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 — something we call 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 our ART framework.

Considering a combination of approaches

Ultimately, shifting risk to an annuity may help lessen portfolio volatility by hedging downside risk. This can empower clients to spend with confidence, knowing their core lifestyle is anchored in stability and not guesswork.

To illustrate, let’s say you have a client who wants to generate $15,000 of annual lifetime income beginning at age 65. Using the ART approach, what strategies might accomplish that goal?

Consider what might happen if we combine strategies to retain and transfer risk — instead of an all-or-nothing approach, there’s a potential for finding the best of both worlds.

For example, if a client wants to generate $15,000 in annual income, the chart illustrates how different approaches can achieve that goal, but with different capital requirements. As shown, transferring risk to a 1-year FIA requires $165,000 less upfront capital than relying on systematic withdrawals from a portfolio alone. By combining strategies, that difference can be reinvested in a diversified portfolio.

When it comes to building a solid retirement strategy, it’s important to consider how much risk to avoid, retain, and transfer to help clients achieve their goals. Using the ART framework can be a simple way to help guide the conversation with clients so they better understand their risks and potential impact, leading to better decisions and helping your clients develop a sustainable income strategy for life.

Deepen your practice and help your clients confidently plan for a secure retirement. Download our e-book "The ART of Managing Income Risk" to dive deeper into the framework and learn how to build a solid retirement income strategy that minimizes risk and improves clients’ retirement outcomes.

It's important to note that FIAs are long-term ​products designed for retirement. Optional benefits may include fees, withdrawals above ​the free withdrawal amount may be subject to charges, and surrender charges, caps, ​participation rates, and other limitations may apply.

For Financial Professional use only. Not for solicitation or advertising to the public. This material is for informational purposes only, and is not a recommendation to buy, sell, hold or rollover any asset. It does not take into account the specific financial circumstances, investment objectives, risk tolerance, or need of any specific person. In providing this information American Equity Investment Life Insurance Company® is not acting as a fiduciary as defined by the Department of Labor. American Equity does not offer legal, investment or tax advice or make recommendations regarding insurance or investment products. Each client has specific needs that should be discussed with a qualified legal or tax advisor.

Under current tax law, the Internal Revenue Code already provides tax deferral to qualified money, so there is no additional tax benefit obtained by funding a qualified contract, such as an IRA or Roth IRA, with an annuity; consider the other benefits provided by an annuity such as lifetime income and a death benefit.

Possible interest credits for money allocated to an index-linked crediting strategy are based upon performance of the specific index; however, fixed index annuities are not an investment, but an insurance product, and do not directly invest in the stock market or the index itself.

Annuity products offered by American Equity. Other retirement options may also support similar goals.

Any information regarding taxation contained herein is based on our understanding of current tax law which is subject to change and differing interpretations. This information should not be relied on as tax or legal advice and cannot be used by any taxpayer for the purposes of avoiding penalties under the internal revenue code.

Taxpayers should consult with their professional tax and legal advisors for applicability to their personal circumstances.
Guarantees are based on the financial strength and claims paying ability of American Equity and are not guaranteed by any bank or insured by the FDIC.