Two very different strategies can help retirees’ retirement savings last a lifetime, and which one is right for you, or even a hybrid plan, may depend on your risk tolerance. Let’s look at probability-based income planning versus guaranteed income planning.
You can probably guess the kinds of questions financial advisors hear most often from hopeful retirees. They tend to look like this:
“When can we retire?”
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“How much will we need? »
“Will we have enough?
“What if there is a major event in health care, the stock market or inflation that threatens what we have saved?”
I wish there were simple answers to these questions (which are all variations on the same theme, by the way). I guess if I had to choose just one answer, it would probably be, “Well… let’s take a look.”
And then I would start asking my own questions.
The goal, of course, is to convert your cash pile (your nest egg) into a reliable stream of retirement income that will last as long as you do. But there are two very different strategies – probability-based income planning and guaranteed income planning – that can be used to help retirees achieve this goal.
And which one is right for you may largely depend on your attitude to risk.
What is probability-based retirement income planning?
Probability-based revenue planning looks at historical market returns and then extrapolates to offer a statistical probability of future success. Many advisors use this approach to analyze an investment portfolio and determine if it can support the owner’s retirement spending goals.
Using a baseball analogy, let’s say you have a batter on your favorite team with a .320 batting average. Based on its past performance, you expect this trend to continue. Yes, there’s a 68% chance he won’t find batting success in his next game. And injuries, illnesses and the occasional depression can further contribute to difficult days. But you can reasonably expect this hitter to perform relatively well in the future, given his history.
Just like a batter in baseball, the stock and bond markets can be relied upon to deliver future performance similar to past performance. But, please repeat after me: past performance is no guarantee of future results. When everything is fine, they can leave really good.
However, when the market stumbles, a retiree’s ability to derive the necessary amount of income from a probability-based portfolio of stocks and bonds can lead to real problems. Without making the necessary adjustments, the money could run out long before you expected.
For retirees who subscribe to the probability-based school of thought, the odds of success may actually be much better than in baseball. The odds of reaching your income goals can be as high as 90% (opens in a new tab) when a portfolio is well designed and well managed.(1) And that level of success may be perfectly acceptable for many retirees, especially when they consider that tough times may simply require spending adjustments to avoid long-term nest egg depletion.
However, those who are not comfortable with a 10% probability of failure may benefit from a different approach: guaranteed income planning.
What is guaranteed income planning?
For those who don’t want to worry about stock and bond market volatility — or making decisions about portfolio adjustments as they age — investing in guaranteed income annuities can provide a less stressful way to create a reliable stream of income in retirement.
In exchange for a sum of money, the insurer agrees to pay you regular monthly payments for a fixed period – which can be the rest of your life or that of your surviving spouse, if you wish.
Even if the market crashes, you probably won’t see any disruption in your payments. That’s because the kind of annuities we’re talking about are offered by highly regulated insurance companies that have long-term investment portfolios, more cash reserves set aside than bonds created, and something called reinsurance which guarantees that everything is paid.
How much of your nest egg should you spend on one or more guaranteed income accounts?
While the correct answer for each individual or couple may depend on several factors, a good starting point might be to match the income stream from one or more annuities to the amount of essential expenses you will need to maintain your lifestyle. retirement life.
Synergy: a hybrid approach
The good news is that it doesn’t have to be a decision.
You can always blend the two approaches into a hybrid plan that’s both mathematically sound and emotionally reassuring.
Once you have a reliable stream of income to use for essential expenses, for example, you can continue to grow the remaining part of your money in a diversified investment portfolio. These funds could then be earmarked for discretionary spending, a contingency fund (for expenses or economic events you cannot foresee) and, if important to you, your inheritance plans.
With this strategy, you’ll take full advantage of the markets’ long-term growth potential while enjoying a reliable stream of retirement income. I’ve seen annuities do wonderful things for retirees who need help answering what pension expert Wade Pfau (opens in a new tab) calls the “4 Ls of retirement”:
- Longevity: Ensure there are enough assets to cover essential expenses.
- Lifestyle: Maintain the desired lifestyle.
- Legacy: leaving something behind for the people and causes you care about.
- Liquidity: Stay flexible for life’s surprises.
For many retirees, a combination of probability-based approaches and guaranteed income can provide benefits that allow them to approach the four Ls in a way that is both mathematically sound and emotionally reassuring. By combining probability-based, or market-based, strategies with guaranteed income products, a retiree can enjoy the benefits of certainty as well as the potential for long-term growth.
It’s this synergy that takes the strain off a wallet, not to mention results in more sleep-filled nights.
(1) Chris Cordaro. Atlantic Regent. Goldilocks and the “fair” probability of retirement planning success. August 2016.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.
This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC (opens in a new tab) or with FINRA (opens in a new tab).
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