Retirement Income Planning has emerged as a distinct field in the financial services profession. But because it is still relatively new, the best approach for building a retirement income plan remains elusive. There are two fundamentally different philosophies for retirement income planning – one based on probabilities and the other based on safety. The critical issue that may determine which approach you choose to favor is based on the risk/reward tradeoffs of the stock market or on the contractual guarantees of insurance products, specifically income annuities.
The fundamental question before you retire should be "how do I meet my retirement income goal?" Retirement income planning is not an either/or proposition with regards to your financial investment choices, but more likely a determination about the most efficient allocation of your dollars in stocks and guaranteed products.
One approach advocated by Wade Pfau: Professor at The American College in Bryn Mawr, Pennsylvania and Principal at McLean Asset Management is to separate out your “essential needs” – housing, utilities, food, transportation, and medical care from your “wants” – lifestyle choices like vacations, recreation, social functions, and entertainment. Use guaranteed income or “essential income” provided by social security, pensions, and annuities to provide income to meet your essential needs. Essential income should not be subject to the whims of the stock market. Use a diversified stock portfolio to provide income for your wanted lifestyle choices.
There are distinct advantages and disadvantages to a stock portfolio. A stock portfolio may provide a more comfortable lifestyle if you are willing to invest in the hope of subsequently earning higher market returns to support a higher income rate. Should decent market returns materialize and sufficiently outpace inflation, investment solutions can be sustained indefinitely. Upside growth could also support a larger legacy and provide liquidity for unexpected expenses. There are disadvantages to a stock portfolio.
Longevity protection (the risk of outliving savings) is not guaranteed with investments, and sufficient assets may not be available to support a long life or legacy. An extended bear market could force a drastic change in the investment portfolio balance. A “reverse legacy” could result if the portfolio is so depleted that the retiree must rely on others (often adult children) for support or Medicaid. This is particularly important in light of the ongoing improvements in mortality, which means that today’s retirees will live longer than those from previous generations. For healthy individuals in their sixties, we are approaching the point where forty years must replace thirty years as a conservative planning horizon.
There are advantages and disadvantages of income annuities too. With an income annuity, you have more peace of mind and less stress. A monthly annuity payment can provide explicit permission to spend and enjoy retirement. The receipt of a monthly check from an annuity can also simplify life for those with reduced cognitive skills or for surviving spouses who may be less experienced in financial matters. Longevity protection is a primary benefit from an annuity solution, as it provides a guaranteed income for as long as you live. Though income annuities can guarantee a lifestyle, they lack the ability on their own to provide upside potential, and inflation-protected income annuities are costly. Also, income annuities do not offer legacy benefits without adding additional riders, which will reduce the monthly income.
You should not get caught up in the idea that either a stock portfolio or an annuity income solution will best serve your retirement needs. The most efficient way to fund your retirement is obtained by combining an investment portfolio with guaranteed annuity income.
For more information about retirement income planning call Western Fraternal Wealth Management or email email@example.com.
CFP®, FLMI, Annuity Product Manager
Call 877-935-2467 to speak with a Western Fraternal Life Representative.