Do You Have an Income Plan?

By: Scott DeMonte

September 18th, 2006

When people start planning for retirement, they generally invest their money into stocks, bonds, mutual funds and money market accounts. What people pay the most attention to is the accumulation phase of retirement, and what they least plan for is the income planning stage of their post retirement years.

Income distribution and planning is just, if not more, important than the accumulation phase or pre-retirement phase. Retirees have a hard time shifting their focus from accumulation to income distribution. This happens because so much is emphasized on the accumulation phase of retirement planning. Therefore, we find many recent retirees investing more aggressively than they should be..

With the leading edge of the baby boomers reaching 60 years old this year, we need to see their focus shift from accumulation to income planning. This should be done before you actually retire to ensure you have a proper plan.

We all know the closer we get to retirement the more conservative we should be with our investments. A good rule of thumb is to allocate your age to some time of income portfolio. For example if you are 60 years old, you should have 60% of your assets in bonds or another type of less volatile investment portfolio and the remainder can be in equities, but conservative equities.

What should you do after you retire though? The same rule as above applies, but you need to ensure you’re planning for income. There are many different ways to plan for income and many different types of products that can provide you with your required income amount. You and a financial advisor need to discuss the right options for your specific needs, but here are a few suggestions.

We recommend looking at a laddered bond portfolio or laddered CD portfolio. This will provide you with income and cash in the future. Unlike a bond mutual fund, all individual bonds or CD’s actually mature and you get your money back. With a laddered portfolio, it gives you flexibility if you have a set amount of money maturing every year to buy new or different bonds. The only time a bond mutual fund makes sense is if you are looking to build a high yield or ‘junk bond’ portfolio or you do not have enough money to build a laddered portfolio.

Lately much attention has been given to products like immediate annuities and variable immediate annuities. These may be appropriate investments, but they involve making an irrevocable decision. If you change your mind after you already bought it, you are still locked into it.

Another option would be to take systematic withdrawals from equity mutual funds. This was widely popular a few years ago, but considering what can happen to the market, it may not make sense. Instead look at a variable annuity with a guaranteed withdrawal benefit (GMWB) or a guaranteed withdrawal benefit for life. This will allow for equity investing, but you are given guarantees to help stabilize your income.

Those benefits, the GMWB, can provide you with steady predictable income. If you choose the for-life option, it will provide you with income for as long as you live without annuitizing the contract. Many of these benefits provide for s step-up which can give you the opportunity to have your income increase over time.

Over the last few years, we have also seen an increase of the use of REIT’s to build income. These products can pay out high dividend yields, but they often times have caveats to them.

For instance, common sense tells us the real estate market is destined to have bad years ahead. Many of these products depend on long term holding periods, such as 10 years, and then they have to go public for you to get your money out. There can also be substantial backend penalties to get out of many of these types of products early.

A stock mutual fund is designed to provide you with capital appreciation, not income. They can provide you with income, but it is the same thing as trying to hammer a nail into a board using a wrench. It might work sometimes, but chances are you will bend or break the nail.

Different investments are used for different purposes, so do not force one type of product to do something it is not really designed to do. These are the basics of income planning and this is what financial advisors do, they help you plan for these types of events. Your plan may fail, but if you fail to plan, you have already failed.