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Alan Haft
Alan Haft
 

Getting the Most Income at Retirement

Here’s how.

December 14, 2009
by Alan Haft

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Since 1999 when the Glass-Steagall Act was officially repealed, the lines between financial institutions are now overlapped and completely blurred.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:

  • Taxes: When and how a client pays them;
  • Losses: How the account is protected from loss, if at all; and
  • Fees: How costs are structured.

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:

  • One can select level fees that are based on the amount being contributed, not the account balance, so the effect is that over time, these fees get proportionately smaller. When compared to a brokerage’s percentage-based fees, distributions can be tax-free and a level-fee structure is often at its lowest pointwhen a client needs to generate income from the account, thereby allowing them to realize more income instead of losing significant portions of it to fees.
  • A client can also eliminate fees. In this structure (as well as the above), there is no market risk to principal and in exchange, earnings are capped but typically at levels that have the potential to produce comparable long term average market returns commonly associated with the brokerage industry. After a period of at least 10 years or more, eliminating fees will generally increase an account value by roughly 10 percent to 20 percent. Although relevant, the more pertinent point is that when in the distribution stage of retirement, this higher account balance will translate into a 50 percent to 75 percent increase in the amount of income over that of a traditional retirement plan nested within a brokerage account.

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:

  • The amount of income one actually gets to spend and
  • The overall account value given that taxation causes the need to withdraw the gross amount of income which often exceeds the returns the account is actually earning.

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.

Conclusion

If within the insurance industry, your client chooses:

  • Level fees, in which costs are lowest at the point of distribution,
  • Eliminate market loss, in which your client can withdraw most or all of the earnings for income, and,
  • Eliminate tax, it is therefore possible for a client to increase their retirement income by a factor of three times the amount when compared to income generated from that of a traditional taxable, brokerage retirement account such as a 401k, IRA or others.

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.

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Alan Haft is the author of three books including the national bestseller,  You Can Never Be Too Rich, and makes frequent appearances in national media. He can be reached at.

* 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.