Retirement income products have long confused investors, but a recent Vanguard paper suggests that investors concentrate more on how the products would be used. “Vanguard’s Principles for Retirement Income” recommends evaluating retirement goals and needs before focusing on account balances.
In its guide, Vanguard writes that a successful retirement plan depends on an investor’s goal, how much income their savings can support and whether that income can be sustained over time.
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For advisers, the framework gives an idea of how to shift the conversation for participants from actual assets to what the assets are meant to support.
“The best guidance always starts with defining what matters most, then building a plan that covers essential expenses with reliable income,” said Garret Harbron, lead researcher and head of advised wealth management strategies at Vanguard in an email to PLANADVISER. “[It] accounts for risks like inflation and market changes, and balances spending today with what’s sustainable over time.”
Vanguard’s framework centers on four principles:
- Finding purpose, meaning defining retirement goals, lifestyle and priorities;
- Covering essentials, using reliable income sources such as Social Security or annuities;
- Making wealth last, with tactics such as managing withdrawals and taxes to sustain income; and
- Simplifying, or reducing plan complexity to support better decisionmaking.
These principles focus on the meaning behind an investment in a retirement income product, instead of simply comparing the wide array of products in the market.
“Without that kind of structure, we tend to see people go one of two ways—they either spend less than they can afford because they’re worried about running out of money, or they spend more freely without really understanding the long-term tradeoffs,” said Harbron in his email.
The paper also addresses how retirement income products can contribute to tax efficiency. Combining different income sources such as Social Security, annuities and portfolio withdrawals can create flexibility in when, and how, taxes are paid.
The research includes examples comparing median annual and cumulative tax payments, with and without tax-efficient withdrawal strategies.
The findings suggest that retirees can reduce their lifetime tax bill by implementing thoughtful withdrawal strategies. Vanguard recommends spending from taxable accounts first to preserve the growth potential of tax-advantaged accounts, followed by tax-deferred accounts such as traditional IRAs or 401(k)s and leaving Roth accounts for last to maximize tax-free compounding and flexibility.
When addressing this tax efficiency tactic to clients, advisers can highlight the importance of reducing taxes over time.
“When speaking with clients about taxes in retirement, the most important point to make is that it’s not just about minimizing taxes in any given year but reducing taxes over their lifetime,” said Harbron. “Advisers should help clients think through where their income is coming from and how to draw from different sources in a more coordinated way throughout retirement.”
As decisions over retirement income products turn retirement systems from being strictly professionally managed and constructed to a more “do-it-yourself” construction, panelists at the recent PLANSPONSOR National Conference in Nashville, Tennessee, organized by PLANADVISER’s sister publication, discussed what kind of guidance defined contribution plans participants need.
“How do I take this money that I’ve accumulated and saved and turn it into income for my life?” said panelist Elise Thiemann, head of DC investment strategy at State Street Investment Management. “This is proving to be an exceptionally difficult challenge.”
Sean Kelly, vice president and financial adviser at Heffernan Financial and another panelist, said plan participants accustomed to automatic features can be overwhelmed in retirement, when they are suddenly responsible for complex income decisions.
“In doing a good job of helping employees prepare for retirement and accumulating assets to do that, we sort of put [them into the] backseat [of] the self-driving car,” said Kelly. “Then, right at retirement, we yank [participants] out and put them in the front seat and shut off the [autopilot].”
The experts said advisers can help sponsors and clients understand the innerworkings of income products.
“It’s important to bring clarity to these [retirement income] decisions. Priorities and situations will change over time, though, so it’s designed to evolve,” Harbron said. “As markets or life circumstances change, advisers can help clients adjust and stay on track.”
