Retirement Income Planning: The Financial Advisor’s Playbook

The retirement landscape has changed dramatically over the past several decades.

Affluent retirees are living longer, and traditional pensions have declined in prevalence. Meanwhile, many retirees are working well past the traditional retirement age of 65.

All of these factors point to the value of retirement plans that are custom crafted for each client. As a financial advisor, it’s important to stay informed on the latest insights to better support your clients and their unique financial goals as they transition into a new phase.

This playbook outlines what you need to know about retirement income planning. We deliver resources and tools backed by Morningstar research to help you guide your clients to a comfortable retirement.

While there’s no one-size-fits-all plan, the 4% rule has been a popular approach. To ensure retirement savings can last for 30 years, the guideline recommends that retirees withdraw no more than 4% of their total investments in the first year of retirement. Each subsequent year, investors would withdraw more to account for inflation.

For many investors, 4% remains a rule of thumb. And Morningstar’s 2023 research supports the approach—finding that retirees can withdraw as much as 4% as an initial spending rate, assuming a 90% probability of still having funds after a 30-year time horizon. That figure is largely due to higher fixed-income yields along with a lower long-term inflation estimate.

We estimate this withdrawal rate also applies to portfolios with equity weightings as high as 40% and as low as 20%.

Because Morningstar’s approach assumes that stocks will deliver significantly better long-term returns than bonds and cash, equity-heavy portfolios typically ended up with more money left over at the end of the 30-year period.

It’s important to note that retirees with shorter time horizons can safely withdraw significantly more than the 30-year baseline assumption, but safe withdrawal rates ratcheted down at a more modest pace for retirees with longer time horizons.

Even though investors have different priorities, one major goal is to have enough retirement income to support their lifestyle. Here are common strategies to consider.

This system offers the benefit of simplicity and most closely approximates the consistent paychecks that people grow accustomed to during their working years. More specifically, it involves setting the starting withdrawal amount and then taking inflation adjustments to that dollar amount each year thereafter.

While taking a fixed percentage withdrawal solves the problem of running out of money, it does so at the expense of the retiree’s standard of living being possibly impacted by changes in the value of the portfolio.

Even though every retirement strategy has trade-offs, dynamic withdrawals offer flexibility to retirees through market fluctuations. These strategies change withdrawal amounts from year to year—taking lower withdrawals in weak market environments and higher paydays in strong ones—typically allowing for higher starting and lifetime withdrawal rates.

The approach may help retirees consume their portfolios more efficiently, factoring in both portfolio performance and spending. But they also add variability to cash flows.

To help identify how these strategies balance lifetime income with considerations of quality of life and the volatility of cash flows, we break down some of the most widely used approaches.

This conservative method begins with the base case of fixed real withdrawals throughout a 30-year time horizon. However, to preserve assets following down markets, the retiree skips the inflation adjustment for the year following a year in which the portfolio has declined in value.

For example, an investor wouldn’t increase portfolio withdrawals after the 2022’s bear market despite the large jump in inflation during the year.

This might seem like a modest step, but the cuts in real spending are cumulative and can permanently reduce the retiree’s spending pattern.

In its simplest form, the RMD method is portfolio value divided by life expectancy and is designed to ensure that a retiree will never deplete the portfolio because the withdrawal amount is always a percentage of the remaining balance. The age for RMDs is now 73. And because money can’t stay in an IRA or 401(k) forever, RMDs will be taken from those plans.

Even though considered “safe,” an RMD system incorporates two key variables for retirement-spending plans: remaining life expectancy and remaining portfolio value. While changes in life expectancy are gradual, the fact that the remaining portfolio value can change significantly from year to year adds substantial volatility to cash flows.  

The guardrails method sets an initial withdrawal percentage, then adjusts subsequent withdrawals annually based on portfolio performance and the previous withdrawal percentage.

That means it attempts to deliver sufficient—but not overly high—raises in upward-trending markets while adjusting downward after market losses. In upward-trending markets where the portfolio performs well and the new withdrawal percentage (adjusted for inflation) falls below 20% of its initial level, the withdrawal increases by the inflation adjustment plus another 10%.

The guardrails apply during down markets, too.

Specifically, the retiree cuts spending by 10% if the new withdrawal rate (adjusted for inflation) is 20% above its initial level. This method acknowledges the fact that weak returns are dangerous early in retirement but less so later on.

We also tested a strategy that incorporates the average decline in spending that occurs over the retirement lifecycle. Research from the Employee Benefits Research Institute demonstrates that inflation-adjusted household spending has historically fallen by 19% from age 65 to 75, 34% from age 65 to 85, and 52% from age 65 to 95.

