How Much Guaranteed Income Do You Need in Retirement?

Key Takeaways

• The main types of guaranteed income that someone could bring into retirement are typically Social Security and people who have pension. Annuities also fall under this umbrella.
• Social Security and Treasury bonds are the closest to guaranteed income. Pensions vary in terms of their backing. Annuities are backed by the insurance company offering the annuity.
• Social Security and Treasury Inflation-Protected Securities are mostly inflation-protected. For pensions, the type of inflation protection depends on the specific pension.
• Social Security provides a lifetime benefit, but many annuities and pensions are also set up to provide a lifetime benefit.
• To figure out how much to generate via guaranteed income, start by spending some time with your budget and identifying the category of fixed expenditures in your household. Then look at how your nonportfolio income sources align with those outlays.
• Guaranteed income can be helpful in a volatile market by helping with peace of mind. And then, importantly, if you are able to adjust your withdrawal rate downward during times of market volatility where your portfolio has taken on losses, that can be beneficial.
• To the extent that retirees have nonportfolio income coming in, they tend to be more comfortable spending it.

Margaret Giles: Hi, I’m Margaret Giles with Morningstar. Nonportfolio income sources like Social Security can go a long way toward smoothing out the bumps in volatile market environments. Joining me to discuss the topic of guaranteed income is Christine Benz. Christine is Morningstar’s director of personal finance and retirement planning, host of The Long View podcast, and author of the bestselling book, How to Retire: 20 Lessons for a Happy, Successful, and Wealthy Retirement. Christine, thanks for being here.

Christine Benz: Margaret, it’s great to see you.

Types of Guaranteed Income in Retirement

Giles: Before we go any further, what are the main types of guaranteed income that someone could bring into retirement?

Benz: Typically, when we talk about guaranteed income, we’re talking about Social Security, certainly people who have pensions. I would throw that under this umbrella as well. Annuities would also fit under the category of guaranteed income, and of course, the type of annuity would influence whether we’d call it guaranteed or not. But generally speaking, a very basic income annuity would fit under this heading. And then, finally, a laddered portfolio of Treasury bonds, especially Treasury Inflation-Protected Securities. I think you could also tuck that under the guaranteed income umbrella as well.

How Guaranteed Is Guaranteed Income in Retirement?

Giles: We call them guaranteed income, but how ironclad are those guarantees?

Benz: It’s a really important question. I would say Social Security and Treasury bonds are the closest to something that’s truly guaranteed, and that Social Security, in order to change the rules around how we get paid from Social Security, that would take an act of Congress. And then Treasury bonds: If the Treasury, for whatever reason, is unable to make good on its payments to bondholders, we probably have bigger problems than that, so those would be the closest to kind of ironclad guarantees. Pensions vary in terms of their backing. Private pensions are backed by the Pension Benefit Guaranty Corp. Public pensions are typically backed by whatever entity is providing that benefit, a state and local government. And so, you’d want to use your pension provider, your state where you live, to determine how safe you should feel about that pension. Annuities are backed by the insurance company offering the annuity, and you want to be very careful to read up on the financial health of that annuity provider. Annuities are also backstopped by the state guarantee associations. There’s kind of a patchwork of guaranteed protections in the case of these things that we tuck under the guaranteed income umbrella.

What Guaranteed Income Sources in Retirement Protect Against Inflation?

Giles: What about inflation protection? Would all of these income sources protect against rising prices?

Benz: Not necessarily. Here again, Social Security and Treasury Inflation-Protected Securities are kind of the most purely inflation-protected of any of these asset types, where you have a CPI-linked inflation adjustment. In the case of annuities, you can purchase an inflation rider, but you can’t currently buy one that is linked to the CPI. That is often kind of stated as a knock against annuities that you can’t buy that pure inflation adjustment. Then, for pensions, the type of inflation protection will depend on the specific pension. Generally speaking, public pensions do have pretty nice inflation adjustments, often not CPI-linked, but sort of a flat percentage. In the case of private pensions, there isn’t typically an inflation adjustment built in, so that’s a big sort of drawback to the private pensions.

Which Guaranteed Income Sources in Retirement Have Longevity Protection?

Giles: How about longevity protection? Which of those income sources provide a lifetime benefit?

Benz: Social Security certainly is going to provide a lifetime benefit, and then, many annuities are also set up to provide a lifetime benefit, and many pensions are as well. Drawback for that laddered portfolio of bonds is that even if you build a really nice long ladder, you may not necessarily exceed your life expectancy. That’s a minor risk factor with that laddered portfolio; it’s not giving you any sort of longevity protection.

How Can Retirees Figure Out How Much Guaranteed Income They Need?

Giles: You suggest that retirees take a few steps to figure out how much to generate via guaranteed income. What are they?

Benz: The first one is just spend some time with your budget and identify the category of fixed expenditures in your household. Things like your healthcare expenses, your taxes, your insurance, your utilities, your food, whatever home ownership costs that you’ve got, your non-negotiables. Tally those up, see what they’ll look like in retirement. Then look at how your nonportfolio income sources align with those outlays. It’s a really great idea to get those two things to line up if you possibly can. To use a simple example, say my monthly fixed outlays are in the ballpark of $4,000 and my monthly Social Security benefit will be $3,000. I have a little bit of a shortfall. That’s where you could have an elegant use of some additional guaranteed income, whether you’re purchasing that laddered portfolio of TIPS bonds or maybe bringing an annuity on board to help meet that shortfall in your fixed expenditures.

How Guaranteed Income Can Help in Volatile Markets

Giles: How can guaranteed income be helpful in a volatile market? What are the key benefits there?

Benz: A key one obviously is peace of mind. If you are retired and spending from a portfolio, it feels a lot more comfortable to have more of your cash flow needs coming from those guaranteed income sources. And then, importantly, if you are able to adjust your withdrawal rate downward during times of market volatility where your portfolio has taken on losses, that can be incredibly beneficial. And it’s obviously easier to do those downward adjustments to your spending if you know that you have your fixed expenditures lined up with your guaranteed income sources. There’s a real-world benefit in terms of portfolio withdrawals if you can take less in those market downdrafts.

Why Retirees Feel More Comfortable Spending More From Their Nonportfolio Income

Giles: You know that there are other valuable benefits when it comes to guaranteed income. What are they?

Benz: The big one is there’s been some research done by David Blanchett and Michael Finca where people do not consider all of their retirement income equal. In particular, to the extent that they have nonportfolio income coming in, they tend to be more comfortable spending it. They give themselves more license to spend, which, to me, translates into a little bit of a happiness dividend. If you’re not worried about the spending that you’re doing, you’re just going to be more comfortable and happy in retirement. I think that’s an important finding that people who have more guaranteed income do tend to be a bit comfier and happier in retirement.

Giles: Christine, thanks for taking the time to give us some insights on these guaranteed income sources.

Benz: Thank you so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch How Do You Maintain a Bucket System for Your Retirement Portfolio? for more from Christine Benz.