Retirement income strategies and styles

Retirement income strategies are different ways to turn financial resources (wealth/capital) into retirement income. Retirement income strategies are also known as decumulation methods. The investor has accumulated financial assets for a number of decades, and now it is time to decide how to use these assets to fund retirement. This is the decumulation phase of the financial life cycle:
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There is a wide variety of decumulation strategies that are possible, ranging from self-managed portfolio drawdown to "safety-first" approaches. Investors, advisors and academics have widely different opinions about which strategy is "the best". But there may not be a unique decumulation solution that is best for everybody, because different strategies can suit different retiree preferences, or retirement income styles.Murguia A, Pfau WD (2021a) A Model Approach to Selecting a Personalized Retirement Income Strategy, working paper available on SSRNMurguia A, Pfau WD (2021b) Selecting a personalized retirement income strategy. Retirement Management Journal 10:46-58, available on SSRNBenz C (2023), What’s Your Retirement Income Style? - Let’s stop bickering about the ‘right’ way to generate retirement cash flows, Morningstar, July 21, 2023, viewed January 25, 2024. 
This article is intended as an overview of the topic, with specific styles and strategies discussed in more detail in other articles. The aim is to show a wide range of possibilities.
==Background==
No single retirement income strategy can work for all retirees because (1) they have different psychological preferences and attitudes; (2) they value possible goals differently; (3) they are more concerned by certain risks than others. Retirees also differ in how they view their budgets.
===Goals===
The different possible goals can be thought of as the four "L"s:Pfau WD (2018) An Overview of Retirement Income Planning, Journal of Financial Counseling and Planning 29:114-120, available at SSRN
* Longevity – maintaining spending power no matter how long the retiree lives, especially for essential expenses, like housing, food, healthcare, etc.;
* Lifestyle – the desired lifestyle likely includes both essential and discretionary expenses (leisure, self-improvement, …), and should be maximized given the available capital, without big cuts later;
* Liquidity – "maintaining sufficient reserves for unexpected contingencies that have not been earmarked for other purposes" (contingency planning);
* Legacy – leaving assets to future generations or charities.
The following pyramid shows one possible way to prioritize these goals, but retirees can value possible goals differently:
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===Risks===
Risks during retirement include:Butt A, Khemka G, Lim W, Warren G (2023) Primer on Retirement Income Strategy Design and Evaluation. Society of Actuaries Research Institute, 104 p.
* Longevity risk – running out of money due to a long life
* Investment risk – portfolio returns being too low over the retirement period (on average) to support the desired spending and bequests
* Sequence of returns risk – if bad portfolio returns early during retirement, the portfolio could be exhausted prematurely
* Sudden unforeseen expenses (spending shocks, due to divorce, health issues, major home repairs, …)
* Compounding inflation – with 3% inflation, the cost of living doubles every 25 years in nominal terms
* One spouse dying early – this can reduce income like Old Age Security (OAS), Canada Pension Plan (CPP)/Québec Pension Plan (QPP), and employer pensions, and/or eliminate the main person managing finances in couple, leaving the survivor "vulnerable to financial predators and other financial mistakes"
All of these risks can lead, separately on in combination, to "income risk": a decline in one’s standard of living, or even portfolio exhaustion. Otherwise stated, income risk is: "the possibility of failing to deliver sufficient income to sustain a desired standard of living until death". This, rather than short term portfolio volatility, should be seen as the main risk during retirement.
A final risk to consider is that declining cognitive abilities can limit sound financial decision making in advanced age. Different retirees are more concerned by certain risks than others, and this will influence their retirement income style.
===Retirement budget models===
Some retires view their entire budget as one amount. This is the total amount they hope to spend every year to reach the desired lifestyle. Other retirees divide their budget into two ‘layers’: essential expenses like housing, food, taxes, etc. ("needs") versus discretionary expenses like travel or gifts ("wants"). This is related to the ‘Longevity’ versus ‘Lifestyle’ goals mentioned above and might partly influence how retirees want to turn their wealth into income.
