We have a combined pension and Social Security income of $8,400 per month that will only drop to $6,730 if one of us passes away. Our RMDs will start soon and we have $1.6 million in a 401(k) which we feel we can use a low-cost (expense ratio 0.12%) total return target fund to avoid the use of a robo-advisor that charges 0.3 – 0.8%. Plus, we have another $350,000 in Roths and a taxable brokerage account of $300,000 which RMDs would flow into. We own our home outright. In place of an annuity purchase can I simply use a target date fund in my IRA from which RMDs would be drawn automatically?
-JR
I hear a few different questions here, JR. First, should you purchase an annuity or rely on your investment portfolio? Next, is the cost of a robo-advisor worth it compared to a target date fund? And lastly, is a target date fund or robo-advisor sufficient for managing a portfolio like yours? Let’s dig into each of them to help you get some answers. (And if you need more help answering questions like these, consider speaking with a financial advisor.)
Annuity vs. Investment Portfolio
An annuity is a form of insurance. You purchase it with the expectation that over the long term, the cost will be greater than the benefit. But, as with other types of insurance, it protects against a key risk. In this case, that risk is the possibility of running out of money, especially if you live longer than expected.
A good, low-cost annuity can be a useful tool in many situations. In your case, however, my initial opinion is that it probably isn’t necessary.
You’ve built an impressive investment portfolio with ample assets spread across different types of accounts, which should theoretically give you a lot of flexibility to manage your income needs in a tax-efficient manner. And with your pension and Social Security income, you already have tools that function like an annuity in that they will provide a dependable stream of income for the rest of your life.
While there are plenty of details about your situation that I don’t know, it seems to me that relying on your investment portfolio instead of purchasing an annuity would be a reasonable approach. (But if you have more questions about annuities and other financial products, consider reaching out to a financial advisor to talk about them in greater detail.)
Target Date Fund vs. Robo-Advisor
Within tax-advantaged accounts, such as an IRA, I don’t personally consider there to be much of a difference between robo-advisors and target date funds or other all-in-one funds. Both make it easy for you to invest your money in a well-diversified portfolio that is managed for you. In both cases, it comes down to finding the right fit for your goals, risk tolerance and fee preferences.
To answer your question directly, it’s perfectly reasonable to use a target date fund instead of a robo-advisor. You can get a very similar portfolio at a lower cost, which can make a big difference over the years.
With that said, there are two main things to consider.
First, make sure you’re picking a target date fund based on your personal goals and risk tolerance and not simply choosing the one that lines up with your age or year of retirement. This is also a decision that will need to be re-evaluated regularly since target date funds typically change their asset allocation over time, and those changes may or may not align with your situation.
Second, robo-advisors can have an advantage over target-date funds within taxable accounts. They are often smarter about things like tax-efficient rebalancing and tax-loss harvesting, both of which can help reduce your costs and increase your investment efficiency. (And if you’d prefer a person to manage your IRA and other assets, this free matching tool can connect with financial advisors who serve your area.)
The Value of a Good Financial Advisor
With all of that said, your situation could benefit from working with a good financial advisor, particularly one with strong investment and tax management experience.
You have significant assets spread across three types of accounts with very different tax characteristics: a 401(k), a Roth IRA, and a taxable brokerage account.
You will also be navigating significant required minimum distributions (RMDs), in addition to your consistent pension and Social Security income, with critical decisions around how much to withdraw and how to invest that money.
This is exactly the kind of situation where things like asset location and tax-efficient withdrawal strategies can make a huge difference. According to Vanguard’s research, a good financial advisor can add up to 0.60% of annual value through asset location strategies and up to 1.20% of annual value through smart spending strategies.
You have enough money in various buckets that the cost of a good financial advisor could be well worth it. In my opinion, neither a target date fund nor a robo-advisor is going to manage all of your assets anywhere near as efficiently as a true expert can. (And if you need help finding an advisor, try SmartAsset’s free matching tool.)
Bottom Line
To sum it up, yes, it seems reasonable to rely on your investment portfolio instead of purchasing an annuity. Also, a low-cost target date fund chosen based on your goals and risk tolerance, rather than relying solely on retirement year, is a reasonable alternative to a robo-advisor. However, I also imagine that you could greatly benefit from working with a good financial advisor who understands the nuances of asset location and tax-efficient withdrawal strategies. At the very least, I would encourage you to have a few conversations with advisors to see if you can find a good fit.
Tips for Finding a Financial Advisor
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As you set out to hire a financial advisor, it’s important to do your due diligence. From their fees and services to their certifications and disclosure history, there’s a lot to consider and research about advisors. That’s why we put together the ultimate guide for how to find and choose a financial advisor.
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Matt Becker, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email [email protected] and your question may be answered in a future column. Questions may be edited for length or clarity.
Please note that Matt is not a participant in the SmartAdvisor Match platform, and he has been compensated for this article.
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