In a rising-rate environment, clients using the bucket strategy may avoid investing the “first bucket” funds as they wait for a better deal. Is there another alternative?
The Time-Based Segmentation method or “buckets” approach has been used in retirement planning for many decades. Initially developed by Harold Evensky in 1985, buckets was a way to reduce sequence-of-returns risk. Over time, the strategy developed into three buckets, each with a clear purpose:
In today’s rising-rate environment, can annuities help with this approach?
For the first bucket, the retiree needs income and cash flow to meet spending needs for the first five years of retirement. Income annuities, such as a single-premium immediate annuity (SPIA), can help meet those essential expenses. A five-year Period Certain annuity can provide guaranteed cash flow without exposure to bond-market volatility. Here’s a tip: Run an illustration to solve for a monthly amount needed to help determine the initial purchase payment.
As rates rise, this type of annuity also may provide income to bridge the gap between retirement and claiming Social Security benefits and ensure the highest Social Security benefit available. Whether delaying claiming Social Security benefits until full retirement age (FRA) or until age 70, this strategy can be a way to manage essential income. This would allow Social Security’s delayed retirement credits (DRC) to grow from FRA to age 70.
For the second bucket, the approach is for an intermediate time frame. This bucket allows for limited market participation. However, the emphasis is on moderate growth and income as well as safety of principal. This bucket will replace the first bucket’s assets as time progresses.
The shorter time horizon makes this option riskier than some clients might accept. An optional guaranteed minimum accumulation benefit for an additional cost with a variable annuity can reduce these concerns. In simple terms, it is a “walk-away” benefit that ensures if the market did not perform during a specified period, the investor will get all or most of the premium back in a variable annuity contract.
By investing in equities and bonds, the investor can now participate in market growth secure in the knowledge that at the end of the period, all or part of the original investment will be returned.
The third bucket is typically used for long-term investing and is the highest-risk bucket. In nonqualified and qualified accounts, an investment-only variable annuity (IOVA) can be just as simple as that. There are no optional living benefits added, which helps reduce costs. An investor may invest as aggressively as he/she wants using as many (or as few) of the subaccounts offered. In nonqualified accounts, the ability to rebalance investments without recognition of gain, can allow assets to grow more quickly.
In addition, some IOVAs offer a death benefit, typically the return of premium (ROP). As a plus, most annuities allow for a 10% annual withdrawal free of sales charges in case the investor unexpectedly needs to move some funds to bucket one or bucket two.
There are various investment options to use when using the Time-Based Segmentation method, also called buckets. This strategy can be attractive to retirees because it is easy to understand. The first two buckets use fixed investments to help mitigate risk; however, with rising rates and market volatility, it may be worthwhile to consider alternatives. For a client who retires in a rising-rate environment, using annuities in the bucket strategy may allow someone to retire sooner rather that later.
Clients concerned about sequence-of-returns risk may use the bucket strategy. For those who do (or plan to soon), adding annuities may help. Reach out to your clients to discuss what may work best for their situations.
All guarantees are subject to the claims-paying ability and financial strength of the issuing insurance company and do not protect the value of the variable investment options, which are subject to market risk.
This material is provided for informational purposes only and should not be construed as investment, tax, or legal advice. Information is based on current laws, which are subject to change at any time. Clients should consult with their accounting or tax professionals for guidance regarding their specific financial situations.
All investing involves risk, including the possible loss of the principal amount invested.
Investors should carefully consider a variable annuity’s risks, charges, limitations, and expenses, as well as the risks, charges, expenses, and investment goals of the underlying investment options. This and other information about Pacific Life are provided in the product and underlying fund prospectuses. These prospectuses should be read carefully before investing.
Annuity withdrawals and other distributions of taxable amounts, including death benefit payouts, will be subject to ordinary income tax. For nonqualified contracts, an additional 3.8% federal tax may apply on net investment income. If withdrawals and other distributions are taken prior to age 59½, an additional 10% federal tax may apply. A withdrawal charge also may apply. Withdrawals will reduce the contract value and the value of the death benefit, and also may reduce the value of any optional benefits.
Pacific Life, its distributors, and respective representatives do not provide tax, accounting, or legal advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor or attorney.
Pacific Life is a product provider. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.
Pacific Life refers to Pacific Life Insurance Company and its affiliates, including Pacific Life & Annuity Company. Insurance products are issued by Pacific Life Insurance Company in all states except New York and in New York by Pacific Life & Annuity Company. Product availability and features may vary by state. Each insurance company is solely responsible for the financial obligations accruing under the products it issues.
Variable insurance products are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA) and an affiliate of Pacific Life & Annuity Company. Variable and fixed annuity products are available through licensed third parties.
No bank guarantee • Not a deposit • Not FDIC/NCUA insured • May lose value • Not insured by any federal government agency
For financial professional use only. Not for use with the public.