By Keith Whitcomb

If retirement income is the goal, why don’t we measure it?

After more than a decade of bull market gains, the COVID-19 pandemic has reintroduced us to market volatility and investment losses. Yeah, you took a suitability survey that asked you how you would “feel” if the markets dropped, but now it is no longer a theoretical exercise. Everyone who looks at their latest 401(k) or broker statement will likely exhibit some of the symptoms of bear market anxiety. You groan (or worse), your shoulders slump, you shake your head, and then that gnawing feeling in the pit of your stomach starts.

Those in accumulation mode (in their 20s, 30s, and 40s) can remind themselves that volatility is just “part of the game,” and, as long-term investors, they can wait for markets to recover in the future. But if you are nearing retirement, the future is now. Will you still be able retire? For retirees, the second-guessing can start. “Maybe I should have purchased that annuity...”

Measuring Income

Part of the problem is that our current reporting tools are basically designed to measure the growth of an account. Gains and losses. The return on your investment. That is all fine and good when you are saving for retirement, or if your goal is to accumulate assets to leave a legacy. However, they don’t work as well when evaluating the generation of retirement income.

So, what does that mean exactly? Here are some income-relevant issues that are not addressed when you focus on optimizing portfolio asset growth:

  • How sensitive to market volatility will withdrawals from each account or product be?
  • Is inflation mitigated by the account or product?
  • Will income tax on Social Security be triggered by the sale of taxable investments?
  • Should product liquidity be somehow incorporated into the analysis?
  • Can longevity risk be included when evaluating assets and products?
  • Are withdrawal strategies integrated into plans for generating after-tax income?

This is not a comprehensive list, but these questions can start a process of looking at your financial resources as income generators instead of just asset balances.

Here are some specific steps you can take to enhance the current asset performance-driven evaluation of your retirement readiness.

Retirement “Red Zone”

If you are in your 50s, you likely need to begin a transition from an asset accumulation strategy to one that will generate cash to pay your expenses in retirement. As a starting point, you can estimate the income potential of your assets by using an online calculator developed by Blackrock. The calculator estimates what an annuity would pay given your age and the size of your portfolio. It allows you to establish a baseline income projection without having to get a salesperson involved, or give up any personal information. I’m not suggesting that you buy an annuity (although that may work for you), rather this exercise is designed to help you initiate and develop your retirement income strategy.

Accrued Income Taxes

Applying the same withdrawal assumption to traditional 401(k) or IRA balances, and a Roth account is a mistake. Your traditional accounts have tax baggage that your Roth account does not. It’s like having a mortgage on your house. When you sell, you have to pay off the debt. The same holds true here. To evaluate your assets on an apples-to-apples basis, the tax liability needs to be estimated and used to reduce the valuation of any traditional account you own. How much will you pay in taxes when you remove funds from those tax-deferred accounts? That will be a function of your overall income during retirement, but even a ballpark estimate of the taxes will help to true-up the income generation capabilities of these assets.

Diversification of Income

Portfolio diversification seeks to avoid unsystematic risk and dampen volatility. You can also apply this methodology to your sources of retirement income. How does that work?

First, take an inventory of your financial resources and map out their income characteristics. Then, build a “portfolio” of different products and accounts to give you income flexibility in retirement. To help you out, here is a list of income characteristics matched with products and accounts that are designed to address (or are impacted by) each one.

Please note, this is not an exhaustive list, nor an endorsement of any product or account. Each alternative has advocates and opponents, many as a result of compensation biases, so it is important for you to have a complete understanding (and hopefully trustworthy advice) before you commit your personal finances to a program that involves blending these products and investments with Social Security.

  • Guaranteed payments – Social Security, annuities, and Treasuries held to maturity
  • Inflation protection – Social Security, Treasury Inflation Protected Securities (TIPS), and “Real Annuities
  • Longevity protection – Social Security, annuities, and in some ways long-term care insurance (LTC) and accelerated death benefits on life insurance (ADB)
  • Tax avoidance in retirement – Roth accounts, capital gains on long-term investments, treasury and municipal bonds, some annuities, health savings accounts (HSA), home equity conversion mortgage (HECM), life insurance, Social Security for some tax brackets
  • Spending limitations – HSA (qualified medical expenses), long-term care insurance (LTC)
  • Liquidity – Roth and traditional IRAs, bank and brokerage accounts

The take away here is that there are a lot of options and significant complexity (in particular with taxes) when determining how to blend and utilize products and accounts.

Withdrawal Strategy for Income

A withdrawal strategy that is responsive to changes in your income needs, the tax code, and market dynamics is a key to optimizing income in retirement. The classic strategy of spending first from taxable, then tax-deferred, and finally from tax-exempt accounts has become obsolete. Today, you can control and shape the utilization of your retirement income by selectively “harvesting” your retirement financial resources. This goes beyond assets in different account locations to include the utilization of debt, e.g., HECM, and insurance products, e.g., annuities and life insurance.

Summary: What is worth more?

What is more valuable, $500,000 in a Roth, a brokerage account, a traditional 401(k), or an annuity? The answer? It depends on your overall financial and personal circumstances. That’s a lot of help, right? The point here is that there is no one solution that fits all. You need to assess the impact of various account locations, products, and withdrawal strategies on an after-tax basis.

The process also has to match these sources with your future budgeted uses of funds. To accomplish this, you need to model the net present value of retirement cash flows. Unless you are into building complicated spreadsheets, it may be best to find an advisor who is tuned in to the new realities of building, monitoring, and actively modifying a comprehensive strategy that responds to your retirement income needs.


About the author: Keith Whitcomb MBA, RMA®, is the director of analytics at Perspective Partners and has more than 20 years of institutional investment experience.