Retirement income for life: 4-box strategy «

    Retirement income for life: 4-box strategy

    Some financial advisers pride themselves on being able to think “outside the box.” But when strategizing about retirement income, Farrell Dolan, a principal at Farrell Dolan Associates, prefers to think inside four boxes.

    The four-box strategy, as Dolan describes it, involves breaking down lifestyle expenses and retirement income sources into two sets of two boxes—and then matching up those boxes to maximize the odds that a retiree’s savings supports him or her for life.

    Retirement income for life
    Think inside the box: Try this four-box strategy to match your lifestyle expenses with your retirement income sources.
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    • See the full special report/conga/story/2012/11/retirementadviser1112.html 234851 Dolan, along with David Blanchett, the director of retirement research at Morningstar Investment Management, and John Olsen, the president Olsen Financial Group, spoke at a recent MarketWatch Retirement Adviser event in New York City. “This whole stage of living in retirement really is less about products about more about lifestyle,” Dolan told the audience. “You first really need to take a look at what your lifestyle is. You have to define it between yourself and your spouse.”

    Dolan’s retirement-income approach, which he also wrote about for LIMRA’s MarketFacts Quarterly, starts with a look at lifestyle expenses, which can be broken down into two boxes: essential ‘must-have’ expenses and discretionary expenses.

    “Essential expenses,” said Dolan, “are the things I really have to have in life to make life worthwhile for us. And yes, it includes food, shelter, and clothing, and taxes, and all those mundane things.” But, he added, “Every one of us has something that goes into this essential box that goes far beyond food, shelter, and clothing. “

    Discretionary expenses, the second box, are more flexible, said Dolan. These are expenses such as travel, entertainment, and hobbies that might be important to you, but could be cut during highly volatile markets or scary times.

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    To be sure, as Dolan acknowledged, it’s difficult for people to determine their total expenses in retirement given that they don’t know how long they might live. “There’s so many unknowns that I think it’s important to start by thinking about what you have to have, and then what you want,” said Dolan. “If you’re planning for a 20- or 30-year time frame, you know, all bets could be off… It’s important to be dynamic in thinking about: What do I have to have and what do I want to have as I move through life?”

    Adding to the challenge, it’s hard to envision your retirement years when they’re still part of the distant future. “The further you are from entering this stage of life, the further back you go… it becomes more difficult,” said Dolan. “The vision is less clear. As you move closer, you really have to work at getting it (clearer)… I find that it evolves and changes over time.” What’s more, Dolan said, “At different points in your life you need different plans.”

    The income “boxes”
    If expenses account for two of Dolan’s four boxes, the other two involve the two major sources of income in retirement: lifetime sources, such Social Security and defined benefit plans, and income from assets such as those found in 401(k), IRA and taxable accounts.

    In practice, here’s how Dolan’s plan would work: You would fill in each of the four boxes with your lifestyle expenses and sources of retirement income, and then you would connect the boxes in a disciplined, specific order, according to Dolan.

    Lifetime sources of income such as Social Security and defined benefit plans should be used to fund essential expenses such as housing, food, health care, even golf for some. And, income from assets such as those found in a 401(k), IRA or taxable accounts are should be used to fund discretionary expenses such as travel, entertainment, and hobbies.

    By linking essential expenses with lifetime sources of income, you’re “making sure that these needs are covered regardless of any risks,” Dolan wrote in his LIMRA white paper. “The key tenet of the four-box strategy is that essential expenses must be covered first and be fully funded by sources of lifetime income.”

    You’ll enjoy some big advantages if your lifetime sources of income are sufficient to fund essential lifestyle expenses. One, you’ll avoid market risk. You’ll get a steady income regardless of what happens in the market. Two, your income will be guaranteed for life. Three, having this sort of income reduces the odds of outliving your assets, or what’s called longevity risk. And four, knowing that your essential expenses are covered with guaranteed sources of income could give you the courage to manage your “income from assets” portfolio more effectively—“to establish an appropriate asset allocation and maintain it for the long term,” as Dolan wrote.