Low interest rates, market volatility, and longer lives for many Americans have upped the challenge of creating reliable retirement income for clients.
While the traditional 4% annual withdrawal from savings is a good rule of thumb, it’s certainly not set in stone. Research and some financial advisors now recommend levels as low as 2.5%. With all these challenges and some other common pitfalls along the road of pre-retirement and retirement, what is the best path to provide people financial security in their post-employment years?
In a previous article in Think Advisor (Jan. 30) my colleague Matt Teel explained how new research by Professor Wade Pfau of the American College tackles the issues of longevity and sequence-of-return risk.
(Related: Making Retirement Income More Predictable)
The Pfau research and our experience with clients also tells us that familiar methods and techniques can be complementary to the research and can help provide clients with smoother sailing in both pre-retirement and retirement.
Taking a broad overview, traditionally there are two different schools of thought about creating retirement income:
- Withdrawal-based solutions. In other words, there’s a pot of money from which the client will take systematic distributions. Strategies such as a “safe” withdrawal rate, variable spending (adjusting spending based on market performance over time), and “bucketing” (allocating investments by certain time horizon segments throughout retirement) all fit within this category.
- Income-based solutions. These entail leveraging guaranteed income sources such as pensions, Social Security and annuities to cover all or most of a client’s expenses. Techniques such as covering essential expenses with guaranteed income, known as “flooring,” would be an example of an income strategy at work.
We are learning from academic research that incorporating permanent life insurance into retirement income strategies can enhance overall income and increase the probability of success of the portfolio. This can be true when utilizing withdrawal-based solutions or income-based solutions.