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 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.