Upside Down

Suppose that everything you know about planning is wrong, incorrect, not helpful to customers and, indeed, upside down. What then?

4% income for life 

There are at least two ways to deal with this popular idea. The first says that, when you retire, if 4% is taken from your pile of cash each year, you and a spouse will probably have enough money to survive for the two required lifetimes. The second way is built on the first and modifies the 4% idea by adding the inflation rate. You take 4% for the first year of retirement, then 4% times 1.03 (where 0.03 is the headline rate of inflation) for the second year, and 4% times 1.0x for the third year, and so forth. Chances are this will work, too. This idea is illustrated via Monte Carlo simulations, through programs like Jeff Manry’s BetaVest and through the seminal work of Bill Bengen. (Both Manry and Bengen are CFPs and planners in Georgia and California, respectively.)

However, Som Basu takes a thoughtful look at the idea of when the money is needed, with his AgeBander software, which calculates such things as leisure expenses early on and additional health care later. Basu is the director of the California Institute of Finance at California Lutheran University. AgeBander software is his separate venture. The software works on determining what is needed, when, and how to manage the funding. It’s available in a personal consumer version or a pro edition for financial planners.

Likewise, SunAmerica, in its investment annuity, allows people to take out more money than other companies at the beginning of retirement. This higher yearly income (usually paid out monthly) recognizes that retirees, on average, spend more in the first decade of retirement than they do in later years. SunAmerica reckons that they should be able to have more money then, so it provides guaranteed income that way. It structures its annuity payouts so retirees take out more in the beginning, and then the income reduces later, when as much money isn’t needed.

Basu’s AgeBander and SunAmerica’s investment annuity ask this question, approximately, of the 4% rule: “Wait a minute, here. Just wait a minute. Do people really spend this way? Is this how they need to receive money?” And here’s the answer: probably not.

So, you may do better designing for a customer to have more income in the beginning of retirement. It’s upside down from the usual inflation-driven argument.

And don’t just think about 10 years. Your customer may have a different timeframe entirely. Really turn things around and look at them backwards, forwards and even upside down. 

Don’t use variable annuities for IRAs

This was a popular cause of the SEC and the National Association of Securities Dealers (before it became FINRA). The idea was that a customer would get no benefit from the tax breaks afforded a non-qualified annuity if he used it for qualified funds. But, what about the fact that many of these annuities offer income forever for a husband and wife, even if they’re in one or the other’s IRA? I have great respect for both the SEC and FINRA, but sometimes I fear that they know little about investing. (How many CFPs, ChFCs, CFAs or finance degree graduates do these organizations employ? Harry Markopolis said none, which is arguably one of the reasons Madoff was successful.)

Clearly, if you have a required minimum distribution-friendly investment annuity, one that says, for example, that it will pay 5% for life and that it’s RMD-friendly, you have Nirvana. Why? Because it will pay 5% for the rest of your life and your spouse’s life, but, if the required minimum distribution amount is greater, it will pay that amount. (The 5%, or whatever percent, is typically an annually guaranteed amount set by a guaranteed withdrawal benefit built from the higher of market value or a minimum growth rate.) Once the contract runs out of “real” money, it will still pay a percentage of the income benefit, set years ago, and the need to follow RMD rules will cease. So what? Receiving good income, based on previous deposits and growth, makes one wonder: who cares that the “real” money is gone? What could be better than income forever?

And what about death benefits inside investment annuities? Some of them are quite creative and give a survivor options. He or she may continue income, take in cash or even reload the contract with the death benefit, whichever is best. Ohio National, for example, will permit two reloads, and so it is possible, if two spouses die in order before age 94, that beneficiaries will get the deposit amount or income benefit base again.