Getting the Most Income at Retirement
December 14, 2009
Put a trivia wiz on Jeopardy, ask what the relevance of 1933’s Glass-Steagall Act was and they’ll most likely answer that it created the FDIC. While this is certainly accurate, a lesser known fact was that it also placed a clear division between banks, brokerages and insurance companies.
Since 1999 when the Glass-Steagall Act was officially repealed, the lines between financial institutions are now overlapped and completely blurred. Because of the repeal, unbeknownst to many, the pursuit of market returns is no longer confined within the framework of brokerages, but is now also available within the banking and insurance industries as well.
Why Is This Relevant?
Well, while all three industries now offer at least some form of access to the market, the characteristics of a client’s money within the framework of the industry they select can be vastly different from one another.
Specifically, the characteristics:
While no client or industry can control the returns they receive, your clients do have control over the above and when they exercise such control, the difference it can make to the amount of income they can expect to receive at retirement can be quite dramatic.
The Effect of Fees
During their lifetime, most clients will pay the brokerage industry’s common percentage-based fees. Such fees start off small but increase over time as the balance of the account rises, often peaking to its most expensive amount at the point just where it matters most: when they need to generate income from the account.
Conversely, the insurance industry offers a variety of fee structures to choose from, two of which I want to address here:
How so? When taking distributions from the framework of the brokerage industry — if we assume a seven-percent average return less typical fees of 1.5 percent, this leaves earnings of 5.5 percent. To cushion against potential loss, the commonly referenced Withdrawal Rate states a person should withdraw no more than four percent of the account value per year. However, if one eliminates fees, earns the same seven-percent average return and has no possibility for market loss, most or all of these earnings can be taken for income, thereby increasing retirement income by a factor of 50 percent to 75 percent.
The Effect of Loss
When an account is protected from loss, fees are level or eliminated and market returns are still possible, then one would not have to hold back earnings to cushion against market downturns; one could use most or all of the earnings for income, and this particular set of characteristics is available only within the insurance industry and is therefore the primary reason I am focusing on it here.
The Effect of Tax
Year after year, taxes effect:
For example, suppose your client retires with $1 million and the desired net income is $50,000. In a one-third tax bracket, your client would have to withdraw approximately $75,000 to actually spend $50,000. If they commonly diversify their portfolio at retirement into stocks and bonds, receives an average return of 6 percent less 1.5 percent fees, the account could be out of money in 20 years.
If, however, your client eliminated tax by utilizing characteristics available within the insurance industry, they would only have to withdraw $50,000 from a $1 million account earning five percent to actually spend the same amount. In this case, the account would likely have far greater longevity than that of a taxable brokerage retirement account.
Eliminate the tax and depending on the bracket, a client can typically increase their income by 50 percent to 65 percent as well as potentially eliminate up to 85 percent of Social Security income’s exposure to taxation as well.
If within the insurance industry, your client chooses:
Your clients should never consider using the insurance industry for their retirement any more or less than they should consider utilizing the brokerage or banking industry.
There are gross misconceptions about the insurance industry, many of which are archaic in nature and based on outdated beliefs including, but not limited to, available fee structures and the belief that the only access our money has to potential market returns is through the brokerage industry. The use of life insurance policies and other products in a modified, suitable and legal manner that emphasizes living benefits requires an individual who thoroughly understands the new evolution of these products and designs the plans only in the best interest of the client.
* For full disclosure, Haft is a part of a firm that utilizes all industries which typically includes us receiving percentage based fees for brokerage servicesas well ascommissions when implementing insurance based plans. I do not work for any particular financial company or industry nor should this column be construed as an endorsement or condemnation for any particular product. Readers should note that all views expressed in this article are solely the author’s and do not necessarily reflect the views of the AICPA CPA Insider™ or the AICPA.
The sole intention of this series (see Are Your Clients Worried? and The Trouble With 401(k)s and Other Retirement Accounts) has been to open up the realm of possibilities many clients don’t know about that could help them realize a more comfortable retirement. Recognizing a short column can in no way contain nearly all the required details and disclosures necessary to fully understand these concepts, I certainly welcome e-mailing you my lengthier version upon request.