Although much has been written about basic tax and financial planning strategies during retirement -- budgeting, cash flow projections, taking distributions from qualified plans, and rolling 401(k)s or 403(b)s into IRAs -- a number of more sophisticated financial issues have received less attention. These include diversification of retirement investment portfolios, developing tax-efficient drawdown strategies and effective use of nonqualified annuities in retirement.

The ability to help address these topics with your clients is a powerful value proposition that can separate you from your peers.  By doing so, you can demonstrate a higher level of understanding about the advanced financial strategies that are necessary to help achieve all of your client's retirement goals. A great way to understand the importance of these complex issues is to look at a hypothetical example.

Our case study involves John and Mary Smith, both age 55, and married for 10 years after previous marriages. John is in his thirtieth year of working for ABC Corporation and Mary has been employed as a human resources specialist at a local company for nearly 20 years. They each have their own children and grandchildren.

John's corporate retirement plan allows him to retire with full benefits after 30 years, regardless of age. Mary would like to retire within the next 24 months. Both John and Mary would like to know that, when one spouse dies, the surviving spouse will have enough income to maintain his or her current lifestyle. At the second death, Mary and John want their four children to receive the residual financial assets.

Diversification Of Retirement Investment Portfolio
One of the first issues for John and Mary to address is how to diversify their investment portfolio. They have $5 million in investment assets, $4.6 million of which is in ABC or XZY stock and options on the XYZ stock. This represents 92.2% of their portfolio and the effective percentage is even higher, because the options provide tax advantages. Not only are John and Mary putting almost all of their eggs in stock and stock options, but the volatility associated with a concentrated portfolio drags down returns. They can help minimize this risk and increase expected returns by diversifying.

There are four general strategies for diversifying that we will focus on in this scenario:
1.    immediate sale of all stock followed by reinvestment
2.    staged selling
3.    hedging strategies
4.    charitable remainder trusts

The simplest way to diversify is to sell some of the concentrated investment assets and reinvest the proceeds in a diversified portfolio.

The best place to start may be with the ABC stock in John's 401(k) plan because it could be sold with no tax consequences and the full amount of the sale proceeds could be reinvested in other available 401(k) investment options.  Selling the rest of the ABC and XYZ stock outside of the 401(k) would require a trade-off. The capital gains tax payable on the sale would reduce John and Mary's current wealth, but their new portfolio would be expected to produce a higher return because of reduced volatility. While they would have a smaller portfolio in the short run, it is expected that the portfolio may grow at a faster rate with the diversification.

If John and Mary are uncomfortable about paying a large tax bill all in one year, have a psychological attachment to the stock, or the stock is subject to sale restrictions, they may wish to sell it gradually over a period of time. Though selling stock more slowly can have a greater upside potential compared with immediate sale of all stock, there is also greater downside potential for a lower median after-tax return (Boyle, P., Loewy, D., Reiss, J., and Weiss, R., "The Enviable Dilemma: Hold, Sell or Hedge Stock," The Journal of Wealth Management, Fall 2004), because you cannot predict the existing stock's value over that period of time. Thus, immediate selling may generally be a better alternative.

Some investors believe that certain hedging strategies can give them the best of all possible worlds - delaying taxes, protecting their downside, allowing them to retain some or all of the upside potential on the concentrated stock position, and permitting diversification. These strategies -- including buying a put, or option to sell the stock, a cashless collar, or a variable forward sale -- might be appealing to John and Mary if they are bullish on the short-term prospects for the ABC or XYZ stock and want to protect themselves while continuing to hold the stock.

Transferring the stock to a charitable remainder trust may be particularly favorable for John and Mary. One of their long-term financial goals is to benefit their favorite charity, and a charitable remainder trust would make lifetime payments to John and Mary which could give them some of the additional cash flow they will need after retiring.
Developing a tax-efficient drawdown strategy.

