The ART of Managing Retirement Income Risk

Retirement is a time to thrive, and thoughtful planning around income risk plays a key role in making that possible. By giving clients some direction for generating a consistent retirement income stream, you can not only help alleviate their stress, you can also increase the probability that they meet their retirement goals.

One of the most effective ways to do that is to know when to help a client avoid, retain, or transfer risk in their retirement income strategy — a method referred to as the ART methodology.

The ART methodology

Avoiding risk

Here, the client is unwilling to accept significant risk, preferring to stick with conservative options such as Treasuries or certificates of deposit to produce retirement income. In some clients’ minds, avoiding risk is perhaps the easiest way to deal with income threats as they can simply buy long-term bonds to match their payment desires. However, while this may have worked well in the past when bond yields were higher, using this strategy now can require a larger amount of capital to satisfy a client’s income gap.

Retaining risk

On the opposite end of the spectrum, the client is willing to assume all risk and will use portfolio diversification and safe withdrawal rates to produce retirement income from a combination of stocks and bonds, managed money and mutual funds, or real estate investments. Retaining risk is helpful in that it may require far less capital. But, as with anything else, if that risk is miscalculated, the results could be less favorable, and future retirement income could be at risk. This strategy will have to account for longevity risk, market risk, interest rate risk and sequence of return risk.

Transferring risk

In the middle the client is looking to move risk to a third party, such as an insurance company. This scenario includes using annuities to produce guaranteed retirement income. Transferring risk uses risk pools and mortality credits to result in a capital requirement that can be far lower than either avoiding or retaining risk, while providing a consistent income stream.

The advantages of avoiding or retaining risk

Clients who choose to avoid or retain risk often do so because those approaches align with their personal comfort level, financial goals, and preferred level of control. Avoiding risk may help provide greater confidence through conservative strategies focused on protecting principal and generating stable returns. Retaining risk may appeal to clients seeking higher long-term growth potential, greater liquidity, and direct control over how their assets are invested and distributed.

The advantages of transferring risk

In a modern retirement strategy, as people may live in retirement for 30 years or more, the most significant threat to a client’s well-being can be longevity risk — the very real possibility of outliving their retirement savings. While avoiding and retaining risk place the full burden of market fluctuations and lifespan uncertainty on the client’s shoulders, transferring risk to an insurance company shifts that weight to the carrier.

By using a fixed index annuity (FIA) — an insurance product, not an investment — clients can build and secure a stream of guaranteed lifetime income. Plus, this approach typically requires less capital than relying solely on bonds or a diversified portfolio to generate income.

Key benefits of transferring risk include:

• Protection for asset growth: Clients can build retirement income through index-linked credits based on the performance of an external market index without ever being directly invested in the stock market.
• Principal protection: Because the client’s principal and credited interest are safeguarded from market downturns, their foundation is secure.
• Sustainability beyond safe withdrawal rates: Transferring risk can be an option for retirees who need withdrawal rates higher than those considered safe (such as the 4% rule) — an FIA provides income at a guaranteed contract rate.
• Portfolio flexibility: By securing a portion of their income through an annuity, clients can free up remaining capital that can be reinvested in equities or growth-focused portfolios. This allows for potential long-term growth to generate increased retirement income, address inflation risk, and support legacy goals.

Explore 5 common retirement income challenges through the ART framework.