Generating Lifetime Income Can Be a Simple Concept

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Managing downside risk has become a critical issue for retirees since the recession of 2008-2009. After watching their savings being reduced by one-third or more, they have a heightened awareness of the financial challenges while living in retirement.

For advisors, their clients are looking to establish a retirement income plan that will generate a sustainable lifetime income that won’t be adversely affected by the downside risk that can be associated with equities. They also want any exposure to the market insulated from typical and atypical volatility. This led to the creation of The 4-Box Strategy for retirement income planning. The strategy is simple in concept, but powerful in action. It’s also rational and, most importantly, easy for an advisor’s client to understand and follow. Over the past four years, many advisors who have used The 4 Box Strategy have found that their clients have generally been satisfied with the process and have been more inclined to consolidate their assets.

Clients who are age 65 or older present a unique challenge within an advisor’s practice. They face important decisions about Social Security, Medicare, and possibly a defined benefit (DB) pension plan payout. While some may still be working for either social or financial benefits, they’re typically trying to meet three key goals while managing their retirement investments:

  1. Generate sufficient income in order to maintain and enjoy their lifestyle.
  2. Balance their growing need for safety, while also positioning their portfolios for growth.
  3. Enjoy life in retirement without worrying about how interest rate and equity market fluctuations will impact their portfolio and their lifestyle.

What is The 4 Box Strategy?

The 4 Box Strategy for income planning is a framework that provides a structure for organizing and categorizing the clients’ lifestyle needs and all their available resources for producing income. Expenses are split into two categories – “essential” and “discretionary” expenses – to help clients identify and prioritize the various lifestyle items that they need or desire in retirement.

Essential Expenses should include not only the must-have basics of food, clothing and shelter, but also the items that define each client’s lifestyle. These are the things that are non-negotiable because they represent the fabric of each client’s life.

Discretionary Expenses are identified for lifestyle needs that are highly desirable, but “nice to do” rather than essential to the fabric of life. These are activities that your clients would be willing to delay or forego during times of extreme market volatility, when they are worried about the value of their investment portfolio.
After identifying and organizing needs and expenses, it’s then an easy transition to focus the client on the sources of income to support their lifestyle. At this point in the process, a client may start recognizing how consolidating assets can help simplify their financial lives. When addressing income, the advisor will record all of the assets and other sources of income that the client will have available to finance his or her lifestyle. Like expenses, sources of income are split into two distinct categories: “Lifetime Sources of Income” and “Income from Assets”. These sources will be assigned to cover specific lifestyle expenditures.

It’s important to understand the major differences and drivers between the income boxes. Lifetime Sources should be composed of guaranteed income sources that have no exposure to market risk. These are lifetime sources of income that are primary driven by mortality credits and the power of insurance pooling, such as Social Security and DB pension payments.  On the other hand, Income from Assets is generated from a client’s investment portfolio. These sources would typically include assets invested in 401(k)s, IRAs, and taxable accounts that are exposed to the market.

The way these two sources of income relate and complement one another is precisely what brings power to The 4-Box Strategy. Once the client’s individual lifestyle expenses and income sources are identified, the next part is to “connect the boxes” in a disciplined, specific order.

“Connecting the Dots”

1) First, would be to link Essential Expenses with Lifetime Sources of Income to ensure that these needs are covered regardless of any risk. If Lifetime Sources of Income are sufficient to fully cover essential lifestyle expenses, then the advisor has created some significant advantages for his or her client, including:

  • Eliminating market risk
  • Guarantying income for life
  • Reducing longevity risk
  • Bringing courage to the investment portfolio.

2) Second, determine if there is a “gap” between Essential Expenses and Lifetime Sources of Income and fill it in using the least amount of Assets. By transferring the lowest possible amount of assets from “Income from Assets” box to the “Lifetime Sources” box to fill the gap, the client will have more assets remaining in their investment portfolio, with the potential to grow with the market over time.

3) The third step is to fund and support a client’s Discretionary Expenses by generating income from remaining assets. The strategy that the client selects to fill any “Essential Expense Gap” will have a direct impact on the amount of assets remaining to produce income to cover their Discretionary Expenses. Ultimately, the objective is to position these remaining assets for future growth. For that reason, establishing and maintaining an appropriate allocation is essential. The 4-Box Strategy helps makes this possible.

Again, Discretionary Expenses are those things that retirees would “like” to do. This includes activities and expenses that they agreed could be delayed or reduced, especially during a time of market volatility. By reducing Discretionary Expenses during highly volatile markets, the client can reduce the strain of generating income needed from his or her investment portfolio and thereby reduce the withdrawal risk by leaving more assets appropriately allocated to benefit from the market “snapping back” whenever it occurs. This produces a “dynamic” withdrawal rate that can be increased during strong markets and decreased when financial markets are weak.

The client’s courage to fund their Discretionary Expenses with a properly diversified portfolio, and to stick with an appropriate allocation, is further reinforced by the fact that the income they receive every month to fund Essential Expenses is not affected by what is happening in the interest rate or equity markets. The combined impact of using guaranteed income to meet Essential Expenses and having a dynamic withdrawal strategy to manage Discretionary Expenses also helps ensure that retirees are comfortable with an appropriate exposure to equities in their investment portfolios.

Every retiree wants to enjoy a long and productive retirement and pursue his or her most desired activities, without worrying about having enough income to support those retirement plans. This plan gives a client the courage to move forward with their long-term asset allocation and investing goals, even in down markets.
The 4-Box Strategy also creates tremendous relationship-building opportunities for advisors with their retired clients. To date, those who have used the 4-Box approach have seen:

  • Higher levels of client satisfaction with the process and with their advisors.
  • Increased consolidation of assets by existing clients.
  • Expanded book of business, as satisfied clients are eager to refer their family and friends.
  • “Stickier” assets which are far less vulnerable to overtures from an advisor’s competitors.

Growth in new business for an advisor comes from two important sources: consolidation of assets from current clients and new highly-qualified referrals from very satisfied customers. Having the chance to focus on lifestyle, then on a financial picture covering this lifestyle is a key to building and maintaining a long-term retirement income planning process.

An online tool to support the The 4 Box Strategy is now available through CANNEX as part of their Product Education service. Training session and workshops for advisors are also available. For more information, contact Jim Dobler at 413-363-2280, ext 102.

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