==Two main factors and four styles==
Murguia and Pfau (2021a, 2021b) propose that two main factors can be used to define a four quadrant matrix of retirement styles. The most important factor, which they use as the horizontal axis, is called "probability-based versus safety-first". The other factor, shown in the vertical axis, is called "optionality versus commitment". This yields four retirement styles:
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While Murguia and Pfau offer tests (questionnaires) for investors to help position themselves in the matrix (typically in exchange for a fee), readers can potentially assess themselves, at least roughly, by reading about the factors, styles and strategies. The authors also occasionally offer their "RISA" test for free. The aim here is not to promote a specific website or tool, but rather to use this matrix to illustrate the broad range of retirement income styles that exist and the corresponding strategies that are available. Again, the idea is that no single strategy can suit all retirees, and choosing a strategy that fits your style while being aligned with your goals is likely to yield a better outcome through long-term ‘buy-in’.
===Probability-based versus safety-first===
Probability-based retirement planning aims to "maximize the probability of success for meeting the overall lifestyle goal".Pfau W, Cooper J (2014) The Yin and Yang of Retirement Income Philosophies, report for Challenger Limited, 28 p. The retiree wants to reach a certain lifestyle: a retirement income floor is not enough. People in the probability-based camp might think that "efforts to dedicate more resources to lock in spending for needs may eliminate the possibility for obtaining enough upside portfolio growth to cover wants".Pfau W (2014) 2 Schools of Thought on Retirement Income, Journal of Financial Planning, April 2014 issue
At the other end of the spectrum, safety-first retirees tend to think in terms of essential versus discretionary retirement income. Essential expenses must always be met through the life of the retiree; no probability of failure is acceptable. Therefore, essential income sources must be guaranteed or protected.
This factor is discussed in the Retire with Style podcast, episode 3.
 
===Optionality versus commitment===
Retirees who value optionality want to maintain control of their capital and keep their options open, rather than commit to an irrevocable solution. They want to be able to change their strategy if required.
Commitment-oriented income solutions provide lifetime guaranteed income, or income over a certain period, in exchange for a loss of flexibility. The retiree wants protection from bad stock market returns and does not like uncertainty in income. Further, "there can also be satisfaction with planning in advance to manage potential cognitive decline and not leaving difficult decisions for a time when such decision-making may be hampered."
This factor is discussed in the Retire with Style podcast, episode 4.
===Four styles===
The combination of the two main factors yields four styles, or quadrants in the matrix, each with a group of retirement income strategies: 
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Direct access to the four strategy groups:
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Bucketing 	Total return
Income protection	Risk wrap
An overview of each of the four styles is presented below, and in the Retire with Style podcast, episode 7, and episode 8.
Most survey respondents studied by Murguia and Pfau ended up in the top-right quadrant (37%) or bottom-left (36%) quadrants of the matrix, so these styles and strategies are presented first. Less common styles in the top-left (13% of respondents) and bottom-right (14% of respondents) quadrants are presented last.
==Total return==
In the upper-right quadrant, people have a preference for probability-based approaches and optionality. These two tendencies often go together: investors want to keep control of their portfolio, and they seek potentially higher returns through stock market participation. Investors in the upper-right quadrant are more preoccupied than average with lifestyle goals, and less preoccupied than average with longevity goals.
The typical retirement income strategy in this quadrant is called "total return" since portfolio withdrawals may consist of a combination of interest, dividends and principal. (This contrasts with "income investing" in which the retiree does not want to spend down the principal and is relying only on interest and dividends.) People in this quadrant are unlikely to consider life annuities attractive. They will continue to manage their portfolios of stocks, bonds, and cash, as they were already doing during the accumulation phase, but now they are self-managing the drawdown (or having an advisor do it for them). 
The two main topics of debate among DIY investors and financial advisors in this quadrant are (i) asset allocation; (ii) withdrawal strategies. These topics are often treated separately but are ultimately linked: "the appropriate investment strategy will itself depend on the preferences of the retiree over the level and variability of income", which dictates the withdrawal strategy.
==Income protection==
Investors in the lower-left quadrant prefer safety-first approaches and are more willing to commit to strategies that guarantee a lifetime income, at the price of decreased flexibility (less optionality). People in this quadrant tend to be more preoccupied than average with longevity goals, and less preoccupied than average with lifestyle goals. In other words, having a safe source of income to cover essential expenses for life is the most important consideration, even if this might mean giving up on some ‘upside’ (potential portfolio growth allowing a higher income in the future). According to academics, "the spending required to satisfy basic needs provides much more value and satisfaction to someone than the additional spending on luxury goods after basic needs are met". Their ideal of financial planning is to smooth consumption over the life cycle.
