says.

Mutual funds are products that Holtzman says he uses in creating an income plan for a client. These funds are preferable to both fixed and variable annuities, he continues. For reasons, he cites the surrender charges associated with fixed annuities and also the costs associated with VAs as well as the performance of investment options in VA subaccounts.

Cost does matter, says Phil Cook, a certified financial planner with Cook & Associates, Torrance, Calif. For instance, he says, putting fixed income assets within a wrap account is “all wrong.”

An advisor also needs to be careful about how annuities are used in an income plan, he says. “There are some good, creative ways to select a product” but “I would be fairly circumspect when I use them,” Cook adds. If a client annuitizes and prices continue to rise, he explains, then there will be a problem for the client because that amount is “set in stone.”

But, Cook adds, there are “creative” approaches such as annuitizing for a 5-year period and having a growth side to the portfolio. The “biggest danger,” he says, is living longer than one expects. He says that in his 30 years of advising clients, he has suggested annuitization once.

For fixed income, Cook says he looks at products that have perhaps a 1%, one-time commission charge. Products he considers include: Ginnie Maes, preferred stocks and collateralized mortgage obligations. He also uses mutual funds, although he notes that a planner has to be mindful that some funds can have loads that are as high as 5.75%.

Expenses do have to be reviewed and analyzed, but the major focus is the use of the appropriate product to accomplish what needs to be done for the client, says Christopher Rand, a certified financial planner and chartered life underwriter with MetLife Securities, San Diego. For example, he says an annuity might be a more expensive way to implement an income plan but if it accomplishes the goal, then it may be the right product.

Other considerations, Rand says, include size and strength of a company, terms of the contract, and what is acceptable to a client. For some clients, a 3% cost may not be an issue if the product is right for them, but for others, a 1% cost may be what they are comfortable with. He does say that it can make a big difference on return. For instance, on a 6% return, the actual return would be 3% if costs were 3%, and 5%, if costs were 1%.

If it is a question of individual bonds as opposed to bond mutual funds, the mutual funds will cost more but also offer diversification to the client, Rand explains.

So, the client needs to look at the benefits and decide how much those benefits are worth. Rand says he brings up the issue of cost before his clients do. One reason, he explains, is that many of his clients have analytical careers in science and they want to know specifics such as how costs are broken out.

Cost is an issue that various financial services firms and trade organizations are also addressing. For instance, Vanguard Group, Valley Forge, Pa., raises the issue on its Web site when it advises consumers that “you can’t control the markets or a fund’s performance, but you can control what you pay to invest. Controlling costs is smart, because [high] costs reduce your investment returns.” To illustrate, the Web site notes the difference between low-cost VAs with a .58% annual fee and VAs with the industry average of 2.35%. The potential savings, according to Vanguard, would be over $1,700 a year on a $100,000 contract.

But the National Association of Variable Annuities, Reston, Va., has a long-standing position that the costs of VAs are being unfairly represented. In letters to various news outlets, NAVA offers points including:

==The fees are used to pay for features such as a guaranteed minimum death benefit.

==An offset to “somewhat higher fees than mutual funds” are lower management fees. NAVA cites 2004 data from Morningstar, Inc., Chicago, that it says found that “the average fee for the management of VA subaccounts was .4% lower than the comparable expenses for mutual funds.”

A NAVA description of VA fees lists investment management fees that average 0.96%; an insurance charge, typically 1.25%; and, a charge for administrative fees, typically running around $30 per year.

This article originally appeared in the September 2005 issue of Income Planning, an online publication of National Underwriter Life & Health. You can subscribe to this monthly e-newsletter for free by going to

An annuity might be a more expensive way to implement an income plan, but if it accomplishes the goal, then it may be the right product, says one advisor


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