Understanding the importance of financial flexibility and liquidity

Doug Horn

In recent weeks while assisting new clients it has been surprising to me the lack of liquidity some retirement portfolios provide. Since a large portion of my practice is working with those who have retired, it is my preference to make sure sufficient access is available to meet the needs of retirees.

While life happens to everyone, money set aside in an emergency fund may be adequate for most of us, but for retirees the demands can be much larger and may be ongoing. With a change in health, the monthly medical expense can go up significantly should one or more medications be required, especially when the cost is not covered entirely by insurance. Unless money has been invested in their home over the years, it is likely some retirees may face costly home improvement expenses or major repairs. A change in health may also create the need for long term care. This can be private care in the retiree’s home, or through one of the many types of facilities. When this occurs, the need to access investments is critical and the ability to wait for specific time periods or anniversaries to occur may not be possible.

Many investments have surrender fees or have limited ability to convert to cash. While most of these investments may be appropriate choices for retirees, this would be true only when the investor has sufficient access to cash elsewhere. Some of the investments that may limit access are annuities, certificates of deposit, REITs (real estate investment trusts), and limited partnerships. While each of these impose a different level of restrictions, the cost to liquidate from the investment may range from tolerable to obscene. It is critical for investors to understand and review the actual fee that may be charged should the need arise to liquidate.

In today’s environment, certificates of deposit will most likely have the lowest fee to surrender. For many seniors, when the CD is a retirement certificate there may not be a fee to cash out early. As simple as CDs are, annuities may be the most complex. There are actually four types of annuities and each offer different rules when it comes to liquidation. Once an annuity has been annuitized or is an immediate annuity, the ability to convert the account to a lump sum of cash is lost. Deferred, variable, and equity index annuities generally offer a reducing surrender fee based upon the product’s anniversary. With the large number of insurance companies and product which exist, it is impossible to share the standard since one does not exist.

From my personal experience, any annuity offering a bonus when purchased, generally has a surrender schedule which is longer by two to three years than the product without the bonus payment. While I prefer to see annuity products with systamatic reduction in the fee for each passing anniversary, there are annuity products which retain a high fee for two to five years and even longer before it starts to decline. There are even equity index annuities that do not permit the lump sum transfer or liquidation. To fully recover the value in these products my experience has been they must be annuitized and payments taken over a five to ten year period. Most variable annuities offer a five to eight year declining surrender schedule. Shorter schedules exist, but a higher annual fee may be charged for the life of the product making the election of the short surrender schedule too costly.

Companies offering REITs and limited partnership programs may also offer liquidation opportunities for the investors. However, these redemption programs can be suspended and generally reduce the profitability of the investment when exercised.

Thus, for retirees it is critical to anticipate future emergency cash needs and structure portfolios where these needs can be met without high fees and expenses. Depending upon the source of monthly income and other factors about the investors, a safe rule-of-thumb would be no more than twenty percent in illiquid investments such as the REITs or limited partnerships. Products such as the annuities offering limited initial access to cash, but full access in less than nine years can comprise a large share of the balance of the portfolio. However, this should be reviewed carefully and such factors as age, health, and whether the investor has significant monthly income or long term care insurance should factor into the decision.

For assistance with portfolio allocations, insurance, estate planning, or investment management contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our learning center on our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other free tools.

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