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Income Stability Ratio

When you plan your retirement income, we believe it is a good idea to arrange things so that a portion of your income comes on a guaranteed basis. Here’s how you can arrange things to get the stability you seek in your retirement income   

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Transcript Below:

Speaker 1 (00:07):

Welcome back to 30 Minute Money, the podcast that delivers action-oriented smart money ideas and bite-size pieces. My name is Scott Fitzgerald and we are at Rock Vox Recording in production just outside of Rochester, New York. Joining me from Focus Wealth Advisors, Steve Wershing, certified financial planner, snappy dresser, and all around. Great guy . 

Speaker 2 (00:26):

Nice to see you, Scott . 

Speaker 1 (00:29):

Good to see you too. Today we're gonna be talking about income stability ratio. We are, and all of those, uh, lovely terms that you, that you throw at me on a daily basis. Managing income portfolios is, uh, different than 

Speaker 2 (00:43):

For growth. Yes. Well, and, and you know, I, I'll just say that, you know, with all those acronyms and that kinda stuff, you know, all of us consultants love those TLAs. We use them all the time, which is of course, three letter acronyms. , 

Speaker 1 (00:55):

Where's my rim shot? Darnt it. Yeah, 

Speaker 2 (00:56):

Right, exactly. 

Speaker 1 (00:57):

Very nice. 

Speaker 2 (00:58):

Fix it and post. So, yes, . Um, you know, I I I want managing what the point I wanted to get across today is that managing portfolios for income is different than managing portfolios for growth. 

Speaker 1 (01:11):

So what, what, what do you mean? That, that, that it's different? 

Speaker 2 (01:13):

Yeah. So, um, it's a, when you introduce the idea of pulling money from a portfolio on a regular basis, it changes some fundamental dynamics. And so there are some, there's some big new risks that you face if you don't pay attention to that. So if you're managing for growth, one of the, one of the things is that, you know, you look at long-term returns and you lo look at ups and downs, and, and that can be fine and you can let it all work out in the end. But if you're withdrawing money from a portfolio, then the ups and downs take on new meaning because when you're pulling that money out, when things are low, you're taking out a bigger proportion of the portfolio. Ah. And so you can start spiraling your balance down. And that's why when you manage an income portfolio, there are a couple other little disciplines and a couple other little things that you need to include in your analysis. 

Speaker 2 (02:03):

Um, and so one of the things that we do when we map out someone's retirement income plan is to calculate what we call an income stability ratio. And the isr, since we're into TLAs, , um, is the proportion of your retirement income that is guaranteed. Um, and if we can make sure that enough of the, of the income is guaranteed, then we can feel a lot more comfortable in what we do with the rest of it. And what we talk about is typically somewhere between 40 and 60%. So of your retirement income, we like to recommend that 40 to 60% should be guaranteed 

Speaker 1 (02:43):

And what parts of your income can be guaranteed. Yeah. 

Speaker 2 (02:48):

Anything that, um, is paid to you like contractually, anything that is, is paid to you on an, on an ongoing basis that's not related to some kind of a balance in an account someplace. So that the two big ones, of course would be pensions and social security. So whatever portion of your income you're getting from a pension that's guaranteed for life and what you're getting from social security that's guaranteed for life. And so we take a look at what proportion those things are, um, against the, the total amount that you're gonna be living on. Now, if yours is low, there are other tools that can use, that you can use. And one of, one of the biggest tools, of course is an annuity 

Speaker 1 (03:26):

That the, A word. Word. The A word word. You said annuities are bad? 

Speaker 2 (03:30):

I did, I did not. 

Speaker 1 (03:31):


Speaker 2 (03:32):

Said, I didn't say that they're bad. So some kind of annuities are bad, but annuities is a big field. And I'm talking specifically about something called an immediate annuity, which means you don't, um, put money into it and let it accumulate. You trade in money for a promise of a monthly paycheck for the rest of your life. And that's one of those things that, that only annuities can do. Annuity annuities are the only kind of a tool that can give you the guarantee of income for the rest of your life. And so if you don't have a sufficiently high income security ratio, then what we will sometimes recommend to people is that they take some of their retirement savings and to get an immediate annuity to sort of create a pension for themselves. 

Speaker 1 (04:14):

Okay, so if I don't have a pension, I should just go get an annuity for part of my retirement, is what you're saying? 

Speaker 2 (04:20):

Yeah, no, no. So this is the kind of thing that is only done when you go to nee when you go to use it when you need it. So this is not something, so I'm not a big fan of, for the most part, buying annuities for retirement plans and letting them accumulate those would be called deferred annuities, where you, you get something and it gradually makes money over time. I'm talking about when you're, when you're leaving your job and you're going into retirement and you're setting up that retirement income, we look at the different sources and if you need a little bit more of a guaranteed source, you do it right at that point. And so you're not gonna leave it in the annuity to accumulate. You're gonna send a bunch of money to an insurance company in return for the promise that they will start sending you monthly checks, like right away, like the next month and keep sending it to you over the course of your life. 

Speaker 2 (05:05):

So, so here's an example. This is a client that I did that that I was working with not long ago. So I've had this client for a long time and she lived in New Mexico, still lives in New Mexico, but, um, she lived in her house and she decided that she wanted to move to a bigger city, sell her house, and go rent someplace in the bigger city, but it's more expensive there. And so she was gonna use the proceeds of the sale of the house to live on for the rest of her life. And we took a look at that and she's getting some money from a guaranteed source and she's getting some money from social security. And we took a look at her new income, her new, uh, expenses, her new household budget, and realized that, you know, the amount that she was getting on a guaranteed basis was a little bit low. 

