Thursday, August 28, 2014

Part I: Income Preservation vs Wealth Preservation

Part I: Income Preservation vs Wealth Preservation
aka Puttin’ It In & Takin’ It Out

            Despite perfunctory winks and nods, all (99.99%) of personal financial planning is about ‘more.’ By external relative comparison more validates worthiness – yes, one’s worthiness in this model/heuristic. Thus, the change and acceptance thereof of income preservation as the primary objective – especially at the dilution & consumption of ‘net worth’ - instead of wealth preservation is a tough transition for most (as well as so called personal financial on a percentage of assets under management compensation mode the higher the assets under management the greater the planner’s compensation; the lowering of assets under management reduces the asset under management compensation of the planner).
            So, the transition and realignment of resources for income preservation usually comes at the expense of more, more, more while explicitly and or implicitly induces the feeling expressed or unexpressed irrationally of being less  - given the ‘lessening’ of net worth and the hardwiring and acceptance of the ‘more’ heuristic.

            A case in point: annuitization.
To annuitize is to convert a sum of money (from capital that has been accumulated) into a series of payments. For example, an investor may pay a sum of money in return for payments of a fixed or inflation adjusted amount for a fixed period of time or a lifetime of monthly payments. However, once the annuitant or annuitants (in the case of a joint and survivor annuity) die unless there is a period certain of annuity payments regardless of annuitants living – the annuitant and any residual accumulation is forfeited to the insuring insurer.
That’s right that $50,000, $100,000, $1,000,000 plus is gone once you are gone except in the cases stipulated above (which lowers the annuity payment during life.)

People hate insurer issued annuities (and well they should –which are a rip off with 2-3% going to fees annually – and variable annuities are worse).
But the concept of annuitization in personal financial planning relative to enough for income preservation is ‘worth’while.
One can do their own ‘annuitization,’ however, as some self serving brokers will state accurately but incorrectly (as a lawyer friend of mine use to say), you still have the risk of mortality and outliving your own annuity.
As far as mortality risk (some annuities pay up at death – not usual but some for a price do) better to have your own much much cheaper life insurance (assuming insurability (1)) than the cost of mortality insurance inside the annuity.
Relative to ‘outliving’ the self funded annuity – that is a question of planning and one’s tolerance for risk relative to the goal. After all, even with state’s limited annuity pool guarantees, insurance companies regardless of AAA+ ratings go down or are merged out to hide that they are going down – delaying annuity payments (remember Mutual Benefit Life’s AAA+ rating as well as New England Life and Confederation Life – Mr. Broker?).
Annuities are really just a wrapper around bonds and income investments though variable annuities have equities inside as well. The only distinction is that – and assuming the insurer doesn’t go down – that the payments will continue – you can’t outlive them for which you pay a heck of a premium – commission (on the purchase or in surrender) and 2-3% every year.
Thus, an alternative privately created ‘variable annuity’ is buying Berkshire Hathaway B  and say a balanced or income oriented mutual fund like Vanguard Wellsley in equal portions over a 3 or 5 year period to minimize ‘interest rate risk’ along with a term life insurance policy to cover ‘mortality risk.’ After all, what do you think the insurers are buying for an immediate fixed annuity or a variable annuity?
So, annuities suggested by a planner (there are exceptions) is buy and large an indication of a lazy ‘so called’ planner.

Still, the overarching problem is the fear of outliving one’s money and therefore irrationally choosing wealth conservation at the expense ironically of the income preservation for not outliving one’s resources!

Income preservation methods (many) aka ‘putting it in and taking it out” (not code for personal financial pornography) will be the subject of the next post.

(1) What most insurers don’t tell those with higher mortality risk (and most planners don’t know) is that there are impaired risk annuities which have higher payouts based to the fact those impaired risk potential annuitants will have shorter longevity and thus the payout period would be less than normal