Taking Care of Mom and Dad: Other Approaches

There are other strategies that lessen the risk of outliving their portfolio -- of course, each of these poses different risks of its own. But, they are worth considering. The options include:

Income for Life. During the 1990s and early 2000s, immediate-fixed annuities became a popular choice among financial advisers. In its simplest form, an immediate annuity involves your parents handing over a chunk of money to an insurance company. In return, they get a check every month for the rest of their lives.

In most cases, an annuity pays more than your parents could get by putting the same money into safe fixed-income investments.

Of course, your parents have to give up access to their money in order to get these better returns.

The question with annuities comes back to mortality. If you think your parents are going to live a long time, you need to make sure they transfer their assets to an annuity. They may want to keep some of those assets outside the annuity in order to meet unexpected expenses, fund occasional splurges...or provide for heirs like you. As we said in Chapter 6, lumping their tax-deferred, defined contribution plans together into one account and then purchasing an annuity with those funds is a smart move.

Another big problem is inflation, which can gradually erode the value of an annuity's fixed payments. Because of inflation and because of the risk that your parents don't live long enough to get much benefit from an annuity, they might put just 25 or 30 percent of their retirement nest egg in one of these products and then invest the rest in a mix of stocks and bonds.

Lifestyle Based on Income. An old financial rule of thumb says you can spend your dividends and interest income, but you should never touch your capital. Some call it clipping coupons. And, in many ways, this is just a conservative version of the critical mass approach.

This is the strategy that most people have followed in the past and it's still used by many retirees -- even those who can't articulate their spending discipline. But it's a very conservative approach.

If your parents are heavily invested in stocks, they may find that their portfolio generates scant spending money. Stock dividends have generally gone down as a percent of stock price over the years, as companies have put more emphasis on maintaining earnings for future growth instead of paying dividends. This makes some sense because, from a corporate perspective, dividends are taxed twice -- once as corporate income and once as individual income to the investor receiving them.

They could, of course, compensate by putting more in bonds...but this could leave them vulnerable to inflation. If their interest income doesn't grow and inflation runs at a modest 3 percent a year, the spending power of their interest income will be cut in half after 23 years. And there's another drawback: By refusing to dip into principal, your parents may force themselves to scrimp unnecessarily. In Chapter 10, we'll look into some lifestyle changes that your parents may have to make, no matter which income option they choose to follow, if they find their cash flow thinning...and life going strong.