Connect with us

Investing Insights

A New Approach to Gamma Using Tax-Efficient Investing to Solve the Retirement Income Challenge

Published

A New Approach to Gamma Using Tax-Efficient Investing to Solve the Retirement Income Challenge

“The retirement income challenge is very real,” says David Reyes, Founder and Chief Investment Officer of Reyes Financial Architecture. “Morningstar came out with a report last year discussing the rate of withdrawal for retirement income. When I started in this business, it used to be 5%, then 4%. But now, Morningstar says it’s 2.8%. How many investors have enough saved to live on 2.8%?”

“Morningstar also introduced a new approach to using Gamma, as a way to measure the added value of making smart financial decisions to increase retirement income. Their new research,Alpha, Beta… and Now Gamma, shows how a tax-efficient asset location strategy can add 320 bps of additional retirement income—every year. That’s why we use tax deferral to help clients accumulate more—and generate more retirement income. And that’s where Jefferson National provides the competitive advantage.”

To learn more about leveraging tax deferral to generate more Gamma and meet the retirement income challenge, we had a conversation with Reyes about his unique approach to tax efficient investing:

Q: WHAT FACTORS ARE DRIVING THE RETIREMENT INCOME CHALLENGE?

A: Talk to almost any investor about retirement and they’ll tell you their number one fear is outliving their retirement savings. They’ll tell you that the retirement income challenge is very real.

It’s real because we’re facing huge challenges as a country— a huge national debt, an eroding safety net, huge obligations that are underfunded on a national level, such as Social Security, Medicare, Medicaid, and underfunded pensions in major municipalities, like Detroit. Those are big problems. Finally, we are still at historically low interest rates. But when interest rates and inflation start rising, watch out.

Q: GIVEN TODAY’S RECORD LOW RATES, WHAT IS YOUR SOLUTION FOR USING BONDS IN CLIENTS’ PORTFOLIOS?

A: Right now, we’re not a big fan of bonds. For the most part, we believe many investors currently are over-allocated to fixed income. There is tremendous interest rate risk, and fixed income may not provide the expected shelter. Any upward push will have an outsized, negative impact. Warren Buffett said it better than I when he stated in one of his annual reports, “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”

But we will buy bonds tactically for clients. Buy in when prices are rising, and move to cash or cash alternatives when prices decline. To optimize tactical fixed income strategies, we use a tax-deferred wrapper like Jefferson National to mitigate taxes when bonds generate ordinary income—and to mitigate the taxes on any short term capital gains from tactical moves. In a challenging fixed income market like the one we face today, using asset location to increase Gamma is more important than ever.

Q: SO WHAT ARE YOUR OTHER SOLUTIONS TO INCREASE GAMMA AND HELP YOUR CLIENTS GENERATE MORE RETIREMENT INCOME?

A: The solution really is to get back to a fundamental investing philosophy that we practice at our firm—we believe you’ve got to protect assets first.

Number 1, you’ve got to mitigate taxes. Pay attention to things like the health care surtax. Use strategies like asset location and tax-loss harvesting. Use tax-deferred and tax-free vehicles to control not only how much you pay in taxes, but when you pay taxes.

Number 2, maximize Social Security. I do a lot of education around maximizing Social Security and integrating it into retirement income planning. More people need to understand that if you are willing to wait, Social Security actually pays you between 6% to 8% per year to wait. What other asset do you have that guarantees you a 6% to 8% rate of return, plus cost of living? None. So you want to maximize that asset.

To optimize tactical fixed income strategies, we use a tax-deferred wrapper like Jefferson National to mitigate taxes when bonds generate ordinary income— and to mitigate the taxes on any short term capital gains from tactical
moves. In a challenging fixed income market like the one we face today, using asset location to increase Gamma is more important than ever.

Number 3, protect downside risk through active risk management. That’s what I call “unconstrained investing.” We can buy and sell into whatever we want, whenever it makes sense, in order to mitigate risk. We can go to cash if we want to go to cash. We can go to another asset class when opportunities arise, when conditions call for it. And when we do this type of tactical investing, asset location is key.

So before we even talk about other solutions, just those three strategies alone—mitigating taxes, maximizing social security, and managing risk with unconstrained investing and asset location— we’re doing those three things proactively to protect assets, to maximize accumulation and ultimately to generate more retirement income. And this approach that we’ve been using for years, ties right into the industry’s new concept of Gamma.

Q: TALK MORE ABOUT UNCONSTRAINED INVESTING AS A SOLUTION FOR THE RETIREMENT INCOME CHALLENGE.

A: Most of our clients have “already won the game” or they are very close. What I mean by that is they have already accumulated enough assets or are getting close to their goal, but need high-level retirement income planning to ensure that they will have enough income to last a lifetime. Just like in sports “a good offense is a great defense,” that is why we first focus on downside protection. As an example, if you only participated in 30% of the upside of the S&P— and avoided all of the downside—you would beat the S&P.

To manage risk, most advisors only use traditional asset allocation. At Reyes Financial Architecture we enhance this approach by implementing three additional strategies to proactively manage risk: Active unconstrained/tactical management of a portfolio, active hedging of portfolios, and guaranteed income strategies such as fixed annuities.

Specifically regarding unconstrained tactical investing, you can have more exposure to the markets when your rules dictate, and you can be more defensive using cash as an asset class to help mitigate risk in market downturns. Through the use of these strategies combined with the proper use of asset location we can significantly raise that 2.8% rule of thumb and give our clients more income to last their lifetimes. As a firm we believe these are much safer strategies.

But tactical investing is an active approach. It can generate a lot of taxes and that can beat the life out of a portfolio. Tactical solutions are not efficient unless we can manage the taxes. That’s where asset location and tax deferral becomes essential. And we use a variable annuity as the “tax protector” for the tactical piece of the portfolio. But only the right kind of annuity.

Q: WHAT IS THE RIGHT KIND OF VARIABLE ANNUITY FOR YOU TO USE AS A “TAX PROTECTOR”?

A: We’ve seen plenty of research to show that tax-deferral can help tax-inefficient assets improve by 100 bps or more—without increasing risk. As long as it’s a low cost tax-deferred vehicle. And now this new Gamma research shows how the smart use of tax-deferral can help generate 320 bps more retirement income. It adds value at every stage of managing the portfolio—from accumulation to decumulation.

That’s where Jefferson National provides the competitive advantage. Jefferson National has a tax advantaged solution that is ultra-low cost, with the most funds, and a very functional platform that supports hands-on asset management. It’s very easy to talk to a client about a strategy that saves them money and minimizes taxes without the high fees, penalties and surrender charges of a typical variable annuity.

When you combine all those things—the choice of funds, the tactical management, plus the tax deferral—you help clients accumulate more wealth for more years, and you help them generate more Gamma during the withdrawal phase, so you can actually increase their distribution rates to ensure that they can have a fighting chance against the retirement income challenge.

ABOUT REYES FINANCIAL ARCHITECTURE

Reyes Financial Architecture serves clients with an integrated, collaborative and multi-disciplinary approach to financial planning. Their services include investment planning, estate planning, asset protection, retirement distribution planning and a strong emphasis on tax planning. Reyes believes that to have a successful RIA firm you have to have a philosophy that is embedded in your culture. It can’t just be a tagline—it has to be real. Reyes planning philosophy is simple: Have no agenda other than that of their clients. To learn more, please visit then here.

For more information about Jefferson National, please visit us here.

Continue Reading

Trending