To reflect this trend, we adjusted the annual spending numbers to match up—our method assumes that real retirement spending declines by 1.9 percentage points per year between age 65 and 75, 1.5 percentage points per year between 75 and 85, and 1.8 percentage points per year between 85 and 95.

Although there are unknown factors in retirement, such as when people may retire and their life expectancy, it’s possible for advisors to help their clients make informed decisions.

Take a deeper dive into these considerations.

The right withdrawal rate and strategy really depend on the time period and confluence of market events in play during that drawdown period. Still, it’s extremely tough to predict market conditions over a specific drawdown period.

Let’s take clients encountering a bad sequence of returns—the danger arising from withdrawing assets from a shrinking portfolio—or poor market conditions early on in their retirement. In those situations, investors should be conservative about their starting withdrawal. Despite not knowing what market conditions will prevail over our specific retirement time horizon, there’s benefit to checking as investors begin retirement planning.

Additionally, Scenario Builder within Advisor Workstation offers an interactive analysis tool that supports the SEC Marketing Rule—allowing advisors to illustrate the hypothetical performance of various proposed investments. By seeing these client-friendly reports, investors can get peace of mind that advisors have diversified their investment portfolios to help them prepare for market dips.

Another issue is that inflation builds upon itself, and that’s a negative for clients.

For example, if there’s a 10% inflation rate in the first year of retirement that returns to normal, every future year of spending has been impacted by that first-year inflation rate.

Plus, older adults tend to spend more on healthcare. While Americans 65 and older make up less than 20% of the population today, they account for over a third of total drug expenditures.

When looking back on historical inflation, we know that healthcare inflation historically runs higher than general inflation rate, making this an additional risk. In comparison to people who work, retirees don’t get those cost-of-living adjustments automatically in their paychecks—proving the importance of building a portfolio that’s protected against cost-of-living increases and inflation.

Spending tends to start higher—often coinciding with people’s good health years—and declines in the middle to late retirement years before elevating later due to healthcare-related factors.

The way that investors decide to spend their money varies based on their needs and wants. When you ask engaging questions, it’s easier to start productive conversations, provide quality service, and retain your clients. This important step may also offer you insight into how clients can use investing tools—such as cryptocurrency or online trading platforms—to reach their goals.

Almost all retirees receive at least one form of guaranteed income. Here’s a closer look at primary consideration for these sources—and how they might be combined with portfolio-based strategies.

For clients seeking a stable stream of real income, financial advisors could explore a ladder of Treasury Inflation-Protected Securities (TIPS)—which can be purchased directly from the US government.

This self-liquidating portfolio takes advantage of inflation-adjusted payouts to give investors a predictable source of retirement income. TIPS ladders deliver two major offsetting benefits: First, they provide a 100% success rate. They’re also immune to inflation’s ravages, as their payments are structured in real terms.

The other benefit offered is that if the yields on TIPS are sufficiently attractive, their safe withdrawal rates can exceed those provided by other investment portfolios. As of September 30, 2023, our research shows that a 30-year TIPS ladder would support a 4.6% withdrawal rate.

On the downside, TIPS ladders are inflexible—retirees who start down that path must either finish it or accept that changes they make along the way will ripple for the rest of the retirement period.

The US Social Security Administration encourages retirees to postpone the date at which they claim their benefits. Not only does the administration penalize retirees who file before the official “full” retirement age (currently 67 for people born in 1960 and after), but it rewards those who delay by substantially increasing their benefits.

By the time retirees reach age 79, those who filed for Social Security at their full benefit age of 67 will have collected more money from their benefit than those who started at age 62.

The advantage that accrues from postponing Social Security becomes considerably larger for those who also postpone tapping into their investment portfolios. Doing so increases the safe withdrawal rate because working longer reduces the length of the expected retirement period, which then creates a larger investment portfolio.

Annuity contracts sold by insurance companies come in many forms such as single-premium immediate annuities (SPIAs)—which distribute monthly payouts for the remainder of the retiree’s life, starting when they are purchased—or deferred annuities, which begin their payments at a specified later date.

Regardless of design, annuities all provide a guaranteed stream of cash flows in exchange for the insurance premium.

In other words, investors can’t trade in their annuity for cash after income payments have begun. Annuity payouts are also customarily normal, making them vulnerable to high inflation. Still, these payouts can protect against longevity and market risk.

Investors are also turning to a new retirement income strategy—combining the familiarity of target-date funds with the risk protection provided by annuities. There are two ways that annuities can be incorporated.

