Five ways to boost retirement income

Managing a comfortable retirement for your clients is all about getting the most out of whatever portfolio has been built up to that point. That is why a diverse collection of safe, income-producing strategies is so important.
As witnessed over the past few years, markets move in cycles, which means that even in retirement, there can be opportunities for capital appreciation in addition to income yield. And the best way to ensure enough flexibility to move in and out of riskier assets and strategies is to establish a steady and predictable income stream that will enable clients to ride out a stretch of lean years.

The following are some examples of strategies that can provide the kind of stable income that appeals to retirement-age investors.

1. Immediate annuities. The single-premium immediate annuity represents the ultimate in predictable income. And growing demand from retiring baby boomers has led companies to make these products a lot more user-friendly.

Immediate annuities still come in all shapes and sizes, but the most basic version is best for those already in retirement. This means a no-load version, and skip the death benefit, as well as any fancy bells or whistles. Just lock in the income.

A current-market-rate example for a 70-year-old married couple is a 6.7% annual yield for life, which includes all fees.

Depending on the size of the initial premium, the annual income from a 6.7% yield might seem low, representing a non-inflation-adjusted annual income stream of $6,700 on a $100,000 one-time premium.

Ideally, the guaranteed income stream is enhanced by investments in some kind of capital appreciation strategy. For example, if half of a $500,000 retirement portfolio was used to purchase an immediate annuity, the 70-year-old couple could count on $16,750 in annual income, and the remaining $250,000 could be invested for capital appreciation.

The list of companies selling immediate annuities is long and growing. Some examples include The Hartford Financial Services Group Inc., New York Life Insurance Co., MetLife Inc., Nationwide Mutual Insurance Co. and John Hancock Financial Services Inc.

However, an “income stream for life” dries up if the insurance company providing the income goes belly up.

Because these annuities are not covered by a Federal Deposit Insurance Corp. guarantee, it might be prudent to diversify across multiple providers.

2. Individual bonds. Bonds are obviously a critical part of an income portfolio, but in a rising-interest-rate environment — which is likely over the next several years — individual bonds have a distinct advantage over pooled-mutual- fund strategies.

As opposed to bond funds, which are never as nimble as a separately managed and customized bond portfolio, the idea here is to shift the emphasis from risk tolerance to income objectives.

Asset Dedication LLC, one of the pioneers in the area of customized individual bond portfolios, borrows a page from the way pension funds forecast and plan for future liabilities.

Beyond a basic bond ladder, which might use long-term zero-coupon Treasuries to generate predictable retirement income, Asset Dedication uses a mix of certificates of deposit, agency bonds, municipal bonds, Treasuries and Treasury inflation-protected securities, all of which are designed to be held to maturity.

The key is maneuvering through various interest rate cycles that drive bond prices up and down, inversely to the direction of interest rates.

“In a declining-rate environment, we don’t have to hold a bond to maturity, but when rates are rising, we can hold to maturity,” said J. Brent Burns, Asset Dedication’s president.

Just like any other bond ladder strategy, the objective is to build a multiyear income ladder that has investments maturing at regular intervals, producing a predictable annual income stream.

3. Reverse mortgages. While reverse mortgages are still a long way from being the first choice for most retirement income strategies, they do represent an opportunity that is worth considering.

On the surface, the idea of enabling older homeowners to convert part of their real estate equity into tax-free income while staying in the home seems like a no-brainer.

The trouble is, since reverse mortgages started gaining popularity in the late 1990s, many senior citizens have been victimized by shoddy sales practices.

But as the 70 million members of the baby boom generation hit the qualifying age for a reverse mortgage (62), there is good reason to believe the forces of supply and demand will lead to significant improvements in the way these loans are sold, structured and maintained.

“It is still the Wild West, but over time, I believe competition and/or regulation will help reverse mortgages,” said Barry Glassman, president of Glassman Wealth Services LLC, a $300 million advisory firm.

“Until recently, reverse mortgages seemed like desperate measures, but they will become as common as immediate annuities,” he added.

There are multiple factors that determine how much income can be drawn from a reverse mortgage, including the location and value of the property, and the age of the borrower.

One reason reverse mortgages will continue to gain popularity among retired people is that unlike home equity loans or second mortgages, the loans are not structured based on income or an ability to make payments.

4. Convertible bonds. Investment-grade convertible bonds can introduce some capital appreciation to a portfolio heavy on income-producing intermediate-term bonds.

This is a strategy that can be easily accessed through a number of mutual funds, including the American Beacon Retirement Income & Appreciation Fund (AANPX), which was originally designed as an income vehicle for retired employees of American Airlines Inc.

The bulk of the income is generated through a 75% allocation to government, agency and corporate bonds, and the strategy taps into some equity market sensitivity through a 25% allocation to convertible bonds.

Just like the rest of the bonds in the portfolio, the convertibles generate a steady stream of income. But they also can be a source of capital appreciation if they are converted to equity when the issuing company’s stock price rallies.

The convertible bond, as a kind of hybrid security, will pay a lower coupon yield than a more traditional fixed-income security, but the appeal in this instance is the potential for capital appreciation with limited risk.

Essentially, if the stock rallies, the convertible acts like a stock, but in any other circumstance, the convertible acts like a bond, characterized by the risk associated with default.

“If the stock price goes lower, you still get par value, plus the income, and if the equity markets go up, you can participate because it converts into a stock,” said Wyatt Crumpler, vice president of asset management at American Beacon Advisors Inc., which has $44 billion under management.

5. Master limited partnerships. A recent trend toward the packaging of master limited partnerships into mutual funds, exchange-traded notes and exchange-traded funds is introducing a viable way to hold these higher-yielding investments in qualified retirement accounts.

While most MLPs trade on exchanges and can be purchased directly, they also come with complicated tax consequences related to their energy transportation partnership structures, which can include paying taxes even on MLPs held in qualified retirement accounts.

The overall market is still small — there are fewer than 80 MLPs — but as the financial services industry continues to find ways to package them into investible portfolios and indexes, they are morphing into straightforward income vehicles.

In May, SteelPath Fund Advisors — a spinoff of MLP index provider Alerian — launched three mutual funds that invest in MLPs: SteelPath MLP Income Fund (MLPDX), SteelPath MLP Alpha Fund (MLPAX) and SteelPath MLP Select 40 Fund (MLPFX).

Last month, Alerian launched the first ETF investing in MLPs, Alerian MLP ETF (AMLP).

There are also at least three exchange-traded notes investing in MLPs: JPMorgan Alerian MLP Index ETN (AMJ), UBS E-Tracs Alerian MLP Infrastructure ETN (MLPI) and Credit Suisse Cushing 30 MLP Index ETN (MLPN).

MLPs are generating annual yields in the 6% range. But as packaged products, they are likely to draw more interest from individuals and even institutional investors.

The percentage of institutional ownership of MLPs reached 20% in August, up from 10% at the start of the year, and that’s the kind of activity that can drive capital appreciation.

“There will be institutionalization of MLPs the same way it happened to [real estate investment trusts],” said Pamela Rosenau, a managing director at HighTower Advisors LLC, which controls $16 billion in client assets.

E-mail Jeff Benjamin at jbenjamin@investmentnews .com.

Related Topics: ING Group