Life would be much easier for everyone if we had a crystal ball to see into the future. Since we don’t, we need to be prepared for all possible scenarios in life, especially when it comes to planning for retirement. Steve Vernon of CBS Moneywatch uses some helpful graphs to help us “Choose the best ways to generate retirement income.” When you are figuring out how much income you will receive from your retirement savings, the current economic conditions should only be one of many things you look into. It’s important to see how your different options for generating retirement income will change based on good market conditions and bad market conditions as well. So-called scenario planning is a good way to see how your income generator will work in both best and worst case situations, as well as everything in between.
In the first graph, made by Dr. Wade Pfau, six different retirement income strategies are evaluated in a negative economic future. The guaranteed income of the different annuity products performed the best when future economic conditions were negative. Inflation-adjusted annuities provided the highest income after 30 years out of all six strategies researched. They were followed by the immediate fixed income annuity, which provided the second highest income after 30 years. Fixed annuities are not affected by market performance, so when markets decline, they certainly pay off as a good investment. Using constant systematic withdrawals, equivalent to the 4% rule, proved catastrophic in a negative economic environment. Retirement income dropped to zero after 20 years and there was nothing left for the remaining 10 years that were studied, not to mention any additional years that you may actually live.
Both graphs use the same scenario to get their results: a 65 year old couple with $100,000 in retirement savings. The second graph determines how your inflation-adjusted retirement income would change if economic conditions proved to be more favorable in the future than they are today. In this scenario, you get the most income from strategies that invest your retirement income and pay you a percentage of that. This makes sense, but are you willing to take the gamble on the markets being favorable right when you decide to retire? Since the fixed annuities listed don’t change with the markets, they provided the least income of the studied methods when markets were up at retirement. But their income was consistent in both graphs, something that provides peace of mind during retirement.
Behavioral science has shown that we as humans are more hurt by financial losses than we are pleased with unexpected financial gains. What this and these graphs show us is that diversifying retirement income strategies may be the best way to protect and provide income in the future. Always be prepared with guaranteed income in case the scenario that you hope to happen is not the true life situation. By assuming the worst and preparing for that with guaranteed income streams, you are protected either way. If you want to use some of your retirement savings in the markets just in case the scenario is favorable, that could be a good option too.
Written by Rachel Summit