===Securing the income floor===
Asset-liability matching is employed in this quadrant: "assets are matched to goals so that the risk and cash flow characteristics are comparable". For the essential part of the retirement budget, this means one or several guaranteed income streams, which can come from:
* Delaying government pensions and benefits
* Single premium immediate (life) annuities (SPIAs)
* Deferred annuities including advanced-life deferred annuities
* Self-managed liability matching portfolios such as bond ladders extending into old age
===Aspirational portfolio===
Not all retirement income has to be contractually protected, and discretionary expenses ("lifestyle"), as well as unexpected contingencies ("liquidity"), can be funded through portfolio withdrawals. In fact, the retiree might be feeling more comfortable owing equities in the non-protected part of the portfolio (the "aspirational portfolio"), knowing that essential expenses are covered with protected income sources. Withdrawals from the aspirational portfolio can be variable, based on flexible withdrawal strategies, since such withdrawals are only meant to cover discretionary expenses and perhaps some emergencies. 
Alternatively, contingencies can be covered with cash reserves or other buffer assets (if they exist, e.g., home equity, permanent life insurance).
==Income bucketing==
In the upper left corner of the matrix, investors value safety of income sources, yet they also want optionality. In the bucketing approach -- also known as time segmentation --, the same asset classes are used as in the total return approach, but the way investors look at them is different. In the bucketing approach, cash, fixed income and equities each have different roles in that they are used to provide income for different time horizons: they are seen as two or three distinct buckets. The cash and individual GICs or bonds (held to maturity) provide income over the short and medium terms, while more volatile equities will cover expenses further into the future.Benz C (2016) The Bucket Approach to Retirement Allocation, Morningstar, September 19, 2016, viewed January 23, 2024.
Despite fitting conceptually on the "safety-first" (left) side of the horizontal axis in the matrix, some authors actually classify bucketing as a probabilistic approachPfau WD (2017a) Time Segmentation as the Compromise Solution for Retirement Income. Advisor Perspectives, March 27, 2017, viewed February 1, 2024. since it still relies on uncertain stock market growth. Bucketing is sometimes described as a mental accounting framework, because it might make equity bear markets more psychologically tolerable by viewing the stocks as long-term assets. Longevity risk is not fully addressed, unlike in true safety-first approaches with more commitment (lower-left quadrant).
==Risk wrap==
Finally, in the lower right quadrant, investors have probability-based tendencies (they want to use stocks for their potential upside), yet they have a commitment orientation as well. They are therefore potentially interested by hybrid approaches sometimes called "risk wrap" strategies. Those allow investors to maintain significant stock market exposure during retirement. But to provide downside protection, a safety net is metaphorically ‘wrapped’ around this ‘risk’, to supply a secured retirement income in case stock markets don’t deliver. This retirement income style is difficult to implement in Canada at present, but is included here for completeness.
In a US context, it involves certain types of complex annuities, including variable annuities, with "living benefits".Pfau WD (2022) The Role and Inner Workings of Variable Annuities with Guaranteed Lifetime Withdrawal Benefits in Retirement, The Journal of Retirement, DOI 10.3905/jor.2022.1.113 In Canada, the annuity market is much less developed. Some segregated funds called GMWB products are partly similar to the variable annuities described in US examples, but are only offered by a few insurers in CanadaInsurance Portal, Guaranteed Withdrawal Benefit: just 3 players still in the game, November 20, 2020, viewed April 27, 2023. (the market is not necessarily competitive), and require the use of an advisorMorningstar, Are guaranteed minimum withdrawal benefits worth their fees?, September 22, 2015, viewed April 27, 2023., adding to fees. In a Canadian context, perhaps the investor can find a more straightforward and lower-cost solution in the total return or income protection quadrants.
==See also==
*Contingency planning for retirement
==References==
==External links==
*Wade Pfau Discusses Retirement Income Planning with Jim Dahle, 2023 Bogleheads conference, video and slides available
*Wade Pfau, 39 Modern Retirement Income Planning Techniques
Category:Retirement planning
Category:Retirement living