The market’s volatility has reinforced the need for diversification among income sources in retired clients’ portfolios, and a recent study, “Four Strategies for Retiring Clients,” by Noelle E. Fox and Drew A. Denning of the Principal Financial Group’s Retiree Services Group can help with this reinforcement by illustrating the risk-return tradeoff.
The authors examine the use of four distinct strategies designed to generate retirement income: mutual funds with automated income payments (both endowment style and self-liquidating); variable annuities with guaranteed minimum withdrawal benefits; income annuities; and combinations of mutual funds and income annuities. The study focused on the pros and cons of each approach, including:
Access to account balance
Inflation risk, and
The researchers used Monte Carlo analysis with the same set of assumptions for each strategy to avoid biasing the outcome. The investor was assumed to be age 65 with $500,000 in 401(k) savings. Inflation was held at a flat rate of 3 percent, inflation was held at a steady annual rate of 3 percent, and the initial income withdrawal rate was 5 percent.
Not surprisingly, the simulations showed a range of outcomes and trade-offs, highlighting the need to understand clients’ risk-return profiles, says study co-author Denning.
“It’s important to be needs-based in your selling approach,” he says. “You need to work with that retiree, understand their needs and expectations, and then look across and see which product or product packages make the most sense for them.”
Several findings stood out, says Denning. One result was the inability of a GMWB (guaranteed monthly withdrawal benefit) income payment to keep pace with inflation.
As Denning notes, many financial institutions heavily promote the GMWB features. Under the simulation’s assumptions, however, the feature didn’t hold up as advertised. “As you can see from our conclusions, after about 10 years, your ability to keep pace with inflation (with GMWB) is extremely limited, is almost non-existent,” says Denning. “I think that was one of the biggest surprises we’ve heard back from advisors on this as well.”
Another result dispels the notion that annuitization has a negative impact on clients’ ability to transfer wealth. “I think our study also points out that if you are expected to live a long time in retirement, you actually benefit from partial annuitization, because it’s a more efficient way of generating income,” says Denning. “The part of your portfolio that you don’t need for income, you can leave it untouched for 20, 30, 40 years, and allow it to grow in the market.
“I think intellectually most advisors assume that if you take money off the table for an income annuity, you are reducing your chance for wealth transfer long-term,” he explains.” And I think we prove out that’s not the case.”
“Four Strategies for Retiring Clients” is available online at: