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Smart retirement income strategies

How a mix of investments can help provide income and growth potential in retirement.

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Just as your life has likely been nothing like your parents’, your retirement probably won’t be either. It’s no longer as simple as signing up for Social Security, collecting your pension, and settling back. You will probably be more active, live and work longer, and need to rely more on what you’ve saved for income. And that means ensuring that this income has the potential to last for your lifetime and to weather rising health care expenses, inflation, and market ups and downs.

While this may sound overwhelming, it doesn’t have to be. First, take the time needed to make a smart choice around how and when to take Social Security, which is an important source of guaranteed income in retirement. (Read Viewpoints: How to get the most from Social Security). Then, turn your focus to creating a diversified income strategy that leverages three types of income-generating investments: fixed-income annuities, variable annuities, and an investment portfolio. Your mix can be made up of one, two, or all three types in various proportions, based on your preferences and income needs.

“Together, these components can work to help provide a stream of guaranteed income1, the potential for growth, some flexibility to refine your plan over time, and protection from market volatility,” explains Fidelity executive vice president John Sweeney.

Creating a plan that includes some guaranteed income is particularly important if you happen to retire when the markets are down or inflation is rising for a prolonged period. The chart below shows that if you had just started taking withdrawals from your retirement investments in 1972 (when the markets were down and inflation was rising), your investment portfolio would have been depleted early in your retirement. The earlier a market downturn happens in retirement, the greater the effect on your portfolio. That’s why it’s important to lock in some guaranteed income for retirement so you can cover essential expenses no matter what the markets do.

Components of a diversified income strategy

We believe it makes sense to use guaranteed income1 from fixed-income annuities and certain types of variable annuities,2 in addition to your Social Security or pension income, to help ensure that your essential expenses (food, utilities, health care, and other must-haves) are covered—even if a bear market hits in the early years. Then you can position your investment portfolio for growth, as well as use it for your discretionary spending (vacations, hobbies, and other nice-to-haves).

“By diversifying your income, you can create an efficient retirement strategy—one that uses the least amount of savings to generate the after-tax income you need,” notes Klara Iskoz, CFA®, vice president in Fidelity Strategic Advisers.

Let’s take a closer look at the three components that supplement Social Security.

1. Fixed-income annuities: guaranteed income

A fixed-income annuity is a contract with an insurance company that, in return for an up-front investment, guarantees to pay you (or you and another person) a set amount of income either for the rest of your life or for a set period of time. The income could start immediately or on a future date that you select.

Why do we suggest including a fixed-income annuity as part of a diversified income strategy? It’s straightforward: Fixed annuities, along with Social Security and/or pensions, provide guaranteed income to help meet essential expenses. The insurance company is obligated to make payments to you for a specific time frame you select, or if you choose a lifetime option, the payments will occur as long as you or your spouse lives. With either the defined period or lifetime option, payments will continue to occur regardless of what happens in the financial markets, subject to the claims paying ability of the insurer.

There are two things that a typical fixed-income annuity won’t provide: access to the money you invested and growth potential. Because you give up access to the savings you use to purchase this type of annuity, you will need to have other assets available to address unexpected expenses that might crop up. And because you also forgo any market growth potential for this money, we believe a fixed-income annuity should be only a portion of your overall strategy.

We generally suggest you consider a fixed-income annuity with a cost-of-living adjustment (COLA) to help protect your income payments from inflation. For example, if you use additional assets to purchase a 2% COLA for your annuity, your income payments will increase by 2% every year and can help address the impact of inflation.

2. Variable annuities2: guarantees and growth potential

Unlike fixed-income annuities, variable annuities have underlying investment options that provide potential for growth and that may help offset inflation. A variable income annuity guarantees payments for as long as you live. Depending on the specific guarantees of the annuity, these income payments may go up or down based on the performance of the underlying investments. You can pay extra for a deferred variable annuity with a guaranteed minimum withdrawal benefit (GMWB) to ensure that your payments won’t dip below a set amount, though they may rise due to market performance.

Why might you purchase a variable annuity rather than invest the money directly in the stock market? A variable annuity with a lifetime income payment option may help protect you against the risk of outliving your assets. This is much harder for an investment portfolio to do on a consistent basis.