John and Mary's monthly income from their employer sponsored defined benefit plans is based on single life values at age 55. When they reach age 57, they want to begin using the defined benefit plans. At age 57, John and Mary will have a total of $118,800 of income each year from their defined benefit plans. They will also have income form Mary's deferred compensation plan and if John sells his stock and reinvests in a diversified portfolio, they may have additional income from interest and dividends.

When they reach age 62, they could augment their income with $43,032/year from Social Security. These sources may or may not be enough to produce their goal of $250,000/year after retirement. If they need additional income, they will have to:
1.    sell portfolio assets,
2.    obtain cash from cash settlement of John's stock options,
3.    withdraw from John's 401(k) plan, or
4.    withdraw from Mary's IRA.

So what is the best order to draw from these accounts?
To the extent possible, taxable accounts should be used before tax-deferred accounts like IRAs or 401(k) plans. The assets in tax-deferred accounts generally grow faster than assets in taxable accounts so it is important to preserve them. Moreover, distributions from a tax-deferred account are taxed at ordinary income rates up to 35 percent, while the sale of capital assets produces tax at a maximum rate of 15 percent in 2012 (these rates are currently scheduled to increase in 2013).

The question then becomes whether John and Mary should withdraw first from their newly diversified portfolio or tap the profits from John's stock options.

Harvesting the stock options is the better choice for two reasons. First, John must exercise the options or lose substantial value. For example, assuming a 40 percent combined federal and state marginal tax bracket, the income after taxes from a cash exercise would be $108,000 in 2013 (0.6 x $180,000), $140,000 in 2014, $90,000 in 2015, $18,000 in 2016 and $144,000 in 2017. For most of these years, this is likely enough to bring John and Mary's income up to the desired level of $250,000. Second, John and Mary want to avoid holding a concentrated portfolio, so they would rather sell off ABC and XYZ stock than assets from their newly diversified portfolio, even if they didn't have to do so to take advantage of the options.

In either case, the nonqualified diversified investment portfolio will not only have tax issues but may require money management -- on an active basis, should they use nonqualified mutual funds. They may also spin off short-term gains as well as have management expenses. John and Mary might want to consider using a low-cost nonqualified annuity to avoid taxable transfer costs and get tax deferral potentially without surrender charges, depending on the contract.

Effective Uses Of Nonqualified Annuities In Retirement
Nonqualified annuities may also be very helpful for John and Mary. To guarantee the desired annual income of $250,000, they could purchase a joint and survivor income annuity to make up the difference. Given the possibility that John may have a shorter-than-average life expectancy, they may want to purchase an annuity for Mary's life instead.

Earlier we discussed the need to develop a diversified portfolio in the nonqualified area of their financial assets. One of the goals is to avoid taxes to the extent possible. That's one reason to use nonqualified assets first, by allowing qualified assets to grow tax-deferred before RMDs are required. The benefits of a nonqualified annuity include its tax deferral of gains and no RMDs. The biggest drawbacks typically are internal annuity charges as well as potential surrender charges.

Various types of annuities may help in this situation. Annuity contracts allow for tax deferral of growth not needed for income, and taxable income at the time of distribution. With a variable annuity, there may also be the ability to use managed accounts and take distributions without any withdrawal charges. In addition, there are fee-based annuities that have the ability to change subaccount allocations with no taxation or fees. Mary and John might consider those contracts to avoid the usual transfer of taxes that active management of nonqualified mutual fund or stock investments typically cause.

As you can see, there are a number of ideas you can use to help clients develop their retirement drawdown strategy. As a financial professional, you are the pilot, guiding your client's flight to retirement as calmly as possible. With a complex topic like retirement drawdown, it's important to work with other professionals, including attorneys, tax advisors, CPAs, etc., in a team environment to assist you in developing a creative strategy that may help your clients feel more comfortable in their retirement years.

Jim Johnson is vice president of Advanced Markets for Allianz Life Insurance Company of North America. Johnson is a frequent speaker on Advanced Markets topics and employs his extensive legal, advanced planning, life insurance and training expertise to help financial professionals achieve  retirement-planning goals for their clients. Content for this article was developed in cooperation with Keebler & Associates LLP.