A Floor with an Upside: The Best Strategy for Lifetime Income?

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Could you live off your investment portfolio indefinitely, if you had too? The answer to that question lies in the relationship among your total assets, your living expenses, your investing skill, the length of your retirement, market valuations when you retire, and market performance thereafter. That’s a lot of variables, only some of which you can control….

My investment results from the two decades before retiring gave me confidence that we could live off our portfolio for the rest of our lives through a variety of economic conditions. We held a conservative but diverse portfolio that had weathered both the 1990’s dot-com bust and the 2008-2009 Great Recession. I knew I owned at least one asset class that would perform well in any investment climate, and I had proven to myself under real-world conditions that I wouldn’t panic out of the others. What was there to fear?

Then I retired and had the time and inclination to dig deeper into the mechanics of generating retirement income. I also had motivation to reflect thoughtfully on what our future might hold, to look at how other family members had dealt with their advancing years and to ponder the similarities, and differences, between their situations and ours.

I uncovered some sobering statistics. I learned that the odds of depleting even a substantial portfolio were much higher than expected. Turns out that the math behind a distribution portfolio (one where you are making steady withdrawals as markets cycle) is much less forgiving than the math behind an accumulation portfolio, where you are saving. The issue in a nutshell is that when you withdraw money in a down market, even a small leg down, you are effectively "locking in" a loss forever, so that portion of your money never has the opportunity to grow again. The results are punishing over the long haul….

In his book Unveiling the Retirement Myth, CFP and professional engineer Jim Otar reports that, even at a low withdrawal rate of 3%, there is nearly a one in four chance that your portfolio will sustain a loss early in your retirement from which it will never recover. That doesn’t necessarily mean you will run out of money, but it does mean your net worth will be launched on a steady downward trajectory. I don’t know about you, but I don’t like those odds!

Thinking through your options for fallback income, you may realize, as I did, that the retirement years divide into two phases: (1) early retirement when you probably have the desire or at least the ability to work part-time and produce some income; and (2) later retirement when, due to health issues or physical limitations, work is simply no longer an option.

Many in early retirement will think, "If my investments begin to underperform, I can always go back to work." That may be true, but it’s wise to be realistic about your options for returning to the work force. A few could easily return to former careers; many couldn’t. In most cases, after a few years away from work, you’ll develop new interests and your original career skills and contacts will begin to atrophy. Even those who could resume their old career in some form, might have difficulty replicating their old salary. For me, even though I’ve always wanted to do some enjoyable, part-time work in retirement, returning to my previous fast-paced, high-tech, corporate environment is a rapidly diminishing option.

Everybody is different, and many boomers do expect to work longer. But, for me, I’m guessing the transition from "early" to "late" retirement happens somewhere around age 70, plus or minus a few years. It’s advisable to keep your own personal dividing line firmly in mind as you plan for retirement income, because it’s a "point of no return" for your investment assets.

And that brings me back to the question posed in the title: What is the best strategy for lifetime income?

In early retirement, you might choose to live off your portfolio in an ad-hoc manner. If the markets don’t cooperate, and your investments take a damaging hit early on, you can probably return to some form of work. Though, as noted above, don’t expect to bring back your old salary.

But what about later in retirement, when you are out of options for producing income and growing your assets. Then what? The choices are slim and grim: borrow from family, move in with children, take public assistance (SNAP aka "food stamps" requires you to spend down all but about $2,000-$3,000 in assets to qualify), live out of your vehicle. I’m serious! It’s not a bad idea to visualize yourself in some of these unpleasant scenarios, to build motivation for what I have to say next….

Once you add up all the factors around retirement income, I’ve come to believe that you should do everything in your power to create a guaranteed income floor for yourself by late retirement. (The time period when you cannot reasonably return to work.) You want to use every means at hand to assure yourself of a reliable income stream that meets your essential living expenses, from the time you can no longer work until the end of your life, however long that may be.

