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White paper summary: Use a retirement income strategy based on client preferences
Wade D. Pfau, Ph.D., CFA®, RICP®, Professor of Practice, The American College of Financial Services
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- We found that clients typically align with 1 of 4 unique income strategies.
- A personalized approach can help identify a client's preferred retirement income strategy.
- More guaranteed income may give some clients a license to spend in retirement.
- Integrating annuities may require an asset allocation change among remaining investments.
There are competing viable approaches for building a retirement income strategy. An investment-centric approach, also called total return, is broadly treated as the default. Professionals who emphasize investment-centric approaches are comfortable relying on earning the risk premium from the stock market to support a retired client’s financial goals. Stocks are expected to outperform bonds over sufficiently long periods, and this expected investment outperformance is relied upon to provide retirees with the opportunity to fund a larger amount of lifetime spending. The upside potential from an investment portfolio is viewed as so significant that insurance products are not needed.
Research by Alejandro Murguia and me (Wade Pfau) used nationally representative samples of Americans at traditional retirement ages to determine that this investments-centric approach will resonate best with only about one-third of the retirement-age population. Other viable strategies favor incorporating contractual protections and commitments, which are more appealing to two-thirds of individuals when seeking to meet essential spending needs in retirement.1
A second retirement income strategy is protected income. An income "floor" of, typically, Social Security benefits combined with other sources of protected lifetime income can help provide the greatest shield against experiencing shortfalls for essential expenses. An important tool to fill any gaps in reliable income are protected retirement options from insurance carriers. After building contractually protected lifetime income to cover essential retirement expenses, a more diversified portfolio can be constructed to fund discretionary spending goals.
A third strategy available to retirees is risk wrap. It works for individuals who maintain an investment-based outlook with a desire for market participation, and also have a desire to commit to a solution that provides a structured income stream and avoids outliving their assets. These individuals may prefer the opportunity to grow their asset base through market appreciation but with the comfort of having reliable income still available if markets perform poorly. Options for building reliable income with the risk wrap approach generally involve the use of variable annuities with living benefits or protected retirement investment options in a client’s defined contribution plan.
A final approach relates to individuals who seek contractual protections, but also desire optionality and flexibility for their assets. This calls for a time segmentation (or bucketing) approach. This is often accomplished not with lifetime income products but rather front-end protections with instruments such as short-term bonds or deferred fixed annuities, as protection is sought just for near-term spending. With short-term protections in place, other assets earmarked for longer-term expenses can be invested for growth and optionality.
A partial annuity strategy can increase client satisfaction in retirement, especially for those living beyond life expectancy.
More financial professionals are recognizing that there are multiple methods for creating sustainable retirement income, and it is important to match these methods to each individual client’s unique preferences within the income plan. Today’s financial professional must also be open to a role for insurance-based tools such as annuities that use risk pooling to support lifetime spending protections. A personalized plan should be tailored for each client using the appropriate combination of investment and insurance tools. Some clients will be OK with using only investments; some may already have enough traditional pension income that annuities are not needed; but many may have a gap between reliable income and core spending needs that they would feel most comfortable closing with an additional stream of guaranteed income.
Discussions about retirement income planning can confuse individuals as there are so many different viewpoints expressed in the consumer media. Financial professionals who can draw from multiple strategies and tools are best positioned to win in the long-term quest for serving and delighting their clients and new prospects. It behooves advisors to beef up their toolkits and have as much comfort with using protected lifetime income options (such as annuities and in-plan guarantees) as they do with investments, and to better understand the characteristics of clients to whom these products appeal. Advisors who can speak the same "language" as those clients, and find retirement income strategies that resonate best, will cultivate fruitful and ongoing relationships.
Financial professionals must identify the retirement income strategy that best supports each client's personal needs.
Review the full white paper to learn more.
[1] "Selecting a Personalized Retirement Income Strategy: A Model Approach," Alejandro Murguia and Wade Pfau, Retirement Management Journal, Vol. 10, No. 1 (2021), pages 46-58.
Neither Nationwide nor any of its affiliates are related to or affiliated with Wade D. Pfau or the American College of Financial Services.
When evaluating the purchase of an annuity, your clients should be aware that annuities have limitations. They are long-term vehicles designed for retirement purposes. They are not intended to replace emergency funds, to be used as income for day-to-day expenses or to fund short-term savings goals. Please read the contract for complete details. Withdrawals are subject to income tax, and withdrawals before age 59½ may be subject to a 10% early withdrawal federal tax penalty.
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