Under the first approach, investors have the option to buy an income annuity with a portion of their balance at the retirement target date. With the second approach, the target date buys units of guaranteed income before the target retirement date. In either case, investors can access their funds until they choose to annuitize or turn on the income stream.

Annuity Intelligence Center, a comparison research tool available within Advisor Workstation, may help you determine the right annuities for clients. Powered by Luma, advisors can explore active and historical data on nearly all variable annuities, get one-page summaries that show benefit information, and use our FINRA-reviewed reports to educate clients about the cost and key details of annuities.

As one of the main categories of retirement income, generating portfolio income is essential for clients. Here are popular approaches to know.

Some 401(k) plans may not allow retirees to pick and choose which investments they tap for withdrawals but require them to take distributions pro rata from all of the holdings in the account.

That lack of flexibility can be a major disadvantage for those who want to use their withdrawals to help keep their asset allocations in line with their targets on an ongoing basis.

Target-date funds are another popular strategy with a 401(k) plan. When considering performance, target-date glide paths matter. For example, series with a “to” glide path lower their equity allocation until they reach retirement, at which point they convert into a “retirement” fund and remain constant. Those that implement a “through” glide path continue to lower their equity stake past the target retirement.

Given “through” glide paths have a further landing point than the “to” peers, they typically have a higher equity allocation at retirement, which investors should be comfortable with prior to investing.

When you stay informed on industry trends, it can be easier to identify how retirement vehicles like target-date strategies can strengthen your clients’ portfolios.

Most people can contribute up to $7,000 per year to their traditional IRA and deduct those contributions from their annual taxable income if they meet certain requirements. Those dollars are taxed once the investor withdraws money from the account.

Because IRAs are for retirement savings, there’s a 10% penalty on withdrawals before the person turns 59 ½. After 72, individuals must make a required minimum distribution (RMD) every year or face a 50% penalty on the distribution amount.

IRA withdrawals aren’t governed by pro rata rules, giving retirees more latitude to manage withdrawals in a way that aligns with portfolio strategy.

If retirees were taking a buy-and-hold approach and using rebalancing proceeds to create cash flows, for example, they’d be able to pull withdrawals exclusively from bonds and cash when their equity holdings are in the dumps—they’d extract money from equities only after robust stock market rallies. 

For investors who want maximum flexibility, this option may be a good fit.

That’s because clients can put as much into a taxable account as they can save. They’re able to pull the money whenever they need it without penalty, and they can invest in anything they like. If the client is a supersaver, a taxable account may be the only approach left once they’ve maxed out their tax-sheltered retirement savings vehicles.

Clients may also benefit from applying bucket strategies to their plan—a retirement-income management tool that establishes multiple asset buckets with different levels of risk and funding purposes.

While a bucket system isn’t necessary for the preretirement years because active portfolio spending hasn’t yet happened, time-horizon considerations should be a key aspect of portfolio planning. By having a deeper understanding of these strategies, you can help your clients avoid common assumptions when planning for retirement.

This approach pays out your home equity as cash. Although reverse loans don’t require monthly repayments, borrowers can default if they fail to make property tax and insurance payments or keep their homes in good repair. Foreclosure can be a big risk, but federal regulation of these loans has been tightened in recent years so it’s possible to use a reverse loan safely.

Advisor Workstation’s App Hub ecosystem houses resources on the benefits of reverse mortgages, allowing you to deliver more comprehensive retirement advice to clients. In the Lending Module, advisors can access important resources such as home equity solutions and detailed scenarios tailored to their clients’ needs. Designed to bridge workflow gaps, App Hub also gives advisors the opportunity to discover and license specialized workflows from vetted third parties.

It’s wise to consider business ownership interests as higher risk than other income sources. That’s because business cash flows aren’t guaranteed and there’s also a chance of having to sell the business in a weak market environment.

Because small businesses are an illiquid asset, clients with significant business ownership interests should prioritize liquidity and safety elsewhere in their investment portfolios. Not only must the portfolio downplay the industry in which the small business operates, but it should avoid big sector-specific and stock-specific risks in general. During the accumulation years, small-business owners need to also prioritize investing in their investment portfolios as well as their businesses. 

Advisor Workstation can help you go beyond what your clients are expecting. Optimize portfolios and proposals to fit client risk profiles, create compelling reports, deliver impactful advice, and more. Request a demo today.

The Investment Planning experience within Advisor Workstation lets you personalize your recommendations based on a client’s risk comfort, values, and goals. The end-to-end solution can empower advisors to drive meaningful conversations and create investment plans aligned to clients’ preferences with clear before-and-after visuals.