This process starts by first understanding your essential living expenses. This involves some personal choices about what you consider indispensable. That is going to be a function of your past lifestyle, your location, your obligations, and your flexibility with respect to your living surroundings. For me, essential expenses allow for a small condo or townhome, food, insurance, medical care, taxes, and utilities. That works out to about 60% of our current retirement budget. The rest is discretionary spending, and could be foregone or cut way back if necessary, especially later in retirement.

Next you must add up all the guaranteed, inflation-adjusted sources of income that you can rely on receiving at retirement. Many of us can count on some Social Security and/or other pensions. You might also include net income from rental real estate in this figure, plus income from any government inflation-adjusted securities that you intend to hold indefinitely.

Finally you compare those two values. If your expenses exceed your income, as they will for many, you must "backfill" up to the amount of your essential expenses from a new guaranteed income source. That means you must annuitize or purchase a guaranteed lifetime withdrawal benefit with whatever portion of your nest egg is required to lock in this essential income floor. In essence, you will pay a portion of your nest egg to an insurance company (or multiple companies, for diversification), in exchange for a lifetime income stream.

Don’t like the idea of parting with some of your nest egg permanently? Most will have no choice in order to generate the income they need. But research does suggest that if your uncovered annual expenses are less than about 2-3% of your assets, you might be able to skip the annuitizing step without undue risk. In other words, if you have sufficient assets, and a low enough draw against them, then your portfolio should survive most conceivable economic conditions over most conceivable life spans. But few will fall into this select wealth bracket. And, even if you do, you still might sleep better, and enjoy fewer money management hassles, by purchasing a small annuity.

Once you’ve accepted the need to part with a portion of your nest egg, you can enjoy the benefits of knowing you and your spouse will never want for basic living essentials as long as you live.

Then you can apply your time and energy to managing your remaining assets for an upside. That’s right, the balance of your portfolio can stay invested in the market and assume some modest risk, or not, as you choose. (Many of us will continue to hold a diversified, balanced, all-weather portfolio.) You can decide to consume only the income from that portfolio, or you can choose to devote some of the principal to things, activities, or causes that might increase your happiness. In most cases, given a reasonable draw, your portfolio will grow enough to compensate. But in some cases it won’t. Either way, you can be confident that you won’t be destitute if your portfolio diminishes or even runs out in later years. Because you will have long ago established a baseline of guaranteed income for life….

So that is a non-technical overview of how to establish a retirement income floor, while keeping an upside. I started by reviewing the risks to a distribution portfolio. Then I discussed the options for additional income in early versus late retirement. Lastly I presented the case for annuitizing as needed during the latter phase of life. And I believe that most of us, once we take all the retirement factors into account, will choose this path.


  1. Darrow,
    As always, I enjoy reading and learning from your thought provoking posts. I’m sorry that I seldom find time to provide the positive feedback that your work deserves!

    This particular post has me wondering about the strategies for timing the purchase of annuities. What are your thoughts about pro/con considerations for buying sooner or buying later? I also hope that you will be writing more about diversification of annuity purchases.

    Thanks for all your great work!

  2. Darrow Kirkpatrick says:

    Thanks MSaw. You've posed the natural next question — about timing an annuity purchase. I expect to write about that eventually, but have a ways to go before I can boil it down to simple rules or formulas.

    One perspective would be that now is not a great time, with interest rates so low. On the other hand, drawing too close to your "late" retirement age (when you could no longer work), is playing with fire.

    Beyond that I hope to write something about optimizing this decision eventually. Meanwhile, anyone can generate quotes online and begin to explore their own scenarios…

         Immediate Annuities
         Vanguard Annuities

  3. Good post! I enjoy Otar's contrarian tough-love approach to how reality can ruin a statistically perfect plan.

    If there's any consolation in his warnings, it's that he leaves Social Security out of his analysis. In fact he says "I am not smart enough to learn fully and comment on the U.S. Social Security system." So for many retirees, SS could provide a few planks on that floor.

