Longevity + Undefined Benefits = Retirement Income Roulette

This is the equity paradox: Our logical brain tells us we need to maintain high equity exposure during retirement, but our emotional brain fears what could happen if a tumultuous financial market occurs during those years.

What investors need to acknowledge is the sequence of returns and how long-term average returns can mask the impact of short-term volatility on the sustainability of withdrawals. For example, an investor might assume equities will average 8%-10% a year during retirement. Consequently, she figures a 5% withdrawal rate should have no problem sustaining her over a long retirement. But, historically, markets typically dont generate smooth returns consecutively. And poor returns early in retirement–combined with withdrawals–can cause the future income stream to dry up prematurely.

Ultimately, the ideal income plan for retirees will be unique to each investor. But for retirees in search of a degree of income stability, the security of a lifetime guaranteed income stream, exposure to equities for inflation protection, and the flexibility to tailor income amounts to changing needs and market conditions, there is a strategy to consider. This may be called the “income triple play.”

Consider the possible benefits of allocating your clients income-generating assets into 3 income “buckets.” One bucket contains a fixed payout annuity providing a guaranteed lifetime payout.

A 2nd bucket, in the form of a variable payout annuity, provides a guaranteed stream of lifetime income that will rise and fall with performance of the funds in which it is invested. This provides the potential for inflation protection. While the income from this bucket can fluctuate, the retiree continues to receive a level number of annuity units each pay period, as long as she is alive. Regardless of market performance, the income stream always has a chance to recover, given that the units always will be there.

Finally, income bucket No. 3 is the income stream generated by taking periodic withdrawals from assets that remain in the accumulation phase. These withdrawals can be increased or decreased, depending on income generated by the other 2 buckets and retiree needs.

Since the 3rd bucket–systematic withdrawal–is not the only method of generating income, the percentage of asset value that the withdrawals represent can be smaller than if it were the sole source of income. This is key, because the smaller the percentage value of an asset that is withdrawn, the better the chance the asset has of sustaining through volatile market environments.

Bottom line: This is a portfolio approach to income. Both the sources and the method of generating supplemental retirement income are diversified. Rather than using an all-systematic withdrawal, all-annuitized, all-fixed income, or all-equity strategy, the client can use an approach that combines all these elements. This just might be the answer for many retirees.

manages the annuity marketing department at Massachusetts Mutual Life Insurance Company, Springfield, Mass. His e-mail is [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, February 13, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.