By Susan Rupe
When it comes to planning for retirement income, clients face a number of risks. Each risk requires the right set of tools to manage it. And each client has their own retirement income style, which dictates the type of strategy needed to properly fund the client’s post-employment years.
How to match the right retirement income strategy to the client’s retirement income style was discussed by Wade Pfau, professor of retirement income at The American College, and Alex Murguia, CEO of RISA, during a recent webinar by the National Association for Fixed Annuities.
Retirement spending strategies
Pfau described four basic strategies to fund essential and discretionary spending in retirement:
- Total return approach, in which a retiree holds an aggressive, diversified portfolio and takes systematic withdrawals from it.
- Risk wrap strategy, which has a lifetime income floor built into it to fund essential spending but uses an annuity to fund discretionary spending.
- Income protection strategy, in which a floor of essential income is built and then investing for discretionary spending.
- Time segmentation or bucketing strategy, in which funds are invested in different vehicles for short-term and long-term spending.
A client’s style leads to specific strategies, Pfau said. He identified the dimensions that best capture a client’s retirement income style:
- Probability based versus safety first.
- Optionality versus commitment orientation.
A client who is probability based depends on market growth through the risk premium for stocks to outperform bonds. Clients who prefer a safety-first strategy rely on funding their essential needs with safer income such as that generated by annuities or bonds.
Clients also vary on how much plan optionality they prefer, Pfau said.
Some clients prefer flexibility to keep their options open and take advantage of new opportunities. Other clients prefer to lock in a solution that solves a lifetime income need.
RISA created a matrix that shows a role for retirement income investments based on a client’s retirement income style.
Choosing an approach
Clients who are commitment-oriented and prefer a safety-first approach need a protected income have a protected income style. Clients who have a commitment-oriented and probability-based approach are more likely to be served with a risk wrap income style. Those who want to combine optionality with a safety-first approach would most likely benefit from a time segmentation income style. A total return approach would be the best bet for clients who want optionality along with a probability-based approach.
What role do annuities play in these different approaches? Pfau explained that some approaches use annuities more for income and other approaches use annuities for growth.
In the commitment-oriented approaches, single premium immediate annuities, deferred income annuities, fixed indexed annuities, registered index-linked annuities and variable annuities can provide income. In the optionality-oriented approaches, FIAs and RILAs, as well as multiyear guaranteed annuities and investment-only variable annuities can provide growth.
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