  4. Darrow Kirkpatrick says:

    Thanks Nords. Otar is consistently thought-provoking. I'm also cautiously optimistic on Social Security. We may see modest benefit reductions, but I don't think the upcoming generation of retirees has to worry about it disappearing altogether. So, as you say, Social Security should contribute a few planks to the income floor, and it's up to us (and the insurance companies) to provide the rest. Thanks again for the comment!

  5. jacksprat says:

    This post hit a topic I've been considering recently, but was unsure of how to think and approach it logically and easily. now I can really begin to plan and take action using this great information .
    Thank you so much !

  6. Darrow Kirkpatrick says:

    Thanks jacksprat, I really appreciate the positive feedback. Your comment goes for both of us, and possibly many others as well!

  7. I would be very content with setting up an annuity that would cover my basic life expenses and investing the rest. That way I know I could always live comfortably no matter what happens to my investments.

  8. Darrow Kirkpatrick says:

    Agreed, thanks Harry!

  9. bigdogslife says:

    Darrow, great post!

    My quandry continues to be "how much is enough" to provide the floor income I think we need given our potential cash flow requirements and the myriad factors in producing that income and determining how it gets spent productively over your indicative 2 phases of retirement, without pinching ourselves early, or incurring too much risk later. And, to leave a legacy for the kids. That last point fights, for me, against the notion of a significant annuity component but I have to keep thinking it through. I have some time 🙂

    Thanks BDL

  10. Darrow Kirkpatrick says:

    Appreciated BDL. You've enumerated the issues nicely. We're all going to be figuring this out together.

  11. JosiahBounderby says:

    One potential fly in the annuity ointment is a black swan market event that threatens the major insurers. During the last one (2009) Metlife, NY life and others were in deep trouble.

  12. Darrow Kirkpatrick says:

    Yes, we can't assume that insurers are impregnable. Still, I'm gradually becoming convinced that the highest-rated ones are among the more conservative and reliable financial institutions. All the same I would not put all my assets in one basket — either the market or a single insurer. Thanks Josiah.

  13. Darrow,

    With proper investing even if it starts as a little sum and living below your means can reap rewards early in life. We are now in a position at 50 that we don't have to worry should anything arise and can enjoy peace of mind with less is more. We never owned fancy cars and lived very basic but I don't feel we missed a thing. Our son attends community college and is also taking some credits for his transfer school still at the community college. He has become accomplished in his field at the young age of 21 which proves a point that it isn't the school but what the student puts into it. It is not what you make but what you keep and people should know it is not a hopeless situation. You need to prioritize what is important in life and look long term.

  14. Darrow Kirkpatrick says:

    Thanks so much Martha. I love your philosophy. You are so right that it's not the school but what the student puts into it that really matters. We've seen that with our son too. In his case the excellent internships he's gotten (through his own efforts) have been far more important than the classwork. Thanks again!

  15. Just found your blog – these are some great articles! Regarding the question of when to buy annuity, one source I read recently (can't remember but I think it was a book from Moshe Milevsky) suggests that the yield of annuities can go up quite a bit if you buy them at a later age. Of course it's pretty obvious that all the benefits of annuities apply more so when they are likely to cover a shorter period of time. Depending on how fast the payout climbs it might be worth considering it as a later option (especially to cover the possibility of a very long life since someone buying an annuity at 85 gets a huge financial win if they live 20 years), or buying pieces every few years to spread out the risk and terms.

    We just need to know the future rates of return to know if that's worth it… if only I could go back in time and watch where I left my time machine ::)

  16. Darrow Kirkpatrick says:

    Thanks SRL! Moshe Milevsky is an authority, and all your suggestions are on target with my understanding. I'm working on some articles on these topics….

    Could you take a look around for my 20's while you're back there in time?

  17. Cool, this is a long way off for me so you know a lot more (about retirement that is, not turning 85)! I'm looking forward to seeing the results of your research.

    I'll check for your young age when I go back; any stock tips you want me to pass on?