Retirement Income Strategies for Managing Market Risk
Retirement income strategies help retirees manage withdrawals, investment risk, and the possibility of outliving their savings. Holding liquid reserves may reduce the need to sell investments during market downturns, while an annuity may provide contractually defined income. The right approach depends on spending needs, other income sources, risk tolerance, taxes, and contract costs.
Key Takeaways
- Negative returns early in retirement can have a greater impact when you are also withdrawing money from your portfolio.
- A liquid reserve may provide flexibility during market downturns, but cash can also reduce long-term growth potential.
- Annuities may provide income guarantees under specific contract terms, subject to the insurer’s claims-paying ability.
- The best retirement withdrawal strategy depends on your circumstances rather than one universal formula.
- Coordinated retirement income planning can help align withdrawals, investments, and income needs with your broader financial goals.
What Is Sequence-of-Returns Risk?
Sequence-of-returns risk is the risk that investment losses early in retirement can have a lasting effect on how long a portfolio supports withdrawals. It matters because retirees may need to sell investments to pay living expenses even when markets are down.
For example, imagine two retirees with similar portfolios who withdraw money for living expenses. If one experiences substantial losses early in retirement, they may need to sell more investments to raise the same amount of cash. That can leave fewer assets available to participate in a later market recovery. The timing of returns can therefore matter as much as the overall investment experience when withdrawals are being made.
This does not mean a market downturn will automatically cause a retirement plan to fail. The outcome depends on factors such as the size of withdrawals, portfolio allocation, investment performance, fees, other income sources, and how long the money needs to last.
Effective retirement income planning considers both how a portfolio is invested and how money will be withdrawn. A plan should also be reviewed when spending needs, markets, health, or other personal circumstances change.
Retirement Income Strategies to Manage Drawdown Risk
Retirement drawdown strategies determine how you use savings and investments to pay for expenses after you stop working. Two approaches that may help manage sequence-of-returns risk are keeping a liquid reserve and evaluating whether guaranteed income from an annuity fits your needs. Neither approach removes every risk, and they are not suitable for every retiree.
Strategy 1: Keep a Reserve of Liquid Assets
One approach is to keep a portion of your assets in readily accessible, relatively stable holdings to cover near-term spending. Some retirement plans consider a reserve equal to two or three years of planned withdrawals, but that is a guideline to evaluate—not a rule that works for everyone.
A reserve may help you avoid selling longer-term investments during a market decline. When markets recover or portfolio gains are available, you may be able to replenish the reserve according to your plan.
However, holding too much in cash can reduce the amount invested for potential long-term growth, and inflation can erode cash purchasing power. The appropriate reserve depends on your essential expenses, predictable income, overall portfolio, access to other funds, and comfort with market volatility.
Practical Questions to Consider
- How much do you need to withdraw from investments each year after accounting for other income?
- Which expenses are essential, and which could be adjusted temporarily?
- How much cash or other liquid assets do you already have available?
- What conditions would prompt you to replenish the reserve or adjust withdrawals?
A written withdrawal plan can help you decide how to use cash reserves during a downturn instead of making rushed decisions in response to market movements. The goal is not to predict the market, but to make sure your income plan can respond to different conditions.
How a Guaranteed Income Annuity May Fit
An annuity is a contract with an insurance company. Depending on the contract, it may provide payments immediately or at a future date. A guaranteed income annuity may help cover some planned expenses with contractually specified payments, but guarantees depend on the issuing insurer’s claims-paying ability and the exact terms of the contract.
Annuities differ significantly. Some provide payments for a set period or for life, while variable annuities expose the account value to investment performance. Optional benefits may offer additional withdrawal or income guarantees, generally subject to specific conditions and fees.
Potential Benefits and Trade-Offs
- Income predictability: Certain annuity contracts can provide scheduled payments, which may help cover planned expenses.
- Risk transfer: A qualifying contract may transfer certain longevity or market-related risks to the insurer, depending on its structure. It does not eliminate all financial risks.
- Reduced flexibility: Access to the money may be limited, and withdrawals beyond contract terms can trigger charges or reduce benefits.
- Insurer risk: Contractual guarantees rely on the issuing insurance company’s ability to meet its obligations. Annuities are not bank deposits insured by the FDIC.
What to Review Before Buying an Annuity
Before considering an annuity, review the contract’s fees, surrender-charge period, available withdrawal provisions, income options, death benefits, inflation implications, and any optional rider costs. Variable annuities may include investment-related expenses as well as fees for optional benefits.
Tax treatment depends on the type of annuity and how it is funded. Taxable portions of annuity distributions are generally treated as ordinary income. Certain withdrawals before age 59½ may also be subject to a 10% additional federal tax unless an exception applies. Consult current IRS guidance and a qualified tax professional about your circumstances.
Read the contract and, where applicable, the prospectus before making a decision. For additional background, see the SEC’s Annuities guide and the IRS guidance on pensions and annuities.
