For much of their adult lives, Americans have worked, planned and worried about saving enough money for retirement. They’ve diverted income to 401(k) accounts, consulted financial planners and learned to invest. But as they reach the promised land of retirement, many baby boomers are confronting a dilemma they have not considered.
Retirees have to make sense of spending their assets responsibly while ensuring that money lasts them the rest of their lives. The process of converting a lifetime of savings into retirement income is fraught with complexity, especially as inflation pressures mount and Americans live longer.
But retirees are developing different strategies and concepts to meet the challenge, retirement income specialists say. A whole field of retirement income planning is evolving into a separate specialty within the financial advice industry. There’s more customization involved in retirement income planning, as opposed to relying on the stock market to generate enough returns in a portfolio, or using outdated, and often contested, guidelines like the 4% rule, which has traditionally dictated how much money a person should take out of their retirement accounts every year.
“True income planning dives into the why and how and pairs them together,” said Brian Bass, the managing director of financial planning at McLean Asset Management, a financial advisory firm in Tysons, Va. “In retirement, it’s like a culture shock. You don’t know what to expect a lot of the time, and they realize the market is dictating retirement plans.”
Bass is a retirement income certified professional, a designation focused on strategies for having and spending enough money in old age. That means Bass is not focused solely on questions like, “how much of my portfolio should be heavily invested in equities?” Instead, he wants retirees to ask themselves, “how do I create a paycheck for myself for the rest of my life?”They must also make sense of any other income they might have, like Social Security benefits or a pension.
Retirement income planning is still a relatively new concept, but more financial advisers have embraced it, adding it to their practices in the last decade. Some even focus on it entirely in their businesses. Instead of advising clients on how much money needs to be saved, and how to invest to meet future goals, advisers are exploring and implementing strategies specifically around withdrawing in retirement — be it in monthly increments from their IRAs, by purchasing annuities, or investing in long-term care insurance to meet unexpected or high expenses later in life.
One of the best new ideas in retirement is to get smarter about asset decumulation and building a framework not for preserving wealth, but drawing it down.
“We taught people for 30 years how to save,” said Jamie Hopkins, managing partner of wealth solutions at Carson Wealth, a financial advisory firm with headquarters in Omaha, Neb. “We didn’t teach anybody how to spend money from their accounts, and there’s a lot of discouragement for spending from these accounts.”
After 30 or more years in a career — ideally saving for retirement while balancing all of life’s other financial obligations — people must transition to a fixed income without any guidance or training on how to use the hard-earned dollars they’ve put away for so long, he added.
Gone are the days of what was known as the “three-legged stool” of retirement income, where the average individual could expect to live on a pension, Social Security and some personal savings in retirement. Now, as Americans live longer, private pensions disappear and financial responsibilities stretch across decades, they find themselves responsible for saving up enough money for the future, and finding the right strategy that keeps them from running out of it before they die. It can be a complex process.
“We have conditioned most people that watching their account balance is good so spending that feels like a loss,” Hopkins said. “You see a lot of people in retirement underspend.”
How Does it work
Retirement income planning differs from traditional retirement planning in important ways, said Wade Pfau, the director of retirement research at McLean Asset Management. Pfau said it focuses entirely on the decumulation of retirement savings and taking advantage of income sources in retirement such as annuities, which are financial products that guarantee specified income payments, life insurance and other investments. Traditional retirement planning focuses more on tax-advantageous ways to save for retirement, and meeting future financial goals, such as traveling, taking on a new hobby, having enough for long-term care plans and leaving an inheritance – it doesn’t spend much time on post-retirement, said Pfau, who is also author of the “Retirement Planning Guidebook.”
“Risk changes in retirement,” Pfau said. People “have to solve the problem of how much they can spend so they don’t outlive their money.”
Pfau oversees the Retirement Income Certification at the American College for Financial Services, which teaches advisers and other financial professionals how to maximize the money retirees can use when they finally get to that chapter of their lives. The first designation was awarded in 2013, and since then more than 9,000 certificants have passed the three-course program. Along with investment options, these lessons emphasize decisions around Social Security, Medicare, long-term care and housing, Pfau said.
““We taught people for 30 years how to save. We didn’t teach anybody how to spend money from their accounts.” ”
— Jamie Hopkins, managing partner of wealth solutions, Carson Wealth
There’s no one-size-fits-all strategy to retirement spending, but a lack of planning could be detrimental to a person’s wellbeing in old age. Retirees may use a mix of options to maximize their income potential in retirement, such as pairing their Social Security benefits with an annuity, or capitalizing on their Roth IRA withdrawals until they’re in a low enough tax bracket to draw down their traditional IRAs. Most people will employ multiple income streams in retirement, if they have the ability to do so. Not everyone has that opportunity however, if they haven’t saved enough for retirement during their working years or if their employers did not offer a pension.
Some income strategies are controversial. Annuities, for example, tend to have a bad reputation. Many investors steer clear of them, regardless of the type, because of distrust of the sales process, a lack of clarity around fees, and a misunderstanding of the type of annuity that may be best in particular situations.
