Income Allocation – Secure Your Income First

Jason Griffith |

Income Allocation over Asset Allocation   

Secure your income first to gain peace of mind.

By: By: Ross Hoffman, AWMA®, CFP®, AIF®

How much do you worry about outliving your assets after you retire? What if you could live off 25% to 50% of your portfolio and feel secure about doing whatever you wanted with the other portion, without fear of running out of money? Most people who have all their assets under active management do not know there may be a better way to provide income and wealth management in retirement.

An income allocation strategy may be that better way. A strategy based around your income needs can help manage some important risks more effectively than standard asset allocation strategies. What’s more, by eliminating the need for you to use every dollar of your savings to generate an income in retirement, an income allocation strategy can free up some of your assets for activities or purchases you dreamed of doing, but perhaps put off for fear of running out of money.

Managing risks

Consider that a high percentage of retirees do not have pensions to replace the salary from their working years with a guaranteed income stream. The goal of an income allocation strategy is to replace the peace of mind offered by a pension using the lowest possible portion of their savings. Many retirees are living off 100% of their investment portfolio and worrying about the next down market and whether they will run out of money. I believe retirees should be confident about their ability to meet their income needs from a predictable source, regardless of market performance and regardless of how long they live.

We have experienced two major down markets in the last 15 years that have devastated investor portfolios. During these down markets, many investors abandoned equities altogether, essentially missing out on the important long-term growth potential provided by exposure to equities. Major market indexes have recovered, but large losses of principal while withdrawing from a portfolio can prove disastrous to retiree’s financial security. Sequence risk—the potential for large losses of principal early in retirement to impact your future withdrawal amounts—is one of the most significant risks to retirement income security. An income allocation strategy can help manage your sequence risk.

In addition to market downturns, there are other important risks that can impact your ability to sustain withdrawals. For instance, longevity risk—the chance of living longer than you expect—is a significant challenge to retiree income streams since there is no way of knowing how long your retirement will last. Inflation risk can erode the purchasing power of your retirement dollars, making your future income stream potentially less effective at supporting your lifestyle in retirement. Similarly, there are risks associated with excessive fees and taxes that can erode your income in retirement. How long has it been since you reviewed the fees in your investment portfolio, including any undisclosed costs? Is your actively managed fund triggering unnecessary tax liabilities as your manager attempts to beat the market?

Income allocation is a retirement plan—not an investment plan. It can help you eliminate your three biggest risks in retirement (longevity, sequence of returns and inflation) while also helping address other risks such as fees and taxes. Proper implementation of an income allocation strategy can help you meet your retirement income needs with only a portion of your savings. The remainder of your assets can be spent on more discretionary items or activities, such as investing for growth, gifting to children, charitable causes or just travelling to places you have always wanted to visit. In short, once you have covered your retirement cash flow needs with an income allocation plan, you can use the balance of your savings to pursue the retirement of your dreams.

Learn more about how income allocation strategies can help protect your retirement savings. Contact Hoffman & Associates Financial & Estate Advisors Inc. to schedule a free consultation at (805) 648-5300. Our team of wealth managers can walk you through the process, and offer insights into how an income allocation strategy might work for your situation. 

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