How Financial Advisors Can Best Transition Boomers And Xers From Capital Appreciation To Retirement Income
The youngest baby boomers turn 58 this year as their generation adds to the increasing number of retirees in the U.S. and Canada. Generation X (including this author) isn’t far behind. In an optimistic scenario, Gen X has about two more decades of productive work, even factoring in the higher longevity rates provided by modern medical and health advances.
Common knowledge says you should carry a significant portion of your portfolio in equity as you begin and even well into retirement – equity that produces capital appreciation for designated periodic drawdowns to fund large portions of your retirement expenses.
But the current inflationary environment, market turbulence and reality that entitlement programs like Social Security may be unreliable in the future beg the question: Are retirement strategies that rely on capital appreciation safe for clients, or do we need to redesign retirement portfolios with reliable income at the center?
Russian Roulette And The Rise Of Fixed Income
According to David Scranton, Founder of Sound Income Group, “Pre-retirees and retirees who are banking on capital appreciation are playing Russian roulette with their financial future. People close to retirement or – what’s worse – in retirement can’t afford the massive swings that traditional 60/40 portfolio models create.”
Scranton explains that there’s never a guarantee for capital appreciation, much less for the timing of that appreciation. “Instead, the emphasis should be on generating retirement income versus capital appreciation, which calls for a portfolio strategy combining fixed income, dividend-yielding equities and possibly certain types of annuities, among other assets.”
Paul Keeton, Managing Director of Investments & Advisory Solutions at Prospera Financial, explains that his firm both predicted and witnessed a renewed interest in fixed income, taking active steps to position itself to better serve clients in this area.
Keeton says, “Because global economic uncertainty and market volatility all intensified during the pandemic, we believed an uptick in demand for high quality fixed income solutions would happen, which has very much been the case.”
Keeton adds that Prospera acquired Dorsey & Company “last year largely because of the industry-leading capabilities of the firm’s fixed income desk” and plans to continue building its fixed income expertise.
Rethinking The Fundamentals
While fixed income solutions gain popularity and equity appreciation can’t be taken for granted as in years past, the emerging portrait of the new retirement income portfolio is more complex than simply eschewing equities in favor of fixed income.
Ed Mercier, President of RetireOne, says that clients in the decade consisting of the last five years of work and first five years of retirement should “defend against a poor sequence of returns by insuring a portion of their retirement portfolio while at the same time, allocating a higher percentage of their portfolio to equities.”
To implement this strategy, Mercier recommends using contingent deferred annuities (CDAs) to provide portfolio income insurance for investments in IRAs, Roth IRAs or taxable brokerage accounts. “[T]he advisor may … cover just a percentage of the portfolio, and increase the client’s risk budget in both the insured portion of the portfolio, and the residual, unprotected portfolio.”
While envisioning a strong future for fixed income, Keeton still leaves room for risk-smart equities investment. Keeton says that most retirees “use a combination of investment vehicles, including individual and packaged equity and fixed income solutions,” and recommends that advisors blend solutions to achieve income needs while avoiding over-exposure to any particular risk area.
Shannon Larson, SVP, Platform Management & Product Development, Advisor Group
Shannon Larson, Senior Vice President, Platform Management & Product Development of Advisor Group, also keeps a keen eye out for risk. “We understand the initial stages of retirement will look different than the later stages and it’s important to blend those different risk stages together in one plan.”
Larson points out that fixed income can’t be considered a simple safe haven solution. Rather, retirement portfolios should contain “highly reliable income-producing assets as well as accumulation-oriented vehicles.”
Expertise And Products
Data demonstrates that firms need to enhance their retirement planning resources. In RetireOne’s recently published annual RIA protected accumulation and retirement income survey, 72% of respondents have clients who asked about how to protect their income during retirement, though over 60% of participants don’t use any retirement planning tools.
Scranton says that financial advisors and professionals who wish to transition clients from capital appreciation to retirement income portfolios must receive the necessary training and coaching to become retirement income specialists.
Furthermore, the advisor cannot merely work with tools for initial portfolio construction. Advisors will need to “ensure they have access to sophisticated resources and tools” that help them maintain portfolios.
Keeton agrees that expertise is crucial. “[T]he real key is having a team of experts in place who are not only experienced in fixed income, but in all potential solutions.” Keeton also states that the advisor needs access to a broad range of products.
Larson says that the available products must include “asset management, protection products, trust services and an insurance brokerage [as] key elements to ensuring clients have a smooth transition to retirement.”
Mercier states that one particular product class – annuities – is central to a retirement portfolio. “Annuities transfer risk to insurance companies to provide pension-like streams of income for life that give them the power to spend wisely and confidently.”
Executing A Tax-Smart Transition
Once the products and solutions are accessible, the advisor has gained the necessary expertise and the software and tools are in place, the advisor must plan to minimize tax consequences during the portfolio transition.
Keeton recommends consulting the client’s CPA, reallocating systematically over time and reevaluating the plan each year. In addition, he says that “a well thought out plan can match tax losses with tax gains, which can ultimately provide the best benefit to the client.”
Mercier points out the tax-planning benefits of CDAs, which allow the assets to remain at the custodian. “If an investor wants to cover mutual funds or ETFs in which they already have positions, and those investment options are approved for use in the CDA structure, then there are no tax consequences.”
A Durable Road Ahead
With significant uncertainties in the markets, pre-retirees, who have a limited timeframe outlook, can’t wager everything on the long-term positive outlook for equity appreciation.
The road ahead may require less complacency and more durability. Fixed income, annuities, advisor training and coaching, sophisticated software and tools, portfolio protection and tax-smart transition planning all have the potential to play key roles to secure the youngest of the boomers and Generation X as we stand on retirement’s threshold.