Building Reliable Retirement Income

Is there a safe haven in an uncertain world
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by Craig Hawley

Nearly 10,000 Baby Boomers turn 65 each day, but only one-fourth (25%) think they are prepared for retirement—or believe that their savings will last through retirement, according to a 2018 whitepaper published by the Insured Retirement Institute (IRI). In fact, Nationwide Advisory Solutions’ Advisor Authority study of roughly 1,600 Registered Investment Advisors (RIAs), fee-based advisors and individual investors shows that year over year, saving enough for retirement—and generating reliable income during retirement—are consistently among investors’ top ten financial concerns.

The retirement income crisis is real and growing. The safety net is under threat, pension plans are on the decline and healthcare costs continue to skyrocket. Market volatility persists and fears of recession grow. All while Americans are living longer and face a retirement that could last 30 years or more. Having a strategy to help your clients prepare for and live in retirement can create that safe haven they seek in this uncertain world.

Social Security: Timing Matters

According to Advisor Authority, nearly three-fourths of investors (70%) have a strategy to protect against outliving their savings—whereas the vast majority of RIAs and fee-based advisors (87%) have a strategy to protect their clients against outliving their savings. Both investors (70%) and advisors (52%) cite Social Security among their top solutions for a retirement income strategy.

To maximize the benefits of Social Security, timing matters. While individuals can currently begin taking Social Security at age 62, waiting until full retirement age of 66.5 (as of 2019) helps ensure they will begin receiving their full Social Security benefits. However, waiting until age 70 increases monthly income even more—potentially boosting Social Security payments as much as 76%. For example, an investor who files at age 62 would receive only 75% of their benefits, while an investor who waits until their full retirement age of 66.5 would receive 100% of their benefits and an investor who files at age 70 would receive 132% of benefits.

It’s clear that older adults are over-reliant on Social Security. Fifty-six percent expect Social Security to cover more than half of their expenses in retirement and roughly one quarter (26%) believe Social Security on its own should be enough to help them live comfortably in retirement, according to the Nationwide Retirement Institute. Yet, the Institute also found two-thirds (66%) of future retirees worry that Social Security will run out of funding in their lifetime.

In fact, nearly half of investors in our Advisory Authority study are concerned that they will need to supplement their Social Security benefits with another source of guaranteed income. Forty-three percent of investors also say that the concern they will need another source of guaranteed income to supplement Social Security keeps them up at night.

Managing the Unpredictable

Today, the only thing that is predictable is the unpredictable. Investors and advisors alike are feeling the weight of this reality. This year’s Advisor Authority study revealed that two-thirds of investors (66%) and more than half of RIAs and fee-based advisors (56%) anticipate market volatility will increase. Over half of investors (54%) and RIAs and fee-based advisors (56%) are concerned about a bear market over the next 12 months. Nearly six in 10 investors (58%) and more than half of RIAs and fee-based advisors (54%) are concerned about a recession over the next 12 months.

Facing rising uncertainty, RIAs and fee-based advisors address clients’ concerns by introducing more sophisticated retirement income strategies and solutions that can supplement Social Security benefits while addressing the potential pitfalls of volatility and market downturns.

RIAs and fee-based advisors are far more likely than investors to leverage additional sources of guaranteed income. Monte Carlo analysis has shown that client outcomes can improve considerably when a portion of the income generating portfolio is allocated to a guaranteed income source. With a guaranteed income floor, clients are able to take on more risk in the growth portion of their portfolio, to increase the likelihood of generating enough income to fund a retirement that could last for three decades or more.

Guaranteed Income Solutions

When it comes to guaranteed income solutions, roughly half of RIAs and fee-based advisors (53%) compared to less than one-third of investors (32%) rely on variable annuities (VAs) with living benefits, according to Advisor Authority. Advisors and investors are aligned in their use of defined benefit plans/pensions (41% vs 43%). In addition, RIAs and fee-based advisors are far more likely than investors to leverage a range of different income generating annuities including Longevity Insurance/Deferred Income Annuity (38% vs 14%), Single Premium Immediate Annuity (38% vs 12%) and Qualifying Longevity Annuity Contract (35% vs. 10%).

