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Imagine two retirees. Same age, same size nest egg, same monthly expenses, and even the same life expectancy.

On paper, you might assume the same retirement income plan would work equally well for both. Yet one person may feel completely comfortable following it, while the other questions the strategy every time markets fall or spending changes.

The difference often comes down to more than the math. It’s also about how each person wants retirement income to feel: how much certainty they value and how much flexibility they’re willing to give up to get it.

Retirement income advice often jumps straight to withdrawal rates, yields, and products. But a plan you can comfortably follow for 30 years also needs to reflect your preferences and how you make financial decisions. 

So, in today’s episode, I’m walking you through a simple framework that organizes nearly every retirement income strategy into four distinct styles. We’ll look at the two questions behind the framework, the tradeoffs that come with each style, and how to determine which approach fits you best.

Welcome to another episode of the Stay Wealthy Retirement Show. I’m your host, Taylor Schulte, and every week I cover the most important financial topics to help you stay wealthy in retirement. Ok, onto today’s episode.

The 4 Retirement Income Styles (And How to Find Yours)

The Two Questions Underneath Every Income Strategy

A few years ago, two retirement researchers — Wade Pfau and Alex Murguia — set out to answer a question that, on the surface, sounds simple: 

“Why do smart, well-informed retirees come to completely different conclusions about the “right” way to create income?”

The answer they ultimately arrived at became a framework called the Retirement Income Style Awareness, or RISA. 

And what I found refreshing is that the framework doesn’t reveal a winner – it doesn’t conclude that one is better than the other. Instead, it suggests that there are four legitimate ways to fund a retirement, and the best one for you depends on how you answer two important questions.

Question number one: where do you want your retirement paycheck to come from?

Some people look at nearly a century of market history and say, “I trust the markets. I trust the math. I know there will be difficult years, but over a 30-year retirement, I’m comfortable relying on a diversified portfolio.” The researchers call this a probability-based mindset, meaning you’re willing to rely on outcomes that are highly likely, but not guaranteed.

But other people hear that and say, “I don’t want my basic living expenses riding on the market.” These retirees want essential spending covered by contractual income that arrives regardless of what stocks are doing, and this is what the researchers call a safety-first mindset.

Question number two: how willing are you to lock decisions in?

Some retirees value flexibility. They want the freedom to adjust spending, shift money toward a new goal, or change their estate plans as life evolves. The researchers call this a “preference for optionality.” 

But, as you might assume, there are other retirees out there who are comfortable giving up some of that flexibility if it creates more efficiency, certainty, or peace of mind. The researchers call this a “preference for commitment.” 

If we put those two questions together, we get four different combinations, or four retirement income styles, and each one approaches the same retirement problem differently, with its own strengths and tradeoffs. 

So, let’s go ahead and walk through all four. And, as we do, notice which approach feels most natural to you, and which tradeoffs you’d have the hardest time accepting.

Style #1: Total Return

The first style is called total return, and, put simply, this style is the combination of trusting the markets and also keeping your options open.

The philosophy here is that your portfolio is your retirement plan. You build a diversified mix of stocks and bonds, you draw from it using a systematic withdrawal strategy, and you adjust as you go.

If this sounds familiar, it should. This is the approach that has dominated mainstream financial advice for roughly 30 years, built on the foundation of Bill Bengen’s original safe withdrawal rate research — or what most people know as the 4% rule. 

In practice, the withdrawal strategy might be that classic fixed rule, a percent-of-portfolio approach, a flexible strategy like Guardrails, or another research-backed method for turning your portfolio into retirement income.

One thing worth noting about this style is the role of bonds. They’re there in the portfolio to reduce volatility, provide a safety net during catastrophic time periods, and give you something to rebalance from when stocks fall. Their main job isn’t necessarily to generate income. 

In other words, a total return strategy still requires ongoing management. You need to monitor the portfolio, rebalance it, and make adjustments throughout your retirement. 

So, the question I would ask here is whether you can stay disciplined as a long-term investor while also depending on that portfolio for income in retirement. Can you watch your balance fall in a bad market without changing course? Can you adjust withdrawals when needed, rebalance when it feels uncomfortable, and continue making thoughtful tax decisions along the way? 

For many retirees, those are reasonable tradeoffs because they value flexibility, control, and keeping more of their money invested. 

So with a total return approach, I’d focus less on whether you enjoy investing and more on whether you have the temperament and the process to stay with the plan when markets inevitably test you.

Style #2: Time Segmentation

Now, maybe you do believe in the markets long term, but the idea of watching your entire retirement paycheck ride every market swing makes you feel a little uneasy. 

That feeling points toward the second retirement income style which is “time segmentation.”

In short, the philosophy here is to match the time horizon of your money to the time horizon of your spending. You’ve probably heard this referred to as the bucket strategy.