As with a fixed-income annuity, however, you may have to give up access to savings you use to purchase certain variable annuities.

3. Withdrawals from an investment portfolio: growth potential and flexibility

An investment portfolio with a mix of equities, fixed income, and short-term investments that matches your time horizon and risk tolerance can be an essential part of a diversified income strategy. Why? It provides flexibility (you can generally access your money when you need it) and growth potential, which is as critical in retirement as it is when you are saving for it, because you may need these assets to last 30 years or more. Of course, there is market risk with an investment portfolio, which is why we suggest that it be used to cover discretionary expenses in retirement to the extent possible or necessary. If the market were to perform poorly, you could always cut back on some of your discretionary expenses to help compensate.

Creating and managing an investment portfolio in retirement can be challenging and it requires discipline. You need to choose an asset mix that reflects your time horizon and risk tolerance, select investments that match your goals, monitor them over time, rebalance when needed and, finally, look for opportunities to maximize your after-tax returns.

Once you’ve created your investment portfolio, the next question is how much you should withdraw each year. The answer depends on how long you want your money to last and how it’s invested. As a rule of thumb, though, our historical research suggests that an annual withdrawal amount of 4% of your starting balance, adjusted annually for inflation, may be sustainable throughout 27 years of retirement. (This assumes a balanced portfolio of 50% stocks, 40% bonds, and 10% short term investments for the duration of retirement.)

When determining your own potentially sustainable withdrawal rate, be sure to consider factors such as inflation, time horizon, market conditions, and your asset allocation. Fidelity Income Strategy Evaluator®3 can help you determine your rate.

An example

So, let’s bring the concept of income diversification to life using the Fidelity Income Strategy Evaluator® tool. Consider a hypothetical couple, Marsha and Charles Wilson.4 They’re both 63 and retired, and have $600,000 in savings invested in a balanced portfolio of 50% stocks, 40% bonds, and 10% short-term investments. Their monthly expenses add up to $4,200, of which $3,000 is essential and $1,200 is discretionary. Their monthly income from Social Security and pensions, adjusted for taxes, is $2,635. So, they estimate they’ll need to generate $1,565 more a month from their savings, of which $365 is for essential expenses.

Discretionary expenses are important to the Wilsons, too. They want to travel and spend money on their children and grandchildren. There’s also a history of longevity in their family, so they’re planning for a 31-year time frame.

Let’s look at two different hypothetical income strategies.

Retirement income strategy 1: withdrawals from an investment portfolio

Can the Wilsons rely on just regular withdrawals from their portfolio to fill their $1,565-a-month income gap? Using our analysis, they would need to invest approximately $533,629 of their $600,000 to potentially generate $1,565 a month based on a withdrawal rate of about 4% per year. Using average market conditions (what we call a 50% confidence level), their portfolio would continue to generate that amount (adjusted annually for inflation) and could grow to $2,327,3135 after 31 years. However, if they were to assume a 0% return market, not only would their portfolio run out of money early, but they would need to tap into their surplus assets, and, after 22 years, all their retirement savings would be depleted.

Although the average market scenario looks good on paper, no one can predict market performance and the Wilsons don’t want to take chances with all their hard-earned money. The impact of bad markets on a portfolio while you’re saving and investing during your working years may slow down your plans and delay your future retirement date. However, after you enter retirement, down markets can be devastating, because your ability to recover is limited because you are taking withdrawals. Because of these considerations, the Wilsons are concerned that this strategy might not be able to generate enough money in tough years.

Retirement income strategy 2: withdrawals from an investment portfolio and annuities

The Wilsons don’t want to risk running out of money, and they’re willing to give up access to some of their savings and some growth potential in exchange for guaranteed income.

To achieve their objectives, they might consider investing $493,901 of their $600,000 retirement savings in a multiproduct strategy. To cover their gap in essential expenses, they could put $148,170 into a joint-life fixed-income annuity with a 2% COLA , and $98,780 into a joint-life variable income annuity. Both annuities would provide guaranteed lifetime income, but the payments would differ. The monthly payment from the fixed-income annuity would start at $450 and increase 2% each year thereafter. The initial monthly payment for the variable income annuity would be $357, with subsequent payments fluctuating based on the underlying investments’ market performance. The couple would leave $246,951 invested in a balanced portfolio. They would withdraw $758 a month for the first year and then increase the amount 2.5% each year thereafter to account for inflation (see pie chart, right, for details).

