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Retirement Income
Portfolio reliance: Key numbers in perspective
Kate Beattie
Senior Retirement Income Strategist
KEY TAKEAWAYS
  • The more reliant an investor is on their investment portfolio for retirement savings, the more likely market volatility will impact their retirement income.
  • Our Portfolio Reliance Calculator can estimate how much of their retirement income is protected.
  • Depending on an individual’s withdrawal rate, higher levels of protected income may correspond with increased investor confidence.
     

A portfolio withdrawal strategy is essential to retirement planning, but it doesn’t paint the whole picture of retirement for clients. Each investor’s portfolio withdrawal rate may differ from another’s, depending on the size of the portfolio, planning horizon and spending needs, as well as inflation and market returns. But those investors who are too reliant on an investment portfolio for income may be more susceptible to outside risks. Understanding the portfolio reliance rate can help you and your clients plan for these risks and consider whether additional protected income is needed.


How volatility affects withdrawals


The portfolio reliance rate, which is the inverse of the protected income percentage, shows how much an investment portfolio is relied upon for retirement income. As reliance on the investment portfolio for income increases, so does the potential sensitivity to market volatility, sequence of returns risk (e.g., the risk of market declines in the early years of retirement), as well as the longevity of a withdrawal strategy.


This graphic depicts the connection between portfolio reliance and withdrawal rates. The graphic on the left shows that a higher withdrawal rate may make investors more sensitive to market fluctuations and other risks, lowering their ability to rely on their investment portfolio for income. The image on the right shows that a lower â   more conservative â   withdrawal rate may permit investors to rely more heavily on their investment portfolio to meet their retirement income needs.

Portfolio reliance and withdrawal rates are connected in that if an investor has a more conservative withdrawal rate — for example, 3% or less — then they may be able to rely more heavily on their investment portfolio to meet their retirement income needs. But if an investor has a higher withdrawal rate, then this increased reliance on the investment portfolio may make them more sensitive to market fluctuations, among other risks.


Check out our Portfolio Reliance Calculator


How to tell if an investor relies too much on their investment portfolio


Begin the discussion with a few key questions:
 

  • How elastic are their income requirements (i.e., delaying lifestyle wants to meet living needs)?
  • How flexible can they be with their spending (i.e., spending less, if necessary, during inevitable short-term market declines)?
  • Are there other options to consider that can increase income from outside sources (i.e., delaying claiming Social Security)?
  • Can they live with a loss of income?

What determines the withdrawal rate?


The withdrawal rate from a portfolio can help determine how long retirement income may last. The rate is affected not only by the income that is needed to live (including taxes and inflation), but also by the protected income sources a client has such as Social Security, pension income and/or annuities. Various other factors will also affect a withdrawal rate, such as an investor’s retirement planning horizon, inflation and market volatility. The length of retirement is a major factor in determining a withdrawal rate. Clients who plan on shorter retirement lifespans may be able to spend more while those with longer planned retirements may want to be more conservative in their withdrawals.


Fluctuations in the market will also affect how much clients can withdraw. Naturally, lower market returns will support a lower withdrawal rate and could impact the longevity of the portfolio. And a higher withdrawal rate may be supported by some combination of a shorter life expectancy, strong market returns and modest inflation.


Know the risks worth taking and protect from those that aren’t


Retirement risks come in many forms. The process of building a retirement income strategy that instills confidence includes helping clients determine if they want to incorporate or protect from various risks.


Incorporating risk could include, for example, a reduction in the withdrawal rate to plan for a longer time horizon or higher inflation rates, or to provide more flexibility of spending.


The Portfolio Reliance Calculator


Starting with a client’s expected spending needs and outside sources of protected income, financial professionals can use a tool like Capital Group’s Portfolio Reliance Calculator to provide a point-in-time estimate of the amount needed to withdraw from a retirement income investment portfolio.


Seeking a balance of retirement income sources — protected and investment income — may help to provide stability and reliability for a retirement income strategy. By helping investors understand how reliant they are on the investment portfolio to meet their retirement income needs, as well as the options available to reduce this reliance, you can prepare them to better withstand inevitable market downturns among other risks.


The value of reducing withdrawal stress


While additional protected income may not be needed for some clients, sources of protected lifetime income, such as Social Security, pensions and annuities, can be important tools for retirement spending and may be used to cover essential expenses that are fixed and not flexible. By helping to reduce some of the withdrawal stress placed on the investment portfolio, these sources could also help reduce the risk of outliving assets due to some combination of a long life and/or poor market returns. For many retirees, the confidence that comes from knowing they have a stable income stream no matter how long they live is of utmost importance.


Why might clients need higher levels of protected income?


Managing longevity risk with insurance can be an alternative to asking retirees to spend more conservatively to account for living longer or dealing with rising health care costs, and it can help protect against the impact that a poor sequence of market returns early in retirement can have on a strategy. Even in cases where longevity risk is not a concern, exploring opportunities to increase their level of protected income may help improve their overall confidence in retirement.


There is no way to be certain what the future will hold, but higher levels of protected income can help instill confidence that clients are prepared for what’s ahead. Depending on an investor’s unique situation, they may look to increase their outside protected lifetime income to provide more predictable income, regardless of market performance or longevity, and reduce the reliance on investment income.



Kate Beattie is a senior retirement income strategist with 16 years of investment industry experience (as of 12/31/22). She holds a bachelor’s degree in economics with a business administration minor from Colorado State University and holds the Certified Financial Planner™ and Retirement Income Certified Professional® designations.


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