Speaker 2 (05:46):

And so what we decided to do is we took the proceeds of the house and we took about two thirds of it and put it in a, in a regular managed portfolio the way that we normally do. And it's, it's, you know, it's, uh, allocated conservatively because of who she is and where she is in life. Mm-hmm. . But we took about a third of it and we got one of these immediate annuities. So now she's got the money from, um, from the other guaranteed source, she's got social security and now she's got this new guaranteed source. And so that's, you know, that gets us up to that 60% or so of the income that she needs that's on a guaranteed basis and she can get it for the rest of her life. So, um, so that's, so that's the kind of a scenario that we're talking about. Now, there are some important trade offs when you, when you talk about an immediate annuity, and the big one is that you are exchanging a lump sum of money, you're exchanging an amount of money for that promise of a long-term paycheck. So you can never get back at that principle. All you can ever get is those monthly checks. 

Speaker 1 (06:45):

Hmm. That sounds kinda like a bad deal to me. I'm not, I'm not quite clear on 

Speaker 2 (06:50):

That. It's a trade off. It's a, it's a benefit that you're buying. So, you know, that's why you wouldn't want to overdo it because you can't get back into it having an, having a guarantee that's great. Um, but never being able to get back at the principle that's not so great. Is there 

Speaker 1 (07:04):

A typical amount of money that, that generally you would do this with? Is there 

Speaker 2 (07:10):

No, no, no. It's a proportion that's proport. It's 40 to 60%, whatever it takes to for 40 to 60%. Now you do wanna be careful about the income, the, uh, interest rate environment. Uh, we, I haven't recommended immediate annuities for a bunch of years because interest rates have been so low. And when interest rates are really low, then the amount of the monthly check that you would get for a given level of principle is relatively low as well. But we did this relatively recently and annuity rates had gone up really substantially, um, you know, in, in the intervening time period. And so it worked out to be a much better time to do it and a good deal. And so we might compare this, for example, to bonds. Um, a lot of people use bonds as income generators and that's what they are, they're income generators and they can, and they, they serve that purpose well. 

Speaker 2 (07:55):

However, we still have to hedge risk and we have to hedge risk a couple of, a couple of kinds of risk. One risk is interest rate risk that as interest rates go up and down, um, you know, your bonds will yield more in one year than they will yield in another year. We also have to worry about default risk. So we've gotta be kind of careful about that. So we may not be able to take as much income as we would like from bonds because we don't want to take everything necessarily because we have to think about what kind of income could be generated down the road. But the great thing about an annuity is it's, it's, um, it's an income that you cannot outlive. And so we can afford to be a little bit more, I don't wanna say aggressive cuz it's still on the conservative end of the spectrum, but, but you can, you can invest without as much stress because this unlike a even a ladder of bonds that, that will pay in interest forever. You know, this is, this is guaranteed. And so we don't have to worry about some of those ups and downs and interest rates or what might happen to bonds in the meantime. 

Speaker 1 (08:54):

Hmm. I was wondering, should, should I even just stay clear of bonds after I retire? Or is it still safe to do 

Speaker 2 (09:00):

That? It's, it's still a good idea to have bonds in your portfolio, and really what we do is we balance it back and forth. You know, if we can get you to a point where you have a sufficiently high income stability ratio and, and we, we measure that not as a proportion of your portfolio, but a proportion of the income that you need, then if you still have, you know, you still have a, a large nest egg beyond that, then bonds absolutely should be part of that. Um, and they can generate income that can supplement the income you're getting. We're just thinking about how much of that income should be guaranteed as opposed to something that is gonna change from year to year. So there are a couple things that you want to be careful about. If you do something like this. First of all, um, you are exchanging a big, a big amount of money potentially for, uh, a, a guarantee of monthly income for the rest of your life. 

Speaker 2 (09:46):

And so therefore we really want to be careful about the financial stability of the insurance company. This is not like term insurance. If you have term insurance, the, the, the company really only has to stay in business for the next year to fulfill its contract. But if you're gonna exchange some money for a lifetime income, then we wanna make sure that the company is really solid. Now in New York, we have some extra protections around that. Um, they're, the New York has the most stringent insurance laws in the country and they also have something called the pre insolvency fund. So in those extremely rare cases in New York, when an insurance company has gone down, the state has either, you know, u tapped into that fund to make everybody whole. Or usually what they'll do is they'll go to the other insurance companies and sort of strong arm them into taking over the company that's failed so that, you know, to protect all the policy holders in New York. 

Speaker 2 (10:38):

No one's ever actually lost money, uh, because of the failure of an insurance company, um, since they've been writing it, since they've passed those laws a long, long time ago. But you still wanna worry about the financial solvency of the company and the stability of the company. And it's another, and the other thing that you want to be, uh, careful about is to shop around. Don't just go to one company and, and get a quote. We've found that, you know, we, we typically get five or six quotes and the difference can be pretty substantial. I mean, the difference can be hundreds of dollars a month for the same amount of investment. So this is one of those areas where it's, it's pays to do your research, uh, or find somebody who knows how to do the research mm-hmm.  or, um, to, uh, and to make sure you're shopping around to a lot of the different companies. 

Speaker 1 (11:21):

That's what I was gonna say. Make sure you know someone who knows how to do the research like, you know. Yeah. Especially a snappy dresser like Steve Washington , 

Speaker 3 (11:33):

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Speaker 1 (12:59):

30 minute action item. 

Speaker 2 (13:01):

Um, take a look at the, uh, income that you're projected to get in retirement and, uh, figure out how much of that is likely to be guaranteed so you can figure out your own income stability ratio. 

Speaker 1 (13:13):

Once again, another very interesting and insightful episode of 30 Minute Money. You can find it at 30minute.money. Steve Wershing can be found at focusedwealthadvisors.com. And if you have any podcasting needs or anything that I can help with, it's rocvox.com. We'll catch you next time on 30 Minute Money.