This strategy provides both upside potential and downside protection. In average market conditions, their income need is satisfied throughout their lifetime and their portfolio could grow to almost $1.8 million5—similar to the first strategy’s outcome under this market scenario. But what’s more important is that they now have the protection of lifetime income to ensure that their essential expenses are covered throughout retirement. Even in a 0% return market, although their investment portfolio (including reserves) runs out of money by year 22, their annuities continue to pay income for their lifetime. This results in an increase of $107,600 in cumulative lifetime income when compared with Strategy 1 ($655,100 versus $547,5005).

Which strategy covers all the bases?

Income strategy 2 delivers the desired mix of flexibility, growth potential, and guarantees to address the Wilsons’ income needs. We believe this approach will more effectively weather rising health care expenses, inflation, market changes, and longevity while providing guaranteed lifetime income (see the comparison below).

How do income strategies stack up?
Investment portfolio only Investment portfolio and guaranteed
income from annuities
Retirement savings available $600,000 $600,000
Assets needed for income strategy $533,629
in balanced portfolio
  • $246,951 in balanced portfolio
  • $148,170 in fixed income annuity
  • $98,780 in variable annuity
Reserves $66,371 $106,099
Estimated initial monthly income (after tax) $1,565 $1,565
  • $758 from investments
  • $450 from fixed income annuity
  • $357 from variable annuity
Average markets
  • Cummulative lifetime income
  • Total assets at end of plan
0% return market5 
  • Cummulative lifetime income
  • Total assets at end of plan
For illustrative purposes only. This hypothetical example was created using the Fidelity Income Strategy Evaluator. Results are calculated based on how the hypothetical portfolio might have performed in a certain percentage of simulated market scenarios. These percentages are called confidence levels. Average market results are based on a 50% confidence level. This means that in 50% of the market scenarios tested, the hypothetical portfolio performed at least as well as the results shown for the average market. Results are also calculated assuming that the hypothetical portfolio experienced a 0% return environment. The variable income annuity values reflect the deduction of the annual annuity charge. Fund fees will also apply and are not reflected. (See the disclosure section below for more information.) Planning age is 31 years from today. Guarantees apply to certain insurance and annuity products (not securities, variable, or investment advisory products) and are subject to product terms, exclusions, and limitations, and to the claims-paying ability and financial strength of the issuing insurance company.

All figures are estimated.

An investment portfolio plus annuities gives the Wilsons some guaranteed income to help cover their essential expenses as long as they live, and lets them invest for growth to help fight inflation, while utilizing the least amount of their savings. Of course, they need to be comfortable giving up access to the money used to purchase annuities in exchange for guaranteed income (see the pros and cons below).

Two income-generating strategies: a comparison

Strategy How it works Potential
Pros Cons
Withdrawals from investment portfolio Withdrawals of both earnings and principal from a diversified portfolio of investments, managed for total return
  • Individually managed portfolio of stocks, bonds, and short-term investments
  • Managed accounts
  • Single-fund strategies
  • Potential to generate income and growth
  • Optional automatic withdrawals may be possible
  • Flexible access to assets
  • Investments subject to market risk, earnings will fluctuate
  • Possibility of outliving assets
Combining withdrawals and guaranteed income from annuities1 Covers essentials with guaranteed income sources and uses withdrawals from a diversified portfolio to cover discretionary expenses
  • Individually managed portfolio of stocks, bonds, and short-term investments with regular withdrawals
  • Variable annuities
  • Fixed-income annuities
  • Potential to generate income and growth
  • Automatic withdrawals may be possible
  • Flexible access to a portion of assets
  • Opportunity to cover essentials with annuity guarantees
  • Limited or no access to annuity assets
  • Investments subject to market risk; earnings and income will fluctuate
  • Possibility of outliving investment assets drawn down for income

These are just general examples of income strategies. The sustainability of a portfolio depends on the investor having the discipline to stick with his/her strategy, and will vary based on actual returns, withdrawals, and taxes.

