section 1 - The American College Online Learning Center

a. Inflation risk is best addressed through an approach that allows more of theclient’s assets to be invested in equities for a longer period of time. This wouldtypically be the systematic withdrawal and the bucket approach.b. The flooring approach does not typically provide for a hedge against inflationunless a cost of living rider is added to the annuity or a variable annuity is used.c. Planning Point: Cost of living riders are often capped at a stipulated percentage,which may be lower than actual inflation.d. A flooring strategy that relies on a delayed Social Security claiming for most ofthe flooring can be very effective because the Social Security benefit is adjustedfor inflation.4. Reinvestment riska. The bucket strategy will have the greatest difficulty managing reinvestment riskbecause the near-term bucket must be replenished with short-term investmentslike bonds, CDs, and other investments that are particularly sensitive toreinvestment risk.b. The systematic withdrawal strategy can also be subject to reinvestment risk but toa lesser extent than the bucket strategy.5. Liquidity and legacy riska. The flooring strategy creates the greatest liquidity and legacy risk problembecause of the use of an annuity to create the floorb. Systematic withdrawals preserve more liquidity than the bucket strategy becausetheoretically less of the investments are tied up in short-term, illiquid investments.However, this may not always be the case depending on the asset allocationmodel used.LO 6-5-2: Recognize common sense solutions1. Regardless of the approach or products used, set aside two-to-five years’ worth ofwithdrawals into low risk investments that can provide income in the short-term period.This avoids the need to draw down variable assets during a down market.a. This strategy is emphasized in the bucket approach. In fact, one could argue it isthe central point of the bucket approach. However, it can be easily implementedin the systematic withdrawal approach by tapping into the conservative partof the portfolio in down markets. It is less necessary in the flooring approachbecause fundamental spending has been secured in a manner that reducesmarket variability.b. This common sense solution illustrates both a strength and a weakness of theflooring strategy. By locking in flooring with a bond ladder, immediate annuity, oranother method, the client has secured assets to account for basic expenseswithout having to be concerned with market risk. On the other hand, if too manyassets are used to create the floor, the client is “missing out on” the samevariability that provides upside return potential to grow assets to be sufficient tosatisfy retirement income needs.2. Regardless of the approach or products used, use a sufficient amount of assets to providegrowth in the long-term. By investing in equities and trying to gain greater return throughgreater risk, the client is effectively addressing longevity risk, inflation risk, and other risks.a. This strategy is emphasized in a systematic withdrawal approach that calls forproper asset allocation over the long-term retirement horizon. The strategy is builtinto the bucket approach because the second and especially the third buckets are6.24