Retirement Income: Flooring and Income Guarantees
There are many ways to structure retirement income. Some come with more risk and uncertainty than others. So, what if you are very risk-averse? What are your options for retirement income?
One strategy that is popular (especially with the broker collecting the fees) is flooring and income guarantees. But understand, it can be an expensive proposition buying lifetime income insurance in this very low-interest-rate environment.
Fees are typically higher for income guarantees than for other investment vehicles. But flooring and income guarantees can offer you peace of mind, in exchange for the guarantee of income. Using this mindset, let’s look at how they might play out.
Say you need $10,000 a month to live on, and social security, pensions and maybe real estate income add up to $8,000 a month. With an income guarantee, you would “pensionize” or guarantee $2,000 a month with your investments. This can be done through income annuities or income riders on annuities.
There are several approaches to flooring. Ideally, you want a “floor with upside” meaning you want a basic income floor with potential for growth. This can happen a few different ways. Traditionally, an annuity-based approach provides you with guaranteed income, with the balance invested for a future upside. The other option is what is commonly called a safe withdrawal rate strategy. Does a safe withdrawal rate really come with both an income floor guarantee and a potential upside? Michael Kitces argues that it does:
“…the reality is that as it’s commonly applied, the safe withdrawal rate strategy is a floor-with-upside approach, too. Unlike the annuity, it doesn’t guarantee success with the backing of an insurance company; yet at the same time, the annuity is assured to provide no remaining legacy value at death, while the safe withdrawal rate approach actually has a whopping 96% probability of leaving 100% of the client’s principal behind after 30 years!”
So those are a few considerations to keep in mind as you think about using a flooring strategy.
One option for creating your income guarantee without the high broker fees is through Differed Income Annuities (DIA). DIAs last for shorter durations, have low sales commissions and produce very high withdrawal rates. This can be a cheaper way to achieve income guarantees than income riders on variable annuities and indexed annuities.
Inflation and its Effects on Flooring and Income Guarantees
Along with potentially higher fees, one challenge with flooring and income guarantees is the potential impact of inflation. That $2,000 in guaranteed income may be fine at the outset of your retirement, but might not stretch very far as you age.
So while a safe withdrawal rate floor is fixed for a target time horizon (let’s say 30 years,) you can also buy an inflation-adjusted, joint-survivorship, immediate annuity that is guaranteed for the lifetime of the couple, regardless of how many years that turns out to be.
A flooring strategy is not for everyone. If you are more risk-tolerant, a systematic withdrawal approach might be a more suitable option. But if you have concerns about outliving your portfolio or market volatility, a flooring strategy with lifetime income sources can provide the kind of peace of mind you are looking for.