What Are Buffer Assets?
During the decumulation phase, one of our top priorities is to protect the equity engine that drives long-term returns. Buffer assets give us a way to put the withdrawal strategy on "pause" when portfolio values are down. This can potentially increase the duration of the plan and reduce the likelihood of running out of money before you run out of time.
A buffer asset is best described as an asset that is not correlated to traditional markets. In other words, it does not respond to fluctuations in the stock or bond market. The idea is simple, when stocks move higher, the annual return creates the necessary value to support the spending goal. When stocks move lower, however, it becomes necessary to spend principal in order to create the "paycheck". A buffer asset is something that can be tapped when equity markets are down to avoid the erosion of capital that occurs when stocks are sold at a loss to fulfill the spending goal.
Buffer assets give us a way to put the withdrawal strategy on "pause" when portfolio values are down.
Types of Buffer Assets
Cash value Whole Life Insurance
The cash value component of the insurance policy is available for "withdrawal" once it has accrued. This process is technically a loan and can either be repaid when portfolio values have recovered or reduce the death benefit of the policy. As an added benefit, this withdrawal will be tax free assuming there is still basis in the contract.
A bucket strategy is essentially a way to divide an investment portfolio into segments, each having a specific purpose. There are numerous iterations if this strategy but the underlying goal is to have a safety bucket containing 2-5 years of "cash" to cover near-term spending needs. The remaining portfolio is used to replenish the safer buckets when markets are up and can be left alone to recover when markets are down.
Having annuities in a portfolio can change the dynamic of the overall asset allocation in several ways. While this discussion could take up an entire blog post on its own, I would be remiss if I failed to at least mention the two (arguably) most relevant annuities to this discussion. The immediate annuity can be used at the start of retirement to create a "floor" of income. When combined with Social Security, this floor can be considered the worst case scenario. If the investment portfolio goes to zero, the income from the annuity and Social Security would still remain. Before retirement begins, the guaranteed income rider on a variable annuity can also function as a risk buffer. The income base value often has a minimum annual credit and is guaranteed by the insurer not to reduce in value if no early withdrawals are made. Planned correctly, the guaranteed distributions can begin at or soon after retirement and function in the same manner as the immediate annuity.
How To Choose
Choosing how, when and why to use a buffer strategy boils down to personal preference. The more risk an investor chooses to take on, the less aggressive the buffer asset needs to be. Some will choose to forgo the buffer asset altogether in hopes of achieving the most upside for the portfolio. Others choose to transfer all their retirement income risks to one or more insurance companies and live on a fixed income. No single buffer asset is perfect for everyone. Achieving a long, happy retirement is a balancing act and will likely include some combination of several different strategies.
All product guarantees, including optional benefit riders, are based on the claims paying ability and financial strength of the issuing insurance company. The optional riders associated with variable annuities carry additional costs and have restrictions. The riders are only available through the purchase of a variable annuity contract, and they must be utilized within the specific confines of the individual contract and may be voided if these guidelines are not followed. Please see the prospectus for complete details.
Investors should consider the investment objectives, risks, charges, and expenses of the variable annuity and the underlying subaccounts carefully before investing. The prospectus contains this and other information about the variable annuity. Read prospectus which should be read carefully before investing or sending money.
Investments in securities do not offer a fix rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and, when sold or redeemed, you may receive more or less than originally invested. No system or financial planning strategy can guarantee future results.