3 strategies for inflation protectionArticle added by Luke Britt on July 14, 2014
Joined: February 23, 2011
Ranked: #88 (814 pts)
You and I both know that one of the top issues that will affect your client’s retirement is inflation. Since you know it is a large concern, how are you positioning your clients’ accounts for success?
Before we get into three of the top planning strategies, let’s cover a few basics. First, we need to define inflation.
Inflation is the general increase in the price of goods. Said a little differently, inflation is the loss of purchasing power.
As you can see in the chart below, a $100,000 lifestyle will become a $120,000 lifestyle in just seven years, while it will require $200,000 by 2040 due to a projected average inflation rate of 3 percent.
But we already know this information, right? So, what are we doing about it?
We’ll look at three strategies to take care of inflation:
The first strategy has received quite a bit of press over the past few years due to a report published by Wade Pfau, among others. Their study found that the 4 percent rule with a 50/50 portfolio (stocks and bonds) would drain assets prior to life expectancy about 57 percent of the time. Even reducing the withdrawal rate to 3 percent would fail 24 percent of the time. This failure rate is due to historically low treasuries as well as the sequence of return risk in the equities markets.
- Utilizing the safe withdrawal rate – the 4 percent rule
- Using guaranteed level income payments from annuities, as well as withdrawing funds from investment accounts
- Generating inflation-hedged guaranteed income from annuities, as well as withdrawing funds from investment accounts
The bottom line is that this strategy relies too heavily on performance. According to DALBAR, the average investor has only averaged a 2.5 percent return over the past 20 years. Using the 4 percent rule while experiencing those returns will lead to a frustrating, and broke, retirement. Don’t you think this makes FIAs look very competitive?
The second strategy uses a combination of a level payment from a FIA with an income rider and withdrawals from an investment account, adjusted for inflation. This strategy relieves some of the pressure put on the investment accounts performance but still will need to perform well enough to provide inflation-hedged income not only for the investment account withdrawals but also to compensate for the annuity’s level income payment in later years.
This strategy provides a strong foundation for income, especially for those with shorter life expectancies. The only downfall is that
poor performance from investments could potentially impact income withdrawals in later years.
The third strategy also uses FIAs and investments, the difference being that the FIA chosen has an inflation-hedged income rider benefit. These types of annuities will either pay a guaranteed increasing payment (usually 2 percent to 3 percent
annual increase) or increase payments based upon policy performance.
This strategy will provide a lower foundation of income immediately but will increase over time, further reducing the performance
pressure on investment accounts, especially in later years. This strategy is ideal for those with a retirement of 15-20 years or more.
So, which strategy is best? Good question. The 4 percent rule is clearly not the best option, but can work quite well if you have the right type of assets and money managers on your side. One of the money managers I work with has returned over 7 percent over the past 20 years with no down years. His asset management style would potentially work well with the 4 percent rule, but not all of you are securities licensed or do not have access to these money managers through your RIA or broker-dealer. This would make the second and third strategies your better option, as long as the annuities you are selling are designed to compliment the other assets your clients have.
But the key in all of this is to remember that we are financial professionals and it is our job to create solutions for our clients' potential future problems. Each client is a new puzzle to solve, with their own unique circumstances, needs and desires.
Here's to proper planning!
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