Historically there has been a two-track approach to retirement income planning. One track focuses on the accumulation of assets—save enough money and your nest egg will spin off sufficient income to support your lifestyle. You might recall Lee Eisenberg’s 2006 book, “The Number: What Do You Need for the Rest of Your Life and What Will It Cost?” More recently financial services firms have asked this question in their marketing campaigns. It’s likely that many of your retired clients used this approach exclusively through defined contribution (DC) savings plans at work and other accumulation accounts, such as IRAs.
The other track focuses on guaranteed retirement incomes, often provided by defined benefit (DB) pension plans or annuity-type investments. Although fewer workers have pensions nowadays, the idea of planning to create a steady income still has numerous proponents. The attempts to instill DB-like guaranteed retirement incomes into DC plans continue, and the emergence of deferred annuities (“longevity” annuities) shows that at least some retirees value guarantees.
So what’s the correct goal of retirement planning: accumulating assets, building income streams or both? Steve Utkus, director of the Vanguard Center for Retirement Research, discussed this idea in an Oct. 6 blog entry for institutional investors. It’s an important issue because the chosen focus influences retirement plans’ selection of assets. DC plans and participants favor equities over fixed income, he writes, while DB plans and income-seekers focus more on fixed income.
The debate over the correct focus has emerged over the past decade with the emergence of DC plans and DB plans that offer participants lump sum distributions. “I think with the growth of defined contribution plans and more people actually facing the choice of deciding how much do they want in the form of guaranteed income in retirement versus how much do they want in the assets, the psychology began to shift, the thinking about what exactly is the purpose of the retirement plan?” he says. “Is it merely to provide inflation-adjusted income at retirement, in which case you take all your wealth and you would obviously annuitize it in some sort of CPI-indexed inflation annuity or are there other purposes to retirement savings?”
Advisors will know from experience that few clients would elect to go 100 percent with guaranteed incomes—it’s just too inflexible to deal with unexpected expenditures. As Utkus points out, retirees typically have multiple goals: income, spending flexibility, and frequently bequests. They also already have an inflation-adjusted annuity in the form of Social Security’s retirement benefits to help cover basic living expenses.
These factors are influencing the way some retirement plans and advisors are approaching the assets versus income decision, he says. But as he notes in the blog post, it’s not necessarily an either-or issue: “It’s not that we have to wholesale switch our mindset from accumulation to income payouts. Rather, participants deserve more of an “income orientation” to their defined contribution plan, without going so far as adopting a liability-driven approach in its entirety, and investing mostly in cautious investments.”
