Can You Build a Retirement Income Plan With Both Risk and Reliability?

Two strategies for making retirement savings last — probability-based income planning and guaranteed income planning — can help ensure you have what you need in your golden years, but which is right for you?

By Scott M. Dougan, RFC, Investment Adviser

published 25 November 2022

in Features

A couple thinks hard about their options when it comes to probability-based income planning vs. guaranteed income planning.

(Image credit: Getty Images)

Two very different strategies can help retirees’ retirement savings last their lifetime, and the one that works for you, or even a hybrid plan, may depend on your tolerance for risk. Let’s look at probability-based income planning vs. guaranteed income planning.

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You can probably guess the types of questions financial advisers hear most often from hopeful retirees. They tend to go something like this:

“When can we retire?”

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“How much will we need?”

“Will we have enough?”

“What if there’s a major health care, stock market or inflationary event that threatens what we’ve saved?”

I wish there were simple answers to those questions (which are all variations on the same theme, by the way). I guess if I had to pick one answer, it probably would be: “Well … let’s take a look.”

And then I would start asking my own questions.

The aim, of course, is to convert your pile of money (your nest egg) into a reliable retirement income stream 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 get retirees to that goal.

And the one that’s the right fit for you may depend largely on your attitude toward risk.

What Is Probability-Based Retirement Income Planning?

Probability-based income planning looks at historical market returns, then extrapolates forward to offer a statistical probability of future success. Many advisers use this approach to analyze an investment portfolio and 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 batting average of .320. Based on his past performance, you expect that trend to continue. Yes, there’s a 68% chance he won’t find success at the plate on his next at-bat. And injury, illness and an occasional slump may contribute further to some tough days. But you can reasonably expect this hitter to perform comparatively well going forward, given his history.

Not unlike a hitter in baseball, the stock and bond markets can be counted on to deliver future performance that’s similar to past performance. But, please, repeat after me: Past performance is no guarantee of future results. When things go well, they can go really well.

When the market stumbles, however, a retiree’s ability to draw the necessary amount of income from a probability-based stocks-and-bonds portfolio can result in real problems. Without making the necessary adjustments, the money could run out long before you planned.

For retirees who subscribe to the probability-based school of thought, the odds of success actually can be much better than in baseball. The chances of meeting your income goals can be as much as 90% 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 adjustments to spending to fend off long-term nest-egg depletion.

Those who aren’t comfortable with a 10% chance of failure, however, 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 about making decisions about portfolio adjustments as they age – investing in guaranteed income annuities may provide a less stressful way to create a reliable income stream in retirement.

What Is Lifetime Income Insurance Worth?

In exchange for a sum of money, the insurer commits to sending 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 tanks, you aren’t likely to see any interruption in your payments. That’s 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 obligations created, and something called reinsurance that ensures the whole thing pays out.

How much of your nest egg should you appropriate to a guaranteed income account or accounts?

While the right answer for each individual or couple could depend on several factors, a good place to start might be to match the income stream from an annuity or annuities to the amount of the essential expenses you’ll need to maintain your lifestyle in retirement.

Synergy: A Hybrid Approach

The good news is that this doesn’t have to be an either/or decision.

You can always blend the two approaches into a hybrid plan that’s both mathematically sound and emotionally reassuring.

Once you have a reliable income stream in place to use for essential expenses, for example, you could keep growing the remaining portion of your money in a diversified investment portfolio. Those funds could then be earmarked for discretionary expenses, 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’d be making the most of the markets’ long-term growth potential while also enjoying a reliable retirement income stream. I’ve seen annuities do wonderful things for retirees who need help addressing what retirement expert Wade Pfau calls the “4 Ls of Retirement”:

Longevity: Ensuring there are sufficient assets to provide for essential expenses.
Lifestyle: Maintaining your desired lifestyle.
Legacy: Leaving something behind for the people and causes you care about.
Liquidity: Staying 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 fashion that’s both mathematically sound and emotionally reassuring. By combining probability-based, or market-based, strategies with guaranteed income products, a retiree can enjoy the benefits of certainty as well as long-term growth potential.

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It’s this synergy that reduces the pressure on a portfolio, not to mention results in more sleep-filled nights.

(1) Chris Cordaro. Regent Atlantic. Goldilocks and the ‘Just Right’ Probability of Retirement-Planning Success. Aug. 2016.

Kim Franke-Folstad contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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As Founder of Elevated Retirement Group, Inc., Scott Dougan has built a comprehensive retirement planning company focused on helping clients grow and preserve their wealth. Under Scott’s leadership, a team of experienced financial advisers, Certified Financial Planners (CFP®) and CPAs use tax-efficient strategies, professional investment management, income planning and proactive health care planning to help clients feel confident in their financial future — and the legacy they leave behind. Scott has also written a book titled “Exceptional Retirement: Tools and Strategies for Retiring on Your Terms” (click here to request a free copy). You can find Scott on YouTube by clicking here, where he creates educational videos for those near retirement. If you would like to talk to Scott’s team, you can schedule a call by clicking here.