Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Retirement Planning > Retirement Investing

Walking the Tightrope

Your article was successfully shared with the contacts you provided.

The pummeling of retirement portfolios suffered during and since the recession of 2007-2009 and continuing high volatility in the equity markets has many still-employed older Boomers asking whether they can recover their losses; and if so, what approaches they need to adopt to get back on track to a comfortable retirement.

Sources interviewed by National Underwriter say that retirement goals established before the downturn remain in many cases. But realizing these aims entails developing, and sticking with, a retirement and wealth management plan grounded in realistic investment objectives. Undertaking a risky “Hail Mary” strategy, they stress, is inadvisable.

“You can’t recover you’re market losses all at once,” says Ray Harrison, a principal of Harrison Financial Group, Roseville, Calif. “Building a nest egg for retirement is akin to a marathon, not a 100-yard dash. Rather than reacting to every market swing, clients need to proceed with intelligence and, in consultation with an advisor, a sound financial plan.”

A Diminished Retirement Pie

A wealth and retirement study published by the National Bureau of Economic Research, Cambridge, Mass., observes that retirement wealth held by 53- to 58-year olds in 2006, before the onset of the most recent recession, declined by 2.8 percentage points by 2010. Among individuals in that age group in earlier generations, an additional 5 percent of retirement wealth would have been saved during a four-year period.

The loss of wealth in the years immediately preceding retirement can be bad enough. But they can be catastrophic when the market goes south post-retirement. A particular hazard for clients who are on living on distributions from their retirement accounts, say experts, is sequence of return risk: the possibility of outliving one’s assets because of the timing of losses on equities invested in the market.

During the wealth accumulation phase of planning, such timing is inconsequential: If a client suffers portfolio declines of 6% annually on a given investment in years 1-5, then a 3% annual rise in years 6-10, the final portfolio value will be the same as when the sequence of returns is reversed: positive returns in the early years, and negative returns in the later years.

But, sources warn, negative investment returns during the early years of income distribution can severely impact the portfolio. As illustrated in the accompanying charts, a hypothetical 65-year-old client who starts with a portfolio value of $566,337 secures by age 90 $2.6 million in assets given one sequence of returns and an average annual return of 8%. But when the sequence is reversed, the portfolio value at age 90 is zero—though the average annual return is the same.

“There are definite risks in taking systematic withdrawals from a pile of money,” says Martin Higgins, a certified financial planner and principal of Family Wealth Management Advisory LLC, Marlton, N.J., “If the market goes into free-fall soon after you start taking distributions, you may not recover.”

To guard against this outcome, many advisors recommend adopting a time segmentation or annuity laddering strategy that divides retirement assets among several “buckets,” each carrying a unique risk level and time-frame for income distribution. In a typical scenario, a portion of the client’s assets will be invested in a single-premium immediate annuity (the first bucket) that guarantees a fixed rate of rate for, say, the initial five years of retirement — the period when the sequence of return risk is greatest.

For the second bucket, also of 5-year duration, the client elects a deferred variable annuity with a living benefit rider that, while allowing clients to capture stock market gains, also protects in some measure against market drops. Popular among the various riders are the guaranteed minimum accumulation benefit (GMAB), guaranteed minimum income benefit (GMIB) and guaranteed withdrawal benefit (GMWB).

Additional buckets, say experts, might also call for a deferred variable annuity, albeit with a riskier asset allocation in the VA’s subaccounts — say, 60% in equities and 40% in bonds, as opposed to a 40% in equities and 60% in bonds ratio for the second VA bucket — because the client has more time with the third bucket than with the second to make up for market losses. Alternately, the client might opt for a comparable asset allocation in a separately managed account under the aegis of a registered investment advisor.

Higgins says he favors this three-tiered laddering strategy for clients who have shifted from accumulation to distribution. Such an approach is particularly needed now, he adds, because equities, while enjoying a recent rise in values, remain prone to steep declines.

“What we’re facing now is a short-term, cyclical bull market within the late stages of a long-term secular bear market,” says Higgins. “These secular bear markets are characterized by significant up-and-down swings. That’s tough for people to stomach who are taking income. Given the prospect of additional market slides, it seems prudent to  be cautious.”

Also subscribing to an annuity laddering strategy for clients in or near retirement is Tilden Sowdon. A producer for Legacy Financial Advisors, Orlando, Fla., Sowdon often recommends as part of a laddered solution attaching an GMIB rider to a VA. In his example, the VA provides an annual reset of the account value based on the higher of the market performance or a guaranteed 8% increase in the account.

To secure the guarantee, says Sowdon, policyholders of the annuity (from Ohio National Financial Services) must put at least 50% of their funds in a hedging program available from the subadvisor Milliman Inc. Investing primarily in exchange-traded funds and exchange-traded futures contracts, the program allocates assets to ETFs using a proprietary TOPS (The Optimized Portfolio System) methodology that aims to mitigate market risk and reduce investment return volatility.

“The TOPS portfolio offers a defensive mechanism against market gyrations,” says Sowdon. “By reducing volatility risk, we’re better able to achieve our ultimate goal, which is to provide a reliable stream of income, regardless of market performance.”

Still other advisors use tactical asset allocation strategies, or short-term adjustments to a portfolio’s asset allocation, to improve the risk-adjusted returns of passive management investing. Harrison says such tactical investing is integral to his firm’s planning process — including plans that call for a VA guaranteed living benefit.

The reason: Though these riders may assure the policy holder of an annual income, withdrawal or accumulation benefit within the terms of the contract, they may not meet liquidity needs if, say, the client needs to withdraw an annuity’s account balance to fund medical expenses.

