Clients’ retirement income plans can get complicated. Plans must address multiple goals and risks: generating sufficient income, hedging against inflation, sequence of returns, safety versus growth, and so on. Factor in optimal asset allocations and account-withdrawal strategies and the puzzle has lots of pieces.

Several approaches have evolved to manage retirement income. The terminology differs but they are typically referred to as income flooring, bucketing or time segmentation, and managed or sustainable withdrawals. Each has its pros and cons but I believe many advisors would agree that income flooring is the easiest concept for clients to grasp.

The 4-Box Strategy, developed by financial advisor Farrell Dolan, is an example of income flooring. Dolan’s process gained attention when he described it in a Fall 2009 article that ran in the LIMRA’s MarketFacts Quarterly magazine. It’s an elegantly simple approach for clients age 65 and older that considers lifestyle expenses and sources of income.

The Basics

The process starts by having clients distinguish between essential and discretionary expenses. “Essential” doesn’t mean only survival level expenditures. If the client has a hobby that he or she considers important to quality of life, for example, that’s an essential expense. Desirable expenses are “nice to do” but the client can give them up if required. Essential expenses go in box 1; discretionary expenses in box 2.

Income sources are separated into lifetime sources such as defined benefit pensions, Social Security and lifetime annuity payments. These payments are guaranteed for a lifetime and will not fluctuate with the investment markets; they go in box 3. Variable income from assets—401(k)s, investments, etc.—gets listed in box 4.

The central idea is that the guaranteed lifetime incomes (box 3) should fully fund the client’s essential expenses in box 1. If there is a gap because expenses exceed income, it should be funded using the least amount of assets. Dolan suggests two possible solutions: a fixed income annuity or a separate withdrawal plan from a separate investment portfolio. Asset income (box 4) that is not needed for essential expenses is used to pay discretionary expenses (box 2).

Automating the Plan

Dolan emphasizes that the strategy is not a product but a lifestyle-focused process, one that requires clients to consider their income and expenses in detail. Initially advisors who attended Dolan’s presentations on the strategy and wanted to implement it with clients had to use a workbook. Participants’ desire for a computerized approach lead Dolan in 2013 to work with CANNEX, a Toronto, Canada-headquartered company that “specializes in gathering, compiling and redistributing comparative information and calculations about products and services offered by financial institutions.” Among U.S. advisors, the company is often best known for providing comparative pricing, illustration, and evaluation tools for guaranteed, insurance-based income products.

CANNEX has made the 4-Box Strategy available on its online data platform. Users enter client and annuity information, preview the results of the analysis, and create a custom report and action plan for the client. The report illustrates how the client’s assets cover essential and discretionary expenses and compare how managed withdrawals from investments compare with income annuities in covering any gaps.

The client fact finder is straightforward and reports are easy to understand. They explain the strategy clearly and also discuss sustainable portfolio withdrawal rates and the risk of depleting funds with excessive withdrawals. According to Gary Baker, president of CANNEX USA, the 4-Box Strategy is available to advisors on a subscription basis for $3 per month per client.