You may often hear clients say, “I want to keep my money liquid, I don’t want to tie it up.” The desire to keep money liquid can be strong across all socioeconomic and political spectrums. Why do many clients insist on keeping out money in a liquid state? And what does that really mean, to keep money liquid?
Think of Money as Water
If water isn’t confined to a vessel, you might find it running all over the place and eventually evaporating into thin air. Like water, money must also be kept in some sort of vessel - like a bank account, brokerage account, or coffee can. But if money is in a coffee can, is it really liquid? Do clients have the choice to do anything they want with it whenever they want to? Maybe, then again, maybe not.
Timeline and Purpose
To determine if money is truly liquid, consider whether those resources have a timeline and purpose. What is the purpose for the money, and in what time frame do clients need it to be available for that purpose? Does the coffee can provide true liquidity then, or just the illusion of it?
When a client says, “I don’t want to tie my money up, I want to have it liquid,” they are most likely referring to having the flexibility of choice, to choose one container over another in which to hold their money. They want to be able to pour it into something else they perceive to be a better basin for their dollars, if the opportunity arises.
Savings accounts are considered liquid since clients can draw on that bank account whenever they feel like it. They can take money from one account and transfer all the money over to another account. Or perhaps your clients prefer mutual funds since they can choose to buy one mutual fund today and sell it tomorrow to buy another one. They could also sell it and do something completely different altogether with that money. Again, their money may appear to be liquid... But is it?
Restrictions on Liquidity
Some vessels with penalties for making early withdraws could be considered to be illiquid. Real estate, depending on the market, may be very illiquid. It might be difficult to find a buyer, let alone at the desired price. Limited partnerships are also considered to be illiquid and could be very difficult to liquidate in order to move money somewhere else. Deferred annuities could be considered illiquid because they often carry steep surrender penalties that may be applied for excessive and early withdrawals.
So, is money in a savings account or bank money market account completely liquid if your client intends to use it to purchase a new car or buy groceries? What about the retirement savings specifically set aside to cover retirement expenses 20 years from now? Your clients may have been keeping it in a portfolio of mutual funds and stocks thinking they were keeping it liquid... but are they?
If resources have been designated with a specific purpose and a timeline, those dollars are not truly liquid. What clients have is what's more accurately described as allocation liquidity. They have the choice to allocate those dollars in many different investment and savings vessels, but cannot spend it without future repercussions. Dollars that are truly liquid are excess resources. When clients have accumulated enough resources to cover current and future expenditures, anything left over could be liquid and used for whatever they want.
So, how can you help your clients get more actual liquidity? Many clients during retirement are holding retirement assets in places that appear to be liquid, but they can’t spend the retirement assets without future consequences.
For a hypothetical example, let’s consider a 65-year-old couple with $1 million in retirement assets preparing for 30 years of retirement. Their financial professional recommends they apply the 4% Rule, first introduced by William Bengen in 1994 to an asset allocation of stocks and bonds. The widely adopted “rule of thumb” known as the 4% Rule has represented the benchmark for a “safe” withdrawal rate in retirement for decades. That means the initial withdrawal from this strategy would be $40,000 adjusted for inflation.
How safe is the 4% Rule?
The 4% Rule may not be as safe as once thought. Several prominent studies show the rule to have a failure rate as high as 50%, meaning that a retiree following the rule may have a 50/50 shot of not running out of money over a 30-year period. I don’t know about you, but if the plane I’m taking has a 50% shot of making it, I’m not getting on it!
The percentage of assets that may be safely withdrawn is debatable. However, what is not debatable is that the strategy holds retirement assets in a state that is not truly liquid because they have already been assigned for a future purpose.
Is it possible to create true liquidity in this situation?
A Single Premium Immediate Annuity (SPIA), for example, could cost around $650,000 to produce a lifetime income stream equal to $40,000 for this hypothetical 65 year old. It may also include a guarantee where at minimum, all money paid for the product would be refunded to a surviving spouse under a cash refund option, if the other spouse dies prior to receiving 25 years of payments. What are the chances that this annuity owner outlives his income stream? A zero percent chance, not 50%. Implementing a strategy like in this example could mean $350,000 is left over. Some of the money may have to be used to adjust for inflation, but there’s the potential for some of it to be truly liquid and used however and whenever.
Giving up control of some retirement resources may be scary for a lot of clients. However, once your clients come to grips with the fact they may not have as much liquidity as they originally thought, it could open their eyes to other ways to generate true liquidity from their available resources.
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