Flooring (essential versus discretionary) can be defined as funding essential income needs with less volatile assets, building an income floor, while investing in more aggressive assets for discretionary expenses.
While a probability-based approach, or total return, like systematic withdrawals may be fine for retirees who are comfortable with market risk and adjusting their plans periodically, others will find great comfort in a safety-first approach to retirement income planning. Flooring can provide meaningful psychological benefits to retirees while simultaneously easing some practice-management burdens to advisors.
Imagine flooring as creating a pension-like income in a world that offers fewer formal pension plans. By targeting an income floor amount, and connecting that amount with certain or guaranteed income sources, any remaining assets are freed-up from income generation duties and are able to remain at-risk for purposes of discretionary wants, inflation protection, long term care needs, and giving.
With the concept understood, how might an advisor structure such an arrangement? Typically, the income floor is constructed using either a bond ladder or income annuities. Because either choice allows some degree of certainty of income, it is possible to pair the income generated with the need.
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Choosing whether to use a bond ladder or annuity strategy (a SPIA, FIA or VA with a guaranteed income rider) is a matter of prevailing interest rates, and product feature competitiveness. Remember that the goal is to build a lifetime of income, so normal constraints of surrender charges or other liquidity concerns are no longer the highest priority. This is, by design, a long-term strategy.
Remaining assets not needed for income generation in the floor can be deployed in a risk-based portfolio that is congruent with the client’s appetite for risk and likely use. In other words, the principles of prudent investing still apply, but the need for those assets to generate consistent income has been removed, thanks to the income floor.