This week, Devin and Brandon talk about “setting a floor.” This contrasts with the methods that they talked about before, where there is no minimum level of income guaranteed. What you will do with a flooring strategy is that you use some type of guaranteed product, such as a bond or an annuity or a CD or whatever, to establish a minimum withdrawal from the portfolio that won’t be affected by the market performance. Then, beyond that, you can maybe take some amount of investment withdrawal.
Going back to that tradeoff between risk and return: If you want to know that regardless of what happens in the market, you’ll still have some level of income. You want to do something that isn’t market-related that gives us a known certainty of an income level.
What is it that you really need to call your minimum? Every person or couple one is going to draw that line at a different level. Then, you lock that amount in with some sort of guaranteed product.
There are a couple of different ways to guarantee that you have that minimum income level.
A common way to do that is with the use of a bond ladder. You purchase bonds that will mature at a faces values that will meet your required minimum level of income. How long of a retirement do you think you’ll have?
So, if $4,000 per month is your needs, you’ll need to find bonds that have a $48,000 maturity on an annual basis. You buy the bonds today, at the discount, that will mature at the needed amount in the designated year.
One of the downsides of this strategy is that you have to estimate how long you’ll need that income. There is a very real risk that you’ll live longer than you estimated, and because you’re using the principal and the interest each month, then there won’t be that money available. You can combat that by drawing out that bond ladder, but then you have the opposite risk of leaving a bequest that is larger than you had hoped.
Another option is an annuity. Don’t run away – not all annuities are bad!
Brandon says that he understands why people aren’t comfortable with annuities. They’ve gotten a bad reputation due to some bad products and bad salesmen. But there is a case for using some of the good annuities to build a minimum income.
Devin’s favorite annuity is a Multi-Year Guaranteed Annuity (MYGA). They work much like bonds. They have a specified period of time, and you can have a specified rate. Devin doesn’t like MYGAs with variable interest rates, and they violate the idea of a fixed income anyway.
Variable annuities can be tricky. They look a lot like mutual funds, and you’ll have a few things guaranteed. It may be the death benefit, or the income stream. What they don’t tell you, though, is that it could cost you up to 4% per year to own that “investment.” You can see your principal balance go down to nothing. Hidden in all the contract language is often a term that say that if your account balance falls below a certain level, your contract is cancelled.
There are long-single premium immediate annuities. These work a lot like a pension. You buy in once, and you’ll get an income for the rest of your life. These can be useful in certain situations.
There are definitely downsides of annuities. You lose control of your money, and you don’t have any flexibility.
You have to think of all of these decisions as relative to each other: What are you gaining vs. what are you giving up? If you want to build an income floor, then you have to choose between the security of longevity protection versus the security that you will have the maximum use of your money.
Using Social Security As Part of Your Flooring Strategy
Most people in the US are eligible for some sort of Social Security benefits. These benefits can be part of your minimum guaranteed income. You can increase the amount of minimum guaranteed income that comes from Social Security by delaying the receipt of benefits. The cost for delaying Social Security is less than the cost of purchasing an annuity that will provide you with the same additional income.
- Why right now is a really hard time to build an flooring strategy
- How using a combination of products might give you the results you want
- Some other types of product to build a similar income stream
Resources mentioned in this episode:
You can find Brandon at BrandonRenfro.com, where he writes about retirement income planning and related topics. You can also sign up for his mailing list!
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