What Research Can—and Cannot—Tell You
The original article refers to an Ibbotson Associates study titled “Retirement Portfolio and Variable Annuity with Guaranteed Minimum Withdrawal Benefit.” This research examined a particular portfolio approach that included a variable annuity with a guaranteed minimum withdrawal benefit.
Results from a specific model depend on its assumptions, time horizon, product features, and costs. They should not be interpreted as proof that a variable annuity will increase income or reduce risk for every investor. Compare the study’s assumptions with your own needs and the terms of any product under consideration.
How to Compare Retirement Withdrawal Strategies
There is no single best retirement withdrawal strategy for everyone. The right approach depends on how much income you need, how flexible your spending is, what other income you receive, and how much investment risk you can afford to take.
| Approach | Potential role | Important limitation |
|---|---|---|
| Liquid reserve | Provides accessible funds for near-term expenses during market downturns. | Excess cash may limit long-term growth and lose purchasing power to inflation. |
| Portfolio withdrawals | Allows withdrawals from an investment portfolio while retaining flexibility over investments. | Market losses and ongoing withdrawals can reduce the portfolio’s ability to support future spending. |
| Annuity income | May provide contractually defined payments to help cover planned expenses. | Fees, contract restrictions, inflation, and insurer claims-paying ability must be considered. |
| Combined approach | Can coordinate liquid assets, investments, and contractual income sources. | Requires careful planning to understand costs, trade-offs, and how each part supports the overall plan. |
When evaluating options, start by estimating essential and discretionary spending. Then identify predictable income, such as Social Security or pension payments, and calculate the remaining amount that must come from savings or investments. Review how withdrawals could change during market declines and whether you have flexibility to adjust discretionary spending.
Also consider taxes, inflation, healthcare costs, time horizon, and the needs of a spouse or other dependents. A strategy should be reviewed periodically rather than treated as a permanent formula.
Retirement Income Planning with ASOFSP
Managing retirement income involves more than choosing investments or deciding whether to buy an annuity. It requires understanding how your income sources, portfolio withdrawals, spending needs, and financial priorities work together over time.
The Art and Science of Successful Planning (ASOFSP) is a fee-only fiduciary financial planning firm based in Fort Myers, Florida. For individuals and families in Fort Myers and Southwest Florida, retirement income planning can help organize these decisions around their broader financial circumstances.
When reviewing your retirement income strategy, it can be useful to assess:
- How much income you need to cover essential and discretionary expenses.
- How Social Security, pensions, savings, and investment withdrawals may work together.
- How market downturns could affect planned withdrawals and future portfolio value.
- Whether a liquid reserve or annuity deserves consideration based on your objectives and the associated trade-offs.
- When to revisit the plan as your circumstances, spending, or financial markets change.
ASOFSP can help you consider retirement income decisions within the context of your overall financial plan. To explore how your income sources and withdrawal approach fit together, contact ASOFSP to discuss your financial planning needs. You can also review our existing resource on sources of retirement income.
Disclaimer: This article is for general educational purposes only and does not provide individualized investment, tax, legal, or insurance advice. Investments involve risk, including possible loss of principal. Annuity guarantees are subject to the issuing insurer’s claims-paying ability and contract terms. Tax treatment varies by product and individual circumstances. Consult qualified professionals before making financial or insurance decisions.
Frequently Asked Questions
What is the biggest risk when withdrawing retirement income?
One important risk is sequence-of-returns risk: poor investment returns early in retirement can be especially damaging when you are also withdrawing money to cover expenses. Those withdrawals may require selling more investments when values are down, leaving fewer assets to participate in a recovery. Spending needs, portfolio allocation, other income, and the length of retirement also affect outcomes.
How much cash should retirees keep in reserve?
Some retirement strategies consider keeping two or three years of planned withdrawals in liquid assets, but there is no universally correct amount. The right reserve depends on essential expenses, predictable income, portfolio risk, access to other funds, and spending flexibility. Holding more cash may help with short-term needs, but it can also limit growth and purchasing power over time.
Can an annuity guarantee retirement income?
Some annuity contracts provide specified income payments or guaranteed withdrawal benefits, subject to the contract's terms and conditions. These guarantees depend on the issuing insurance company's claims-paying ability. Fees, surrender charges, inflation, access restrictions, and optional-benefit costs can affect whether an annuity fits your plan. Review the contract carefully and compare it with other income options before making a decision.
What is the best retirement withdrawal strategy?
The best approach depends on your spending needs, other income sources, investment portfolio, tax circumstances, risk tolerance, and expected retirement length. Some retirees may benefit from a liquid reserve, while others may consider a mix of portfolio withdrawals and annuity income. Reviewing different scenarios can help you understand trade-offs and build a strategy suited to your circumstances.
How can retirement income planning help?
Retirement income planning brings together expected expenses, Social Security or pension income, savings, investments, and withdrawal decisions. It can help identify how much income must come from your portfolio, how market downturns might affect withdrawals, and when a plan may need to change. A financial planner can help you evaluate these decisions in relation to your broader financial goals.
