Two very different strategies can help retirees’ retirement savings last a lifetime, and which one works for you—or even a hybrid plan—may depend on your risk tolerance. Let’s look at probability-based income planning vs. guaranteed income planning.
You can probably guess the kind of questions financial advisors hear most often from hopeful retirees. They tend to be something like this:
“When can we retire?”
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“How much will we need?”
“Will we have enough?”
“What if there is a major health care, stock market, or inflation event that threatens what we have saved?”
I wish there were simple answers to those questions (which, by the way, are all variations on the same theme). I guess if I had to pick one answer, it would probably be, “Well… let’s take a look.”
And then I would start asking my own questions.
The goal, of course, is to turn your pile of money (your savings) into a reliable stream of retirement income that will last as long as you do. But there are two very different strategies, probability-based income planning and guaranteed income planning, that can be used to help retirees reach that goal.
And which one is most suitable for you can largely depend on your attitude towards risk.
What is probability-based retirement income planning?
Probability-based income planning analyzes historical market returns and then extrapolates them to provide a statistical probability of future success. Many advisors use this approach to analyze an investment portfolio to determine if it can support the owner’s retirement spending goals.
Using a baseball analogy, let’s say you have a hitter on your favorite team with a .320 batting average. Based on his past performance, he expects that trend to continue. Yes, there is a 68% chance that he will not have success at the plate in his next at-bat. And injury, illness and the occasional rough patch can further contribute to some rough days. But you can reasonably expect this hitter to perform comparatively well going forward, given his track record.
Just like a batter in baseball, the stock and bond markets can be counted on to deliver future performance similar to past performance. But please, he repeat after me: past performance is no guarantee of future results. When things are going well, they can go Really right.
However, when the market falters, a retiree’s ability to earn the necessary amount of income from a probability-based portfolio of stocks and bonds can lead to real problems. Without making the necessary adjustments, the money could run out much sooner than anticipated.
For retirees who subscribe to the probability-based school of thought, the odds of success may actually be much better than in baseball. the chances of meeting your revenue goals can be up to 90% (opens in a new tab) when a portfolio is well designed and well managed.(1) And this level of success may be perfectly acceptable to many retirees, especially when they consider that tough times may simply require spending adjustments to avoid depleting long-term savings.
However, those who are not comfortable with a 10% chance of failure may benefit from a different approach: guaranteed income planning.
What is guaranteed income planning?
For those who don’t want to worry about volatility in the stock and bond markets, or making decisions about portfolio adjustments as they age, investing in guaranteed income Annuities can provide a less stressful way to create a reliable income stream in retirement.
In exchange for a sum of money, the insurer agrees to send you regular monthly payments for a set amount of time, which could be the rest of your life or the life of your surviving spouse, if you choose.
Even if the market crashes, you’re not likely to see any disruption to your payments. This is because the type of annuities we’re talking about are offered by highly regulated insurance companies that have long-term investment portfolios, more cash reserves set aside than liabilities created, and something called reinsurance that guarantees everything gets paid.
How much of your savings should you put into a guaranteed income account or accounts?
While the correct answer for each individual or couple could depend on a number of factors, a good starting point might be to match the income stream from an annuity or annuities to the amount of essential expenses you’ll need to maintain your lifestyle for a lifetime. The retirement.
Synergy: a hybrid approach
The good news is that this doesn’t have to be an either/or decision.
You can always combine the two approaches in a hybrid plan that is both mathematically sound and emotionally reassuring.
Once you have a reliable income stream to use for essential expenses, for example, you could continue to grow the remaining portion of your money in a diversified investment portfolio. Those funds could then go toward discretionary spending, a contingency fund (for expenses or economic events you can’t predict), and, if it’s important to you, your legacy plans.
With this strategy, you’ll take full advantage of the markets’ long-term growth potential while enjoying a reliable stream of retirement income. I’ve seen annuities do wonderful things for retirees who need help dealing with what retirement expert Wade Pfau (opens in a new tab) called the “4 L’s of Retirement”:
- Longevity: Ensuring there are enough assets to cover essential expenses.
- Lifestyle: maintain the desired lifestyle.
- Legacy: Leaving something behind for the people and causes you care about.
- Liquidity: Stay flexible for life’s surprises.
For many retirees, a combination of probability-based and guaranteed income approaches can provide benefits that allow them to address the four Ls in a mathematically sound and emotionally reassuring way. By combining market or probability-based strategies with guaranteed income products, a retiree can enjoy the benefits of certainty as well as long-term growth potential.
It’s this synergy that reduces the strain on a wallet, not to mention results in more sleepy nights.
(1) Chris Cordaro. Regent Atlantic. Goldilocks and the ‘correct’ probability of success in retirement planning. August 2016.
Kim Franke-Folstad contributed to this article.
The appearances at Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm in preparing this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.
This article was written by and presents the views of our contributing advisor, not the Kiplinger editorial team. You can check the advisors’ records with the SEC (opens in a new tab) or with FINRA (opens in a new tab).