Why Product Allocation Matters More Than Asset Allocation

Why Product Allocation Matters More Than Asset Allocation

Several years ago, I attended a continuing education seminar from an insurance carrier. And recently, one of my co-workers gave a webinar about tax efficiency using life insurance. Both reminded me of how quickly we drift back to our old habits of asset allocation.  


So, I went through my continuing education files and found the case study from the seminar several years ago. Surprisingly, even with the drop in interest rates, the example still provides value to many retirees and their portfolios. Let me share it with you. 


The Situation

A husband and wife are both age 65 and getting ready to retire. Like many Americans, they have no pension plan but have managed to create a nest egg of $750,000. They have $20,000 of Social Security income between the two of them, starting at age 65. The difference in income, $30,000, needs to come from the assets under management using a systematic withdrawal strategy. That withdrawal equates to a 4 percent distribution. 


You may be thinking this sounds like a lot of your middle-American clients. And, you would be right. As I travel around the country, I see a lot of clients taking income off their assets through a more conservative asset allocation. But here are the problems with this set up:

  • There is no guaranteed income for life outside of Social Security
  • Research indicates that the 4 percent withdrawal rate may be aggressive, regardless of asset allocation modeling
  • 60 percent of their income would stop if they run out of money, which puts pressure on the management of the assets and the allocation strategy. Essentially, the clients may be forced to take on more risk (assume more return) later in life when volatility might not be appropriate.  


The Solution

Now, let’s look alternatively at product allocation and how beneficial it can be to our sample client. The client places $100,000 in a fixed indexed annuity with a guaranteed income rider that generates $5,000 annually. Next, they purchase a $160,000 single premium income annuity that pays $9,000 per year. Both are guaranteed for both the lives of the husband and wife, no matter how long they live. Finally, $490,000 remains in the asset allocation strategy, where they take $16,000 of annual income from the account.  


Here are the improvements with this strategy that generates the same $30,000 of income:

  • $34,000, or 68 percent, of the total income will never stop, regardless of how long they live, even if they run out of money in their assets under management. Social Security may adjust after the first death, but income will continue. 
  • Only $16,000 of their income is at risk if their account balance draws down to zero.
  • The systematic withdrawal is now just 3.3 percent. It’s still not at the recommended 2.85 percent, but it is half of the 4 percent strategy before the product allocation. 


The Takeaway

Product allocation is more important than asset allocation. The use of guaranteed income can provide the needed leverage to lower withdrawal rates and increase the stability ratio of the entire income portfolio.  


Winning Strategy

Product allocation should be the first thing you look at when constructing an income portfolio. Think about the location of products and income assets before assigning an asset allocation strategy.  


About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”