Your mix

Everyone’s situation is unique, so there’s no one diversified income strategy that will work for all investors. You’ll need to determine what’s more important to you in retirement—growth potential, guarantees, flexibility, or potential preservation—to help you pinpoint the strategy that is right for you. For instance, more growth potential can mean settling for less guaranteed income. With more guarantees, you get less growth potential and less flexibility. Consider, too, your family’s history regarding longevity and whether you plan to leave a legacy to your heirs.

The following questions can help you get started on your own personalized income strategy:

  • Would you call yourself a sophisticated investor with many years of experience?
  • Are you willing to accept ups and downs in asset value and/or income value in exchange for potential growth?
  • Do you need income that is guaranteed to last for a lifetime?
  • To get guaranteed income, would you be comfortable giving up access to a portion of your assets?
  • How important is it to have your income protected from market downturns?
  • Are you willing to pay a fee for help managing your retirement portfolio?

Learn more

Retirement is a new and potentially long chapter of your life. Why not take the time to figure out how you want to live it? Then, develop a retirement income plan that helps you do that.

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Before investing, consider the investment objectives, risks, charges, and expenses of the fund or annuity and its investment options. Call or write to Fidelity or visit Fidelity.com for a free prospectus or, if available, a summary prospectus containing this information. Read it carefully.
IMPORTANT: The projections and other information generated by Fidelity’s Income Strategy Evaluator (ISE) tool regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Estimates of potential income and assets illustrated by the tool are in future dollars and are based on data entered, product attributes, and Income Strategy Evaluator assumptions, including market performance assumptions based on hypothetical scenarios using historical data. Other investments not considered by Income Strategy Evaluator may have characteristics that are similar or superior to those being analyzed. Numerous factors make the calculations uncertain, such as the use of assumptions about historical returns and inflation, as well as the data you have provided. Our analysis assumes a level of diversity within each asset class consistent with a market index benchmark, which may differ from the diversity of your own portfolio. Results may vary with each use and over time. Fund fees and/or other expenses will generally reduce your actual investment returns and, other than the applicable annual annuity charges for the variable annuity, are not reflected in the hypothetical projections generated by this tool. For specific assumptions about the variable annuity, fixed-income annuity, and investment portfolio components, please see the disclosures below titled “Variable annuity assumption”, “Fixed-income annuity assumption,” and “Investment portfolio assumption.”
A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, make a qualified first-time home purchase, suffer a disability, or die.
Information regarding hypothetical retirement income plan example: Results generated by the tool are not intended to predict present or future values of actual investments or actual holdings and results may vary with each use and over time. Essential expenses are matched with the annuity income at an assumed 0% return level and total expenses (essential and discretionary together) at the 50% confidence level. The average market conditions (50% confidence level) are used to match the total income need. Rates may change daily.
Variable annuity assumption: The variable annuity is assumed to be a joint-life variable income annuity with a 10-year guarantee period, 3.5% benchmark rate of return, 0.60% annual annuity charge, and a 100% survivor benefit at the death of either annuitant. The illustration assumes an asset allocation consistent with VIP FundsManager 60.
The variable income annuity values reflect the deduction of the annual annuity charge. The 0% rate of return is equivalent to a –0.60% return after this charge is reflected. Fund fees will also apply and are not reflected.
The amount of each payment from a variable income annuity is not guaranteed and will fluctuate based on the performance of the selected investment option.
Benchmark rate of return: The benchmark rate of return is one factor used to determine a variable income annuity’s initial and subsequent payments (note that it is not a guaranteed rate of return). Assuming withdrawals are not taken from the contract date to the first annuity income date, and from one annuity income date to the next, then annuity income will (a) increase if the annualized investment return for the contract is greater than the benchmark rate of return, or (b) decrease if the annualized investment return for the contract is less than the benchmark rate of return. The annualized investment return includes the contract’s fund performance minus the annuity and fund fees. This is true for this hypothetical scenario but may not apply to all variable annuities.