“It is the perception we are trying to change,” said Jason Fichtner, who leads the Retirement Income Institute at the Alliance for Lifetime Income, a Washington, D.C.-based nonprofit dedicated to retirement income strategies. In surveys, the alliance has asked individuals if they would like to receive a paycheck for life so that they don’t outlive their savings. Respondents tend to say, “yes,” but when asked if they would like an annuity, they say, “no” – an example of how not all individuals may understand the potential benefits an annuity could have on their retirement security.
Investors do need to vet any annuity products they pursue, as well as the financial advisers and salespeople suggesting these options. But there are many choices within the realm of annuities, and with the right planning, one could be appropriate for a person’s retirement income plans. A few options include immediate annuities that are paid for with one lump sum; variable annuities, which are tied to an investment portfolio (and thus can be risky); and fixed annuities that provide a set amount of money regularly. A person purchasing an annuity product can choose the term for these payments as well as how much income they want generated based on the investment they’re comfortable making.
“What we find is consumers do not want all of their money tied up in an annuity,” said Jean Statler, chief executive officer of the Alliance for Lifetime Income.
Some retirees may choose to use only a portion of their 401(k) or IRA to purchase an annuity. “We can convert defined contribution assets into a stream of income and give people that security they want, while still giving access to the market,” Fichtner said. The annuity check they receive every month could be used to cover basic expenses, and then the investors can dictate how the rest of their savings are invested, saved or stored.
Retirees may choose to continue working in some capacity, such as through occasional consulting, a part-time job, or a side gig related to a hobby they’ve always loved. This is yet another income strategy to delay both Social Security benefits and retirement account withdrawals. When planning for income strategies in retirement, individuals may also consider how interest rates and inflation might affect their current and future investment decisions and spending strategies – if they’re earning a salary that affords them the luxuries they love, they might choose to stay in the workforce a bit longer while stock market volatility normalizes and inflation is no longer taking a chunk of their everyday spending on groceries and utilities.
Retirement income planning is still growing in popularity, but there has been a more evident focus from Americans across the country, including politicians. For the last few decades, legislation has encouraged saving for retirement through company and retirement account contribution incentives. In 2019, the Secure Act included provisions that also touched on guaranteed income, and the proposed Secure Act 2.0, which is currently moving through Congress, expands on that.
What to do now
Financial advisers and clients are adapting to new versions of traditional advice when thinking about decumulation, particularly the proper percentage for monthly or annual withdrawals. For years, the 4% rule reigned supreme. Clients were told if they were to withdraw just 4% of their portfolios every year they should have enough money to last them the rest of their lives, but experts have reassessed this guideline and now suggest people withdraw less, perhaps around 3.3%, according to Morningstar. A 3.3% withdrawal rate, assuming a balanced portfolio and fixed withdrawals, would give investors a 90% chance they wouldn’t run out of money.
But like with any strategy, some years will require a tweak or two, especially in years of high inflation or extremely volatile markets. Retirees might also require more money a few years within their retirement, if they need to make major renovations to their home or suffer a medical emergency. Retirement plans need to be flexible to withstand those fluctuations.
Social Security is also a dominant force in retirement planning, especially as so many Americans rely on it for a major portion of their income in old age. There are what feels like thousands of ways for retirees to begin drawing Social Security, including tapping into spousal benefits first or choosing a specific year to begin claiming to maximize benefits based on their life expectancy and tax liabilities going forward. Claim too early and beneficiaries get a permanent cut to their retirement benefits every month, but claim too late and they may struggle to pay their bills.
Part of a secure retirement will boil down to comfort with the plan, which is why advisers who specialize in retirement income planning find it imperative to talk about their client’s hopes, fears and concerns. A retiree could have amassed millions of dollars for retirement, but if they’re worried about the stock market or losing money in investments, they might live well below their comfort level to avoid spending their money. Others might have saved very little for retirement, but spend on inappropriate insurance products so they feel some level of safety. The behavioral aspects of planning are just as important as the financial ones, experts said.
One of the key arguments for implementing retirement income planning is longevity. Life expectancy is unknown, but it’s one that retirees must account for when spending down their savings. Between 1960 and 2015, life expectancy for the U.S. population jumped by around 10 years, and between 2016 and 2060, it will increase another six, according to the Census Bureau.
Retirees must consider longevity when determining at what age to claim Social Security – people who want to delay their benefit to age 70 to maximize how much they receive every month won’t actually get to enjoy much of their benefits if they only live to age 75, for example.
They must also weigh how they’ll be able to pay for medical expenses. The average couple retiring today at 65 can expect to spend at least $300,000 on healthcare alone, and that figure excludes long-term care costs, such as a nursing home or paying for an in-home aide. Long-term care insurance can be expensive and may be unnecessary for most Americans, but there are hybrid products that pair life insurance with long-term care riders – another option advisers discuss with their clients when planning ahead.
A long life expectancy can be a blessing for most people, but paired with an earlier retirement (such as before age 65) and insufficient savings, it can be disastrous. “It’s a great thing, you want to live as long as possible,” Hopkins said, “but it makes all the things more impactful – the risk of running out of money, healthcare costs – so people tend to hold assets because they don’t know how long they’re going to live.”