Creating a lifetime income strategy
By Peter “Coach Pete” D’Arruda
If you are in the financial red zone, now is no time to fumble the ball by playing fast and loose with your savings. You may reason that risk is required so as to make up for lost time. But the “advance and protect” strategy needs to be employed here.
“Retirement is like a long vacation in Las Vegas. The goal is to enjoy it the fullest, but not so fully that you run out of money.” – Anonymous
Hosting a radio talk show and taking calls from listeners with questions about money has taught me to listen more carefully for the question behind the question. For instance, a caller will ask a question such as, “Am I making a mistake to retire when I turn 62, or should I wait until I’m 65?”
What’s really going through the caller’s mind is, “I’m afraid I may run out of money. I have no guarantee. My money is in a retirement account that is tied to the stock market. What will happen to me if it takes another nose-dive?”
When it comes to mapping out a financial future, many don’t seem to know exactly where they are going. In general terms, they may know what they want. They want freedom, independence and leisure time. But when you ask them to color in the details and explain exactly how much income they expect to have coming in each month during their retirement, and exactly where that money will come from, they can’t tell you. And yet, if asked, “Would you like to have a guaranteed lifetime income in retirement?” the resounding reply from most people would be “Yes!”
From where I watch the world, one of the most critical topics that needs discussing, and yet one of the most ignored by most financial professionals, is how to create a lifetime income strategy. This is partly the result of uneducated consumers who are not aware that such strategies exist. Could this lack of awareness also be because many financial professionals are button-pushers and order-takers instead of problem-solvers? I think so.
The water wheel of money
What's the waterwheel of money? When colonists first settled the area of North Carolina where I live, they would look for an area where water ran quickly downhill and build a water-powered grist mill. Some of these mills still exist and a few are even still functioning. The early settlers knew that if they were to eat all year long, they would need to have some means by which to grind the corn and wheat into meal and flour so they could make bread. If you have ever seen one of these mills in action, you will see how the natural force of gravity, combined with the motion of running water, serves to create the closest thing to a perpetual motion machine there is. As long as the water keeps flowing, the wheel will continue to turn, powering the gears and cogs of the mill-works. In areas of the country where streams moved slower, the colonists became engineers, constructing dams and creating artificial waterfalls.
Financial engineers accomplish the same thing when they put in place a mechanism for creating a continuous flow of income from assets that we have accumulated. Financial cruise control occurs when we can just sit back, relax and watch that water wheel of money turn. We have created it for that purpose. Now it can continue to generate for us a lifetime income that will be there as long as we need it. With the proper planning, we can adjust our financial landscape so that it provides us with a reliable, guaranteed lifetime income.
That image of water cascading over a water wheel is a great analogy to how a lifetime income strategy might work. It’s continuous, dependable and self-attending. We don’t want to have sleepless nights worrying about how our income in retirement may be threatened by market forces or world events. Those settlers knew that as long as water continued to roll downhill, they would have bread on their tables. We want that kind of peace of mind. Creating income buckets
The mechanics of creating your perpetual money water wheel can be illustrated by picturing a row of five buckets, each with a different purpose.
Bucket #1: Immediate income — This bucket represents money that starts in the first year of retirement and continues for the next five years. We are going to put a spigot on the bottom of this bucket that will allow for a steady flow of money for five years. How much do we put in this bucket? That will depend on your chosen lifestyle and your asset level. Here’s where a little budgeting and planning needs to be done. You and your financial advisor will establish a budget that’s right for you. Then, this bucketful of money will be put in a position where it will be safe from loss, grow at a reasonable rate and provide income for the next five years.
The assets we place in this bucket could take many forms as long as they perform, they meet the criteria of being reliable and they are there for five years. We could use a series of CDs, for example, and stagger the maturity dates. When we exhaust one, we tap into another, all the while letting the money accrue interest as we go. We could use a combination of CDs and bonds, or we could use an immediate annuity. Everybody’s circumstances are different, and exactly which vehicle we use for this five-year income bucket will depend on those circumstances.
Bucket #2: Years 6-10 — Another five-year bucket will now generate the income while the bulk of your assets continues to grow as much as safely possible. As with the first bucket, there are a number of savings and investment vehicles we might use here, all based on individual circumstances.
Bucket #3: Lifetime income — While our first two buckets have been performing the dual task of providing income and interest, the third money bucket has been waiting until year 10 to do what we put it here for — generate a lifetime income. Here is where we scan the shelves of all the retirement programs out there for the best guarantees. We will always have an emergency fund if we need it, but it is this block of money that we will look to for long-term security and as much growth as safely possible. In today's financial world, there are many products available to retirees that will contractually promise compounded growth for that income at 5 percent, 6 percent or 7 percent per year. This allows us the ability to look forward into the future and know what awaits us. If you take the right steps, it’s almost like having a financial crystal ball.
Bucket #4: Emergency money — While your other buckets are working for you, either providing income or earning interest, this bucket is kept for emergencies that may present themselves. None of your money should be lazy, so this money will earn interest until you need it. But it must be fully liquid (money you can put your hands on when you need it without filling out any paper more complicated than a check). How much you keep in it is up to you. As previously mentioned, all circumstances are different. If you are the type of individual who is cautious by nature, you may have a tendency to stuff too much money in this account. Don’t worry. You are always able to pull money from your other buckets if absolutely necessary. They may not be quite as liquid, however. The characteristics of this bucket dictate that the money is at your fingertips and available at a moment’s notice.
Bucket #5: Extra money — Now that all of your needs have been accounted for, both current and future, the rest of your assets go into this bucket. You may use it any way you wish. You may wish to blow it on travel. You may wish to use it to provide a legacy for your children or grandchildren. Do you enjoy having some of your assets at risk in the stock market? Then go for it. Risk is not so much a concern here because you are certain of an income that you cannot outlive. The market is a turbulent place. But you are psychologically better able to deal with its ups and downs if you aren’t so worried about the downticks interfering with your lifestyle. It is still a good idea to follow the rule of 100 (a percent sign after your age tells you how much money you should have utterly safe). But now you may be more creative with your investments, if you desire. Core money and explore money
Call your safe money your “core” money, because it is at the very center of what propels your water wheel/income mill. Call your other money your “explore” money, because you can use it to explore investments that may return better-than-average rates of return for you in your golden years. Don’t forget to congratulate yourself. You have placed your assets in what is called an “advance and protect” strategy. In other words, you are always going forward while protecting what you have.
Don’t fumble now
In football, the red zone refers to the last 20 yards before the end zone on the football field. When you are that close to the goal line, everything changes. Offenses have special plays to adapt for a shorter playing field. The cardinal rule for everyone who touches the ball in the red zone is, whatever you do, don’t turn the ball over. Many a game has been decided by a fumble just when the prize is within reach of the team with the ball.
If you watch football, maybe you have seen the ball carrier try to stretch for that extra yard by holding the ball in one hand and extending that arm as far as he can. Then a defensive player swats it free and the drive is over. Good coaches tell their players to keep the ball safely tucked away under the arm closest to the sideline and hold it with two hands.
Likewise, if you are in the financial red zone — that is, just retired or within 10 years of retirement — now is no time to fumble the ball by playing fast and loose with your savings. You may reason that risk is required so as to make up for lost time. But the “advance and protect” strategy needs to be employed here. Keep your money tucked away safely. Advance the ball, to be sure. But risk only what you can afford to lose. The ball is your retirement income. You simply cannot be risky with that money, not at this stage of the game.