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Retirement Income Planning

Retirement Income Planning

Retirement Income planning involves the art and science of a financial adviser helping a person to making the transition from working (the accumulation phase) to retirement (the distribution phase). This transition involves educating the public about how the distribution phase is different from the accumulation phase from a financial planning perspective. During the accumulation phase, the focus for investments is on the rate of return performance. In other words, how well are my investments growing. During the distribution phase, the focus is on the distribution rate and making sure that the lifestyle objectives will be met, without the fear of running out of money, with having the proper level of liquidity, and ensuring that the legacy objectives will be met. The distribution phase requires a different set of strategies and thinking compared to the accumulation phase.

In the accumulation phase, the investment products used are typically growth orientated, depending on the risk profile of the person. Examples are equity mutual funds, stocks, equity exchange traded funds.

Asset allocation* is the typical approach for determining how the investment portfolio should be invested, based on a risk profile developed from a questionnaire. Asset allocation recommendations are based off of models which will be used to match the appropriate asset allocation to the investor. The models usually range from conservative to aggressive, and the models are conservative, conservative moderate, moderate, moderate aggressive, aggressive. The models are comprised of a mix of fixed income investments such as bonds, and various equity investments, such as growth mutual funds. The conservative models have more bonds in them, the more aggressive models have more equities in them. The allocation between the bonds and equities is what determines the level of risk for the investor. The chosen asset allocation model will determine the potential for wealth accumulation (rate of return) and volatility (risk). It is very important that during this phase the risk profile for the investor is consistently reviewed and adjusted for their changing circumstances; getting closer to retirement, the need for more liquidity, etc. Annuity products can also be useful in the accumulation stage, especially the closer one gets to the distribution phase.

The shift in preparing for the distribution phase should begin about ten years away from retirement. The focus shifts from rate of return to what the distribution rate will be in order to deliver the retirement income. In order to plan correctly for this, an analysis is required which will identify what the future retirement income amount needs to be to support the lifestyle objective. This requires that current expenses are identified, and forecasted for the future using inflation adjusted numbers. Current expenses that will not be part of the distribution phase will need to be acknowledged and the future expense amount adjusted for that.  Also, future income sources, such as social security and pensions, need to be included in the analysis. Any special or extraordinary expenses will need to be included so that the lifestyle desired will be supported. At this point in the analysis the income amount that needs to be delivered from the investments can be identified, and the planning for how the investments should be invested to deliver the income can begin.

The process involves begins with identifying the lifestyle objectives, then figuring out the strategies that will fulfill the lifestyle objectives, then the identification of companies which can provide the appropriate investment products to fit the strategies. It is critical that people work with a qualified financial professional who understands all the nuances and has the skills and resources to deliver the correct analysis. The types of products used for the distribution phase can include some of the same products used in the accumulation phase. However, there is a shift toward using products that are actuarially science based, such as annuities and life insurance. It is only through including the use of these products that a person can be guaranteed** the distribution rate on their investment portfolio to meet their lifestyle objective, without the fear of running out of money. The distribution phase can last twenty to thirty years, depending on factors such as the retirement age, and how long a person will live.

It is important to review and adjust the plan during the distribution phase and make adjustments for macroeconomic conditions, stock market performance, lifestyle changes, etc. As people get older, the actuarial science products deliver a higher distribution rate than at younger ages, and offer a means to offset the impact of inflation without incurring additional risk to a portfolio. So, it can be a good idea to shift the allocation of the overall portfolio to a higher percentage of actuarial science based products as people age.

*Asset Allocation does not assure a profit or guarantee against loss.

**Guarantees are dependent upon the claims-paying ability of the issuing company.