Fixed-income annuity assumption: The fixed-income annuity is assumed to be a joint-life income annuity with a 10-year guarantee period, 2% cost of living adjustment, and a 100% survivor benefit at the death of either annuitant. In order to arrive at the estimate, the best quote available as of June 12, 2015, was used from among the fixed-income annuities distributed by Fidelity Insurance Agency, Inc.; these annuities are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. Rates may change daily.
Guarantee period: A guarantee period is a feature available on certain fixed and variable income annuity contracts. A contract with a guarantee period provides annuity income through a specified date, even if no annuitant lives to the end of the guarantee period. If no annuitant lives to the end of the guarantee period, each beneficiary will continue to receive income for the remainder of the guarantee period (note that certain annuities give the beneficiary the option of choosing a commuted value as a lump-sum benefit instead). A contract with a guarantee period will provide lower annuity income on each annuity income date than an otherwise identical contract without a guarantee period.
Investment portfolio assumption: Illustrations of investment components are based on a balanced target asset mix. The balanced target asset mix is composed of 35% domestic and 15% foreign stocks, 40% bonds, and 10% short-term investments. Domestic stocks are represented by the S&P 500® Index; bonds by U.S. intermediate-term government bonds; and short-term assets are based on the 30-day U.S. Treasury bill. Foreign equities are represented by the Morgan Stanley Capital International Europe, Australasia, Far East Index for the period from 1970 to the last calendar year. Foreign equities prior to 1970 are represented by the S&P 500® Index. Historical returns for the various asset classes are based on performance numbers provided by Ibbotson Associates in the Stocks, Bonds, Bills, and Inflation (SBBI) 2007 Yearbook (annual update work by Roger G. Ibbotson and Rex A. Sinquefield). It is not possible to invest directly in an index.
Generally, among asset classes, stocks may present more short-term risk and volatility than bonds or short-term instruments, but may provide greater potential return over the long term. Although bonds generally present less short-term risk and volatility than stocks, bonds contain interest rate risk (as interest rates rise, bond prices usually fall, and vice versa), the risk of issuer default, and inflation risk. Finally, foreign investments, especially those in emerging markets, involve greater risk and may offer greater potential return than U.S. investments.
The results are calculated based on how the hypothetical portfolio may have performed in a certain percentage of simulated market scenarios. These percentages are called confidence levels. The average market results are based on a 50% confidence level. This means that in 50% of the market scenarios tested, the hypothetical portfolio performed at least as well as the results shown for the average market. Results are also calculated assuming the hypothetical portfolio experienced a 0% return environment.
The S&P 500® Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation and its affiliates.
The Ibbotson U.S. Intermediate-Term Government Bond Index is a custom index designed to measure the performance of intermediate-term U.S. government bonds.
The Ibbotson Associates SBBI 30 Day T-Bill Total Return Index is an index that reflects U.S. Treasury bill returns. Data from the Wall Street Journal are used for 1977–present; the CRSP U.S. Government Bond File is the source from 1926 to 1976. Each month a one-bill portfolio containing the shortest-term bill having not less than one month to maturity is constructed.

Indexes are unmanaged. It is not possible to invest directly in an index.

The retirement planning information contained herein is general in nature and should not be considered legal or tax advice. Fidelity does not provide legal or tax advice. This information is provided for general educational purposes only and you should bear in mind that laws of a particular state and your particular situation may affect this information. You should consult your attorney or tax adviser regarding your specific legal or tax situation.
1. Guarantees are subject to the claims-paying ability of the issuing insurance company.
2. Investing in a variable annuity involves risk of loss—investment returns, contract value, and, for variable income annuities, payment amount are not guaranteed and will fluctuate.
3. Fidelity Income Strategy Evaluator is an educational tool.
4. In the Wilson’s hypothetical example, we assumed that of the $600,000 in assets, $350,000 is held in tax-deferred assets [Charles’s 401(k)], $200,000 is held as tax-free assets (Marsha’s Roth IRA), and $50,000 is held in a taxable account (joint assets). The Wilsons’ total effective tax rate (federal and state) is 15.0%.
5. Amounts reflect the inclusion of Reserves ($66,371 for Income Strategy 1, $106,099 for Income Strategy 2).
Some insurance products are issued by third-party insurance carriers, which are not affiliated with any Fidelity Investments company.
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