When dealing with percentages, an offer that sounds good at first may turn out to not be so great, depending on where you are in your retirement planning.
As you accumulate savings, for instance, you’re looking to generate growth in your account and so you may hire an investment advisor to help you make the best choices.
Their fees are typically around 1%.
That number seemed low to my trainer, for example: “Only 1% a year,” as he said.
(Of course, on $1 million of savings, you would pay $10,000 – and more – each year.)
What about when your main objective is retirement income?
Your perspective changes when you retire, as you create a plan to generate income and/or make withdrawals from your savings. Let’s be generous and take 4.5%, or $45,000, as your target income for your $1 million in savings.
Suddenly that 1% ($10,000) represents more than 20% of your income. It doesn’t seem low any more. Especially now that advisory fees are no longer tax deductible.
And expenses don’t just come from advisors. Mutual funds and ETFs usually impose asset management fees as well. Those expenses all come out of the growth of your account and will eventually reduce the amount of money you can withdraw.
What approach would be more reasonable?
An income allocation plan is a good starting place
Whether you express fees as a % of savings or as a % of income, it’s the dollar amount that counts.
However, the plan that’s built around income is most effective when it considers fees in relation to the sources of income.
In our $1 million example, a female client age 70 has an income allocation plan that provides $46,000 in annual income at the start, from the following sources:
- $7,500 from dividends
- $6,100 comes from interest
- $18,100 from withdrawals from savings
- $14,300 from annuity payments
She also has $24,000 in Social Security per year, fora total income of $70,000.
What would be reasonable fees for that result?
I suggest somewhere between 5% and 10% of income, or between $2,300 and $4,600 per year. Substantially less than $10,000.
Is that level achievable? I believe so, if the investments are in ETFs or index mutual funds. Importantly, when you think of fees coming out of income and not savings, then you’re getting the growth, particularly from your stock dividend portfolio, free of charge.
And if you start with fees at, say, 5% of income in the first year, you can expect the percentage to decrease over time as annuity payments become a larger percentage of the total. Studies we’ve done show that fees can fall below an average of 4% over a lifetime.
What about income taxes?
Think about income taxes as another deduction from income. Focusing on sources of income, as I advocate with an income allocation plan, can help you reduce your tax bill. As I wrote previously, a well-planned approach can keep your retirement tax rate below 10%.
One tax-saving idea: consider investing the maximum amount allowed from your IRA or 401(k) savings into a Qualifying Longevity Annuity Contract (QLAC). As I explained in this article, that investment will decrease the amount of taxable Required Minimum Distributions you must pay yourself when you reach age 70½.
Again, just as with fees, think of taxes as a percentage of income, and try to get the percentage as low as possible. Fees at 20% and taxes at 10% mean 30% of your income is not yours to spend.
In contrast, 5% in fees and 5% in taxes means that only 10% has gone to your advisor or government. That’s a reduction of two-thirds.
How to Use this Information
Educating yourself about your financial opportunities and options is not as difficult as it may seem. Start by reading some of my previous columns and visit Go2Income.com to learn more about income allocation.
And in your planning and discussions, you can use the income numbers generated by the income allocation plan as a benchmark against which to compare whatever your advisor suggests.
Make sure you have a full understanding of the fees and income taxes which will reduce your spendable income. Don’t be afraid to ask questions. These answers may make a difference in your secure retirement.
To learn more, visit the income allocation page at go2income.com or contact me at Ask Jerry, and I will answer your questions.