There’s no doubt: clients are acutely worried about their retirement. Will they have enough to live on at a level they find comfortable? And will an extended lifespan mean more good times or simply too many years of reduced independence?

No one has all the answers. But putting the appropriate financial strategies in place to ensure your clients have a sustainable stream of income throughout their golden years can ease their worries.

Unfortunately, many people do not have a process in place to ensure that they will be comfortable throughout their retirement years, says Francis D’Andrade, author of Am I Going To Be OK? Achieving Financial Comfort in Today’s World (PerCapita Publishing, 2006). “They are either insufficiently focused on meeting their future needs,” he says, “or are too ambitious about what investment returns they can expect during retirement to sustain their needs.”

There are many approaches to ensuring that your clients have a sustainable flow of income during retirement. Two such approaches are the “bucket” approach and the “income-layering” process.

The bucket approach to retirement planning has been made popular in recent years by Harold Evensky, a certified financial planner (CFP) and president of Miami-based Evensky & Katz LLC.

This approach has its roots in the defined-benefit pension sector’s so-called “liability-driven investing strategy.” The main objective of this approach is to have sufficient assets to meet all current and future liabilities by focusing on the differing needs for cash at different stages of retirement.

The theory behind the bucket strategy is simple: it uses three buckets of investments, each containing different types of investments to meet short-, medium- and long-term retirement-income needs. Money for short-term needs, perhaps one or two years, is parked in cash or liquid short-term investments; for medium term needs – say, three to 10 years – a mix of stocks and bonds is used, with a bias toward bonds; for the longer term, 11 to 25 years or more, an equities-biased portfolio is developed.

This strategy segments your client’s time horizon into three phases. The asset mix in each bucket reflects the correlation of the risk/reward profile of each type of security with the need for income at each phase along the client’s time horizon. For example, equities that have a higher risk/reward profile are dominant in the long-term bucket, which is designed for growth.

However, your client may not always need three buckets. Christine Benz, director of personal finance with Morningstar Inc. in Chicago, advises that an older retiree with an expected 10-year horizon might need only two buckets – for short- and medium-term needs.

Benz says buckets, which place a structure around retirees’ portfolios, help your clients to visualize where their income will come from at different periods during retirement. “None of the buckets presupposes a rate of return,” she says. Returns will depend on each retiree’s “sustainable spending rate,” which is a function of the size of the investment pool and the expected withdrawal rate.

The underlying rationale for a bucket strategy is that retirees can set aside a pool of cash for short-term income needs, thereby allowing them to ride out potential volatility over the medium and long term without having to sell assets in the short term. This approach can be customized to suit the needs and risk tolerance of each client but requires ongoing adjustment. However, Benz advises, the bucket approach is flexible and easy to implement.

D’Andrade contends that the bucket strategy is not unique, although it can give your clients psychological comfort because the buckets represent manageable pieces of their retirement pool of assets.

Unlike the bucket strategy, the so-called”income-layering” process assesses the unique characteristics of each source of income during retirement and then layers each source to create a safe and consistent income. At the same time, taxes and portfolio risk are minimized, says Douglas Nelson, president and CFP with Nelson Financial Consultants in Winnipeg, who advocates the process in his book, Master Your Retirement (Knowledge Bureau, 2011).

Nelson describes the income-layering process as a five-step strategy. In the first step, the sources and characteristics of income that your client typically receives during retirement are identified. Whether the income is guaranteed or will fluctuate is also determined. This is important, Nelson says, “because markets fluctuate and, when you are withdrawing money gradually over time during a [time of market fluctuation], there is a high risk of a loss of capital.”

The second step establishes how much your client will choose to spend on needs vs wants. Nelson says he “encourages people to think in terms of monthly after-tax needs and monthly after-tax wants.”

More important, Nelson adds, is the understanding that what your client spends is often much more important than generating a high rate of return. By understanding client spending, you can assess how much risk your client needs to take in the portfolio to achieve the income target.

In the third step, Nelson says, match your client’s guaranteed sources of income with the basic income needs established in step 2.

Step 4 deals with taxes. “Getting the tax picture right,” Nelson says, “is more important than getting the portfolio right.” He says it’s crucial to understand how retirees can benefit from things such as pension income-splitting, the disability credit and the age credit; and how different types of income are taxed and how each spouse is taxed on his or her unique increasing marginal tax rate. Then, assess “how much of each type of income each spouse should receive to achieve the greatest amount of income with the least amount of taxes.”

For the final step, Nelson advocates doing an income analysis twice a year. “Then,” he says, “project the income and the tax picture forward for the next three to four years. If you can get the short term right, time and time again on a rolling three- to four-year basis, the long term will take care of itself.”

Unlike with the bucket strategy, Nelson does not recommend retirees set aside money in a money market fund and draw down this income over a 12- to 24-month period so that the rest of the investments can grow. He believes this is a risky strategy, as significant market declines typically happen once every four to five years. If you use that approach, then 5%-15% of your capital is missing out on the growth that naturally occurs 70%-80% of the time. IE

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