Beyond Diversification: Adapting a Financial Plan for Retirement Income

People approaching retirement face a new goal for their financial plan: Turning the savings they’ve accumulated into income to help cover living expenses. While a diversified mix of investments remains critical for providing income potential, there are other ways to help generate income and preserve wealth for a potentially long retirement.

Here is an explanation of a common scenario that can affect retirement income planning and the way that an additional diversification technique — known as product diversification — can help people protect future retirement income.

Timing Matters — How the Market’s Ups and Downs Can Affect Retirement Income

How the market is performing when you retire can have a big impact on how much income can be generated — and for how long. Consider the following hypothetical example: Three individuals have each saved $100,000 in a portfolio made up of 60% stocks and 40% bonds. Each needs to make a 4% annual year-end withdrawal for 10 years. But each person can have a very different outcome, depending on when they begin making withdrawals and how the market performs over the next 10 years.

Based on market data from 1998 to 2017, someone who made withdrawals between 2008 and 2017 would have experienced the best outcome, generating $43,506 in income and seeing their portfolio grow to $131,850, providing assets for later in retirement. The worst outcome would have come for someone who made withdrawals between 1999 and 2008, when the portfolio generated slightly less income and would have declined in value to $79,783, leaving fewer assets available for later in retirement.

Same Investment Mix, Different Outcomes

How the market performs during periods when people make withdrawals from their retirement accounts can lead to very different outcomes. Here are three scenarios for investors with the same diversified investment portfolio, making the same 4% annual withdrawals for 10 years, based on market performance from 1998-2017.

*Assumes $100,000 saved in 60% stock/40% bond portfolio, from which the account owner makes 4% annual year-end withdrawals that continue for 10 years.

The only difference in these three scenarios is the market performance during the 10-year periods in question. The difference in these outcomes illustrates that even though diversification is crucial in a retirement plan, it can’t protect savings entirely from the ups and downs of the market. This variability makes it difficult to predict how much income a portfolio can generate, and might require additional strategies for securing income in retirement.

How Product Diversification Helps with Income Planning

During retirement, a diversified portfolio of stocks, bonds, and other assets remains important. Yet product diversification — the combination of different types of accounts, investment vehicles, insurance products, and annuities — may be equally important as the asset diversification within those products.

Relying on only one product or category, such as mutual funds held in IRAs and 401(k)s, may not allow people to maximize periodic income payments, maintain liquidity for emergencies, satisfy their legacy needs, and sustain payments for a lifetime. That’s because investments held in retirement accounts are subject to the ups and down of the market. Additionally, accounts such as IRAs dictate when withdrawals must be made through required minimum distributions, providing less flexibility for income or legacy planning.

To address these concerns, consider the extra protection that other financial products can bring to a retirement plan. Guaranteed sources of income, such as annuities, can help diversify financial products in a retirement plan and add an element of protection. For example, variable annuities allow savings to grow based on market conditions, while offering features that provide a level of income protection. A variable annuity purchased with an optional guaranteed lifetime withdrawal benefit provides a guaranteed stream of income for life. Savings in a variable annuity also have the opportunity to grow on a tax-deferred¹ basis. That’s because a portion of the money is allocated to investment options within the annuity, which annuity owners and their advisors can diversify according to their individual needs and risk tolerance. Unlike savings in a mutual fund held in an IRA, if the annuity’s underlying investments aren’t gaining, income remains flat because the annuity’s annual payments can be locked in at the previous years’ rate. However, if investments are growing, income may rise above that flat rate.

Products like these help with retirement planning by putting “guardrails” around a portion of retirement income. Though the annuity owner gives up a chance for the highest possible growth in exchange for a partial cushion against losses, they gain the ability to stay diversified and generate potential growth.

While the impact of market performance combined with income withdrawals can affect the sustainability of retirement savings, product diversification can provide additional ways to reduce this risk. This strategy, along with traditional investment diversification, provides a way to help ensure that the savings accumulated over time will be there to support your income needs in retirement. Talk with a financial advisor to explore ways to help enhance diversification’s benefits in your plan.