When dealing with percentages and asset-based fees, an offer that sounds good at first may turn out to be not so great, depending on where you are in your retirement savings journey.
As you accumulate savings, for instance, you’re looking to generate growth in your account, and so you may hire an investment adviser to help you make the best choices. Their fees are typically around 1% of the value of assets under management. Whether that sounds like a good deal probably depends a lot on how much money you have in your account.
That number seemed low to my personal trainer, for example: “Only 1% a year,” as he said. He doesn’t have a whole lot stashed away right now, so 1% is no big deal to him. But if you have $1 million to manage, you’d pay $10,000 — and more — each and every year. Quite a different story.
Looking at fees through the lens of income
That 1% fee sounds even worse when you look at it as a taking a cut from your income, rather than your savings. Here’s what I mean by that: Your perspective changes when you retire, as you create a plan to generate income and/or make withdrawals from your savings. Many retirees go by the “4% rule,” which says that you can withdraw 4% of your portfolio each year without serious concerns of running out of money in retirement.
Let’s be generous and take 4.5% out of our $1 million in savings, generating $45,000 in income. Suddenly that 1% fee ($10,000) represents more than 20% of your income ($45,000). That doesn’t seem low anymore. Especially now that advisory fees are no longer tax deductible.
And portfolio expenses don’t just come from advisers. Mutual funds and ETFs usually impose asset management fees as well. Those expenses all come out of the growth of your account and will eventually reduce the amount of money you can withdraw.
How can you cut those costs?
Income allocation is a good starting place. Whether you express fees as a percentage of savings or as a percentage of income, it’s the dollar amount that counts.
However, a plan that’s built around income is most effective when it considers fees in relation to the sources of income. In our $1 million example, a female client age 70 has an income allocation plan that provides $46,000 in annual income at the start, from the following sources:
- $7,500 from dividends
- $6,100 comes from interest
- $18,100 from withdrawals from savings
- $14,300 from annuity payments
She also has $24,000 in Social Security per year, for a total income of $70,000.
What are reasonable fees?
I suggest somewhere between 5% and 10% of income — remember, it’s income we’re talking about here, not assets under management — or between $2,300 and $4,600 per year, based on the $46,000 in income that she is drawing from her portfolio. Substantially less than the $10,000 per year someone would pay on a $1 million account that carries a typical 1% fee.
Is that level achievable? I believe so, and let me give you an example:
- Our $1 million client has devoted $335,000 to generating annuity payments. She invests the remaining $665,000 in a combination of high-dividend, bond and balanced portfolios of ETFs and index funds.
- The asset management fees for these portfolios average 0.15%, or around $1,000 in the first year. The platform imposes no trading costs.
- She uses a robo-adviser or a low-fee adviser who helps her with portfolio selection, rebalancing, substitution, withdrawals, etc., and pays 0.25% or around $1,600 in the first year.
- There are no ongoing fees attached to the annuity payments. All commissions and administrative costs have been built into the pricing of annuity payments.
- Depending on her comfort with managing her income plan, she may want to elect a plan management service for, say, $600 per year.
- The total is $3,200 for a full-service plan.
Importantly, our client is willing to accept the market returns rather than have her adviser pick individual stocks or bonds. And she likes the guarantees that annuity payments bring. Finally, she is focused on securing her income and less concerned about maximizing her legacy.
When you think of fees coming out of income and not savings, then you’re getting the growth — particularly from your dividend portfolio — free of charge. And if you start with fees at, say, 5% of income in the first year, you can expect the percentage to decrease over time as annuity payments become a larger percentage of the total. Studies we’ve done show that fees that start at 5% can fall below an average of 4% over a lifetime.
What about income taxes?
Think about taxes as another deduction from income. Focusing on sources of income, as I advocate with an income allocation plan, can help you reduce your tax bill. As I wrote previously, a well-planned approach can keep your retirement tax rate below 10%.
One tax-saving idea: Consider investing the maximum amount allowed from your IRA or 401(k) savings into a Qualifying Longevity Annuity Contract (QLAC). As I explained in this article, that investment will decrease the amount of taxable Required Minimum Distributions you must pay yourself when you reach age 70½.
Again, just as with fees, think of taxes as a percentage of income, and try to get the percentage as low as possible. Fees at 20% and taxes at 10% mean 30% of your income is not yours to spend.
In contrast, 5% in fees and 5% in taxes means that only 10% has gone to third parties and the government. That’s a reduction of two-thirds.
How to use this information
Educating yourself about your financial opportunities and options is not as difficult as it may seem. Start by reading some of my previous columns and visit Go2Income.com (opens in new tab) to learn more about income allocation.
And in your planning and discussions, you can use the income numbers generated by the income allocation plan as a benchmark against which to compare whatever your adviser suggests.
Make sure you have a full understanding of the fees and income taxes that will reduce your spendable income. Don’t be afraid to ask questions. These answers may make a difference in your secure retirement.
Jerry Golden is the founder and CEO of Golden Retirement Advisors Inc. (opens in new tab) He specializes in helping consumers create retirement plans that provide income that cannot be outlived. Find out more at Go2income.com (opens in new tab), where consumers can explore all types of income annuity options, anonymously and at no cost.