VAs with living benefits are a solution for tax-deferred accumulation that can include upside potential with downside protection, as well as the ability to turn on a future stream of income that is guaranteed for life. Upside potential comes through a range of different underlying investment options that offer equity exposure. Downside protection can include a Return of Premium (ROP) rider or a more sophisticated structure, such as locking in a step-up on gains. Living Benefit riders can guarantee a base amount of lifetime income or a guaranteed rate of withdrawal. Notably, more than one-fourth of RIAs and fee-based advisors (27%) say that market volatility would make them even more likely to use variable annuities with living benefit riders to generate retirement income.

Your clients can benefit from other annuity solutions. Some provide income now, others offer income later. Single Premium Immediate Annuities (SPIAs) provide income soon after the client makes an initial lump sum investment. Deferred Income Annuities (DIAs), also known as longevity insurance, are funded with non-qualified dollars, typically purchased around age 65 with the future payout beginning at age 80 or 85. Qualified Longevity Annuity Contracts (QLACs) are annuities funded with qualified dollars from 401(k)s, 403(b)s and IRAs.

When considering annuities, the real key to creating value for clients is a product that is simple and transparent, with lower costs, more underlying funds and a technology enabled platform built to fit the way RIAs and fee-based advisors work, as explained in our recent whitepaper, “Fee-Based Insurance: The Missing Asset Class for a Holistic Financial Plan.”

Income without Guarantees

There are other popular solutions for generating income in retirement. Some are less risky and more predictable than others. RIAs and fee-based advisors are far more likely than investors to leverage bond ladders (50% vs. 18%) and yield generating ETFs (39% vs 18%), while advisors and investors are aligned in their use of dividend yielding stocks (44% vs. 46%).

Bond laddering can help clients meet expenses and cash flow needs at predictable intervals, with bonds staggered by maturity dates across a specified period of time. This also protects assets against market risk and serves as an effective buffer for the equity portion of the portfolio, so that clients are not forced to sell equities in a down market and can wait to harvest gains in years of positive returns. But while income is steady, there are still inherent risks, because income is not guaranteed.

Yield generating ETFs and dividend yielding stocks allow for payouts on a quarterly or monthly basis. However, these payouts fluctuate based on a company’s performance and market movement—making them a slightly riskier income strategy for investors concerned about predictable payouts and worried about outliving their savings.

Managing the Impact of Taxes

Taxes owed on investment returns present a challenge for clients focused on generating reliable retirement income. The reason is simple: For many clients—especially higher net worth clients—taxes are among the biggest investment expenses they may face, with rates of 40% or higher after federal and state taxes are factored in.

In fact, a recent Nationwide Retirement Institute survey found that more than one-third of retirees (37%) say they did not consider the impact of taxes when planning for retirement—potentially losing the ability to save for six or more years of additional retirement income. The survey also revealed that an overwhelming majority of those nearing retirement (82%) want to learn more about the impact of taxes on their plans to prepare for and live in retirement.

This year, managing taxes and planning for retirement may have become further complicated as you and your clients were required to navigate the nuances related to the Tax Cuts and Jobs Act (TCJA), the most dramatic tax reform package in nearly three decades. According to Advisor Authority, roughly eight in 10 RIAs and fee-based advisors (79%) are adapting their approach to tax-advantaged investing in response to tax-reforms.

When you are considering a tax-advantage approach to generate reliable retirement income, you need to diversify across the tax-efficiency and the timing of taxes for each investment vehicle you recommend. Balance the tax treatment of withdrawals from taxable accounts, qualified plans such as 401(k)s and IRAs, and tax-free qualified plans, such as Roth 401(k)s and Roth IRAs. And for high earners and the High Net Worth, who can easily exceed the low contribution limits of qualified plans, Investment-Only Variable Annuities (IOVAs) can help maximize the power of tax deferral. They can also serve as a vehicle for an asset location strategy to improve tax-efficiency of a retirement income portfolio.

The Safe Haven of a Holistic Retirement Income Plan

The retirement income challenge is real—and only growing—as more Americans head toward retirement in an uncertain world where volatility is on the rise, while markets and the economy may be poised for a downturn, and gridlock in Washington and global instability persists. Social Security alone is simply not a sustainable solution.

As an advisor, your job is to help clients maximize accumulation, mitigate market risk and manage longevity risk so they can prepare for and live in retirement. There are reliable strategies and guaranteed solutions for a holistic plan that can enhance growth potential, while minimizing the hazards associated with shorter time horizons and the tax obligations clients face every year. Create the safe haven that will help alleviate clients’ concerns about meeting their financial needs in retirement—today and thirty years from now. ◊