“The client may need to take a [pre-annuitization] lump sum distribution rather an income stream,” says Harrison. “So we endeavor to maintain liquidity at a level approximating [the contract-guaranteed] income level by dialing down equity market exposure when market risk is higher and increasing exposure when market risk is lower.”

Benefits of Guaranteed Income

Predictability for a portion of the client’s nest egg—typically advisors counsel investing not more than one one-third of retirement assets in an annuity, an amount that, combined with Social Security income, is often sufficient to basic living expenses —has an added benefit. The guarantee, sources say, lets clients feel freer to invest more aggressively funds held in non-guaranteed or taxable vehicles.

Among them: ETFs tied to the Chicago Board Options Exchange Market Volatility Index or VIX. A measure of expected volatility in the S&P 500 index over the next 30 days, VIX offers money managers a tool with which to hedge against market dips. Because of the (generally) negative correlation between volatility-based assets and equities, the VIX tends to spike when stocks decline in value, and vice-versa. Thus, VIX ETFs offer investors a measure of protection against market slides.

Higgins says the VIX ETF strategy is well suited to pre-retirees who are still accumulating assets for retirement. For other clients, he may recommend one (or a combination) of four asset allocation strategies customized for market conditions.

These include: (1) a traditional buy-and-hold bull market strategy in which 60% of the portfolio is composed of equities and 40% of bonds; (2) a tactical-constrained strategy that may also call for a 60:40 ratio, but that will overweight or underweight the portion composed of equities, depending on market assumptions; (3) a bear market “rowing” strategy composed of absolute return products that aim to secure a modest return on investment; and (4) a tactical-unconstrained bear market strategy that dispenses with any ratio mandate for equities to bonds.

“Under the last strategy, we might put all of the client’s money into cash to ride out a steep market slide,” says Higgins. “Or during a bull market, we might move everything into equities.

“By blending all four strategies,” he adds, “we can massage a portfolio in a way that tends to weather a [market] storm better and that takes advantage of volatility, be it positive or negative.”

What options are available to clients who, having suffered financially during a bear market, reach retirement age with a smaller than expected nest egg? Sources say these folks may have to choose between among unpalatable options: working past age 65 (part-time, if not full-time); reducing their post-retirement standard of living; or a combination of the two.

To help clients decide on the appropriate strategy, Harrison counsels them to cut expenses while still employed to an amount they expect to live on once retired. If they can make ends meet at the reduced income level, then they can safely move forward with the retirement plan.

“If you’re know you’re going to be retiring in five years, don’t just keep spending like mad because your job income is now $120,000 when it’s going to decline to $60,000 post-retirement,” says Harrison. “See if you can live on $60,000 now. Also, every dollar you don’t spend today is another you’ll have to spend five years from now.”

If working beyond normal retirement age is the only option, the extra years on the job could actually be a good thing. The work, source say, keeps active clients who might not otherwise be ready for retirement (for financial or non-financial reasons); and, if work-related income is adequate, staying on the job lets them postpone tapping into Social Security or a deferred annuity.

The benefit of waiting translates to mortality credits: a yield paid to survivors in an annuity pool that is higher than can be achieved through investments outside of the pool. The credits accrue when premium-paying policyholders die before life expectancy, thereby leaving the pool to be divided among a now reduced (and older) number of policyholders.

Those mortality credits increase income when annuity holders begin taking distributions in later years. But credits that aren’t needed for income, sources say, can also be used to buy life insurance to provide a legacy for beneficiaries. The death benefit, in turn, lets the insured spend retirement funds more freely than would be prudent if a portion of the funds were (absent the policy) needed for heirs.

“A client of mine has increased her retirement spending after having purchased a life insurance policy,” says Higgins. “She’s traveling more with her kids and grandkids because she doesn’t need to set aside money for them. She’d rather be making memories with them — they’ll get the life insurance money when she passes. So the insurance is a great tool.”

Additional Uses of Life Insurance

And not only because of the death benefit. Sources point out that life insurance can also provide a yield superior to that other investment vehicles, particularly in years bordering on life expectancy. The internal rate of return of life insurance — the interest rate at which the premiums paid into a policy must grow to equal the death benefit paid when the insured dies — can be in the high double digits (depending on the insured’s life expectancy, premium payment, coverage amount, and age at the time of the policy’s purchase).

As a source of retirement wealth, experts say, permanent life insurance can also be tapped for income via tax-free withdrawals or loans against the policy’s cash value. The policy thus can provide a safety net for clients whose nest eggs had been pummeled by market volatility since the recession.

Particularly well suited to this purpose, market-watchers say, are maximum-funded universal and variable universal life policies with cash values larger than necessary to maintain the policy’s amount; and dividend-paying whole life policies. Dividends paid by the insurer can be returned to the policyholder as cash, fund future premiums or increase the death benefit.

“We generally favor reinvesting dividends into the policy as paid-up additions to enhance the death benefit,” says Randy Brickman, a principal at Forest Hills Financial Group, Melville, N.Y. “With a paid-up additions rider on the policy, a client can pay three times the normal premium amount without the risk of the policy becoming a [taxable] modified endowment contract. So life insurance can be a great vehicle with which to build wealth.”

In part because of current market volatility, Owen has been spending more time on the phone with clients updating them about their portfolios and, when necessary, offering words of reassurance. But the emotional support, he cautions, can only be carried so far.

“I always tell clients, if the market goes down, it’s not my fault; and if the market goes up, it’s also not my fault,” he says. “As with the weather, you need to be adequately prepared for the market gyrations.

“The additional client-servicing work has meant putting more in more hours on the job,” he adds. “The good news is that, because all of the outreach I’ve done, I’m getting a lot more referrals to prospects.  So it’s actually been easier to acquire new clients in this environment.”


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.