Retirement Income Strategies
When planning for retirement, choosing how to convert savings into income involves balancing certainty with flexibility. Broadly, retirement income strategies can be divided into two categories: Reliable Income Strategies and Variable Income Strategies. Each has its own advantages and considerations depending on personal risk tolerance, financial goals, and the need for predictable income.
1. Reliable Income Strategies (Guaranteed)
Reliable income strategies focus on creating income streams that are consistent and predictable, providing retirees with a “floor” of guaranteed income that typically lasts for life. These strategies are ideal for covering essential expenses, such as housing, healthcare, and daily living costs, since they reduce the uncertainty of income fluctuations.
Social Security: Social Security benefits are one of the most common forms of guaranteed retirement income. Payments are determined by your lifetime earnings and the age at which you claim benefits, with the added protection of inflation adjustments.
Pension Plans: Pensions provide a fixed monthly income, usually for life, and are offered by some employers as part of retirement benefits. Pensions reduce income volatility but are less common in today’s workplace.
Annuities: Annuities are insurance contracts that can promise guaranteed income for a specified period or for life. There are a number of different annuity types out there but in general the annuities that fall under this category are those that pay guaranteed income for life.
These strategies provide peace of mind by ensuring a predictable income stream but may limit flexibility, as they often require committing capital upfront in exchange for the lifetime guarantee.
The common theme behind these strategies is that the pool of money and the income paid is based on the law of large numbers and actuarial sciences to calculate sustainable income numbers. The benefits are not based on a single individuals experience but rather the group as a whole which is much easier to predict with some accuracy. See How Insurance Works: The Law of Large Numbers – Gilbert Wealth
Pros
- Steady, regular income regardless of market volatility
- Easier management. Check just arrive.
- Income for as long as you live
- Lack of control
Cons
- May lose value to inflation
- Income cuts if backing organization goes under
- Lack of liquidity
- Lack of control
That’s right. Lack of control is both a Pro and a Con. Some people need to not have access to all that they can withdraw for their own good and financial prosperity.
2. Variable Income Strategies (Non-Guaranteed)
Variable income strategies allow retirees to withdraw income from their investments but do not offer the same guarantees as reliable income strategies. These strategies offer more control and the potential for growth, but they also carry the risk of depletion, especially in times of market volatility.
There are numerous types of variable income strategies out there but they all can be boiled down to several base elements:
- How the Initial Income is Set
- If the Income Maintains Spending Power
- If the Income is Adjusted for Performance
Systematic Withdrawal Strategies: One of the most popular flexible income strategies, the 4% Rule suggests withdrawing 4% of your retirement savings in the first year, adjusting for inflation each year thereafter. While simple and effective under normal market conditions, it carries the risk of outliving your savings if market conditions worsen or your lifespan extends beyond expectations. If you want to get a lively reaction from advisors, ask if they think this rate should be lower or higher. Here’s how it fits my base elements:
- Initial Income is set by applying a percentage income rate to your portfolio value at retirement.
- Income is adjusted for inflation each year.
- Income is not adjusted for performance.
Required Minimum Distributions (RMDs): Yes, RMD’s is a variable income strategy. RMD rates are set by the IRS and indicate how much should be taken out of pre-tax retirement accounts. The rate starts off lower and is increased each year by age. Here’s how it fits my base elements:
- Initial Income is set by applying a percentage income rate to your portfolio value at retirement.
- Income is not adjusted for inflation each year but can go up or down depending on market performance.
- Income is adjusted by based on performance of account but is generally increasing due to the increasing RMD rate.
Guyton/Klinger Spending Rules: This is another popular strategy falling in the Systematic Withdrawal Strategy grouping. It adds a few tracking features that can adjust your income upward if you experience better than expected portfolio performance or lower your income if you experience lower than expected income. Additionally, there are times when inflation adjustments are forgone if the market is down. Here’s how it fits my base elements:
- Initial Income is set by applying a percentage income rate to your portfolio value at retirement.
- Income is adjusted for inflation up to a cap (6%) or not taken at all if your portfolio is down.
- Income is adjusted by based on performance if certain thresh holds are reached.
Why all of these strategies? The goal is to create an estimated spending plan that can provide income over a lifetime. With variable income strategies, there are no guarantees, so the goal is to provide income with a high degree of confidence. This is an important consideration when choosing the variable income strategy.
Pros
- More flexibility
- Customization to Spending
- Potentially Higher Spending or Legacy
Cons
- Chance of depleting portfolio before death
- Potential variability of income
- Emotional toil of pulling money during difficult markets
- Higher degree of management needed
Choosing Between Reliable and Variable Income Strategies
In retirement income planning you do not have choose just one of these to rely on. Selecting between these strategies—or combining them—depends on an individual’s risk tolerance, financial goals, and desire for income stability. Most retirees will already have some reliable income through Social Security.
By maintaining a balance between guaranteed and non-guaranteed income sources, retirees can achieve both financial security and the flexibility to adapt to changing needs or market conditions throughout retirement.
Portfolio Strategies
There are other strategies that on the surface appear to be a separate income strategies than the two outlined above but in reality are variable income strategies or ways to implement a variable income strategy. These tell you what to do with a portfolio while generating the income needed but not necessarily how much income should/could be taken. These include:
- Bucketing
- Laddering
- Rising Equity Glide Paths
- Falling Equity Glide Paths
- Lifecycle Funds
- Preserving Principal