The basic structure is straightforward. A short-term bucket holds one to two years of cash for near-term expenses. A medium-term bucket, often built with bonds maturing over the next five to ten years, covers the period after that. And a long-term bucket, invested mostly in stocks, is given more time to grow and recover from market declines.

The appeal is easy to understand. When markets are strong, you can refill the short-term buckets by trimming from the long-term portfolio. When markets are down, you can spend from cash and bonds instead of selling stocks at an unfavorable time. 

As a quick example, suppose you need $120,000 per year from your portfolio. Well, rather than viewing all of your retirement savings as one large pool of money, you might set aside several years of upcoming withdrawals in cash and bonds while leaving the money you won’t need for many years invested for growth. That can make a difficult market easier to live through because next year’s spending is not directly tied to what the global markets happen to do. 

At our firm, though, we don’t typically build three rigid buckets and manage each one in isolation. We borrow  the most useful idea from this strategy and maintain what we call a war chest — usually 2-3 years of living expenses in cash and bonds — alongside a traditional total return portfolio. 

The war chest doesn’t magically eliminate investment risk. What it does is give us another tool for managing withdrawals during difficult markets and, just as importantly, can make it easier for a retiree to stay disciplined when stocks are falling. 

The tradeoff is that every additional dollar held in cash or bonds is a dollar with a lower expected long-term return. That makes the size of the war chest important. We want enough of a buffer to help the plan withstand difficult markets, while still keeping enough invested for long-term growth.

But even with that buffer in place, one major risk still remains: you’re responsible for making sure you don’t live longer than your money.

And that brings us to the third style.

Style #3: Income Protection

The third style is income protection, which combines a safety-first mindset with a willingness to make more permanent decisions. 

The basic idea is simple: secure enough guaranteed income to cover essential expenses, then invest the rest for growth, discretionary spending, gifts, or legacy. 

Social Security forms the foundation and a pension helps if you have one. And if those sources don’t fully cover your essential spending, this approach will often lead you to use an income annuity to fill the gap. 

And that’s because annuities can do something a traditional investment portfolio cannot: mortality credits. When you buy a lifetime income annuity, your money is pooled with other policyholders. People who die earlier effectively help fund payments to those who live longer. And that pooling of longevity risk allows an insurer to provide lifetime income with less capital than you would typically need if you tried to fund the same uncertain lifespan with bonds alone. 

Supporters of this approach also point to another benefit. Once essential expenses are covered by guaranteed income, retirees may be more comfortable keeping the rest of the portfolio invested through market declines because their basic lifestyle isn’t dependent on selling securities. 

In an actual retirement plan, I’d start by identifying the expenses you would be uncomfortable exposing to market risk. If Social Security and a pension already cover them, you may not need anything else. If there’s a meaningful gap and you have a safety first mindset and a willingness to make a permanent decision, a simple income annuity may be worth evaluating. 

And that order is important. Start with the income problem you’re trying to solve, then evaluate the available tools. Too often, the process happens in reverse. Someone is sold an annuity first and only afterward tries to figure out how it fits into their retirement plan.

And this is where I become more cautious. As I discussed in episode 269, the annuity that works well on paper is often much simpler than the products retirees are commonly sold. 

Many commercial annuities are complex, expensive, and difficult to unwind. And even with a simple annuity, the guarantee comes with other tradeoffs. You’re relying on the financial strength of an insurance company for decades, fixed payments can lose purchasing power to inflation, and annuitizing assets typically means giving up some liquidity and potentially leaving less to your heirs.

And there’s also a behavioral cost that shouldn’t be dismissed: writing a large, permanent check to an insurance company doesn’t always feel good, even when the math seems reasonable.

That’s why, at our firm, it’s rare that we recommend annuities. When applicable, we generally prefer the simplest version: a single premium immediate annuity, usually later in retirement, sized only to cover a specific gap between essential expenses and guaranteed income. The goal is simply to cover that gap without asking the annuity to do anything more.

Style #4: Risk Wrap

That tradeoff between greater certainty and reduced flexibility leads naturally to the fourth and final style: risk wrap.

This is the one combination we haven’t covered yet, which attempts to provide safety-first, but with a preference for keeping options open. In other words, you want some guarantees, while still maintaining access to market growth and your account value. 

Now, similar to the commercial annuities we just discussed, I do have concerns about this approach, and I don’t think it’s appropriate for most retirees. But I also don’t believe there’s one right answer for everyone, and a big part of my goal with this show is to give you the information you need to make thoughtful, informed decisions for yourself. I often say “there’s the textbook answer, and then there’s your answer. And if your answer supports your goals, gives you more confidence, helps you sleep better at night, and doesn’t put the success of your plan at unnecessary risk, it deserves consideration. So even though risk wrap wouldn’t be my default recommendation, it is a legitimate part of this framework and could be fitting for the right person. 

With that little disclaimer out of the way, let’s go ahead and look at how it works, what you get, and what you give up. So, the basic structure is an investment portfolio inside an insurance contract, most commonly a variable annuity or a registered index-linked annuity, with a guaranteed lifetime withdrawal benefit that’s attached. 

Your money remains invested in market-like assets, which gives your guaranteed income the chance to potentially step up to a higher level along the way if the investments perform well. But if they perform poorly, and the account value eventually gets drawn all the way down to zero, the insurance company continues paying that minimum income documented in your policy for the rest of your life.

And you can see why that is appealing. You still have an account balance, there’s often a death benefit if leaving money behind is important to you, and the potential income step-ups can help offset some of the effects of inflation. For couples where one spouse values guarantees and the other prefers staying invested, it can seem like a reasonable middle ground. 

My concerns mostly come down to cost and complexity. An income rider alone can cost around 1.5% per year, before adding the underlying fund expenses and other contract charges. In episode 269, which I will share a link to in today’s show notes, I shared an analysis of more than 48,000 annuity policies where total annual costs reached as high as 3.88%. Which means, a retiree with a $1 million dollar nest egg who doesn’t know any better, could be paying nearly $40,000 per year for insurance protection they don’t even need.  

Then there’s the complexity. These contracts can be difficult to compare from one company to another, surrender charges can limit your flexibility for seven to ten years, and you’re relying on one insurance company to honor those guarantees for decades. And over a long retirement, those costs can add up to the point where the hybrid approach ends up comparing poorly with either a straightforward investment portfolio or a straightforward income annuity.

So if you’re considering this style, the details really do matter. And before signing anything, I’d want someone who isn’t being paid to sell you the product to review the contract and help you understand exactly what you’re paying for.

Because, as I’ve shared many times before: every guarantee and every benefit attached to an annuity or insurance policy has a cost, a cost you are paying for. Downside protection, inflation protection, guaranteed returns, guaranteed income for life… none of those features are being given away for free. They’ve all been priced into the product.

That doesn’t automatically make them bad or mean you should avoid them at all costs. But the insurance company has done the math, across a very large pool of policyholders, to make sure the guarantees they’re offering are priced in a way that works for them. Your job is to make sure those same guarantees are valuable enough to work for you.

Three Decisions Your Retirement Plan Needs to Make

Now, rather than trying to score yourself into one of these four categories or styles, I think a more useful way to apply the framework to your retirement plan is to start with three decisions.

Number one: figure out which spending truly needs to be protected. I.e., What expenses need to be covered regardless of what markets are doing? Housing, groceries, healthcare, insurance — whatever those essentials are for you.

Number two: decide where flexibility matters most. Said another way, which dollars may need to do a different job later? Maybe you move, healthcare costs rise, you want to help your kids or grandkids, or your legacy goals change. Those are dollars I’d be careful about permanently committing today.

Lastly, number three, decide which risks you’re comfortable carrying yourself. For example, are you willing to accept market volatility for higher expected returns? Would you rather transfer some longevity risk to an insurance company? Or would keeping several years of spending in safer assets give you the confidence to stay invested through a difficult market?

Those answers probably won’t place you neatly into one of the four boxes, and that’s fine. What matters is that they tell you what your retirement income strategy actually needs to accomplish.

Build a Core Strategy, Then Borrow From the Others

Once you know that, you can build a core strategy around your biggest priorities and then borrow from the other styles when they solve a specific problem.

Because in the real world, most good retirement plans end up pulling from more than one of these approaches. Social Security provides guaranteed lifetime income. A diversified portfolio provides growth and flexibility. Cash and bonds can support near-term spending during difficult markets. And in the right situation, an annuity can transfer a risk you’d rather not carry yourself. Let’s also not forget that life isn’t a straight line, and what might be the right solution today, may not prove to be the right solution tomorrow. 

The value of this framework is that it helps you see the tradeoffs clearly, decide which ones matter most to you, and build a retirement income strategy around the life you actually want to live.

Bottom Line

If there’s one idea I hope you take away from today’s episode, it’s that a good retirement income plan should work both financially and behaviorally. You can build a strategy that looks great in a spreadsheet, but if it asks you to tolerate more uncertainty than you’re comfortable with, give up more flexibility than you want, or make commitments you’ll regret later, there’s a good chance you won’t stick with it when things get difficult. 

The framework we walked through today should hopefully give you a better way to think about the choices in front of you. How much certainty do you actually need? Where is flexibility most valuable? Which risks are you comfortable keeping, and which ones would you gladly pay to transfer? 

And remember, you don’t have to choose one of these four styles and stay there forever. Your retirement plan can borrow from each of them, and it can evolve as your life, your priorities, and your circumstances change. 

The goal is to understand the tradeoffs you’re making, make them intentionally, and build a retirement income plan you have the confidence to actually follow. 

Thank you, as always, for listening. To view the research and resources referenced in today’s episode, head over to youstaywealthy.com/298.

Disclaimer

This podcast is for informational and entertainment purposes only, and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.