Building Retirement Income Requires More Than Monte Carlo Wizardry

Should inflation remain elevated in the years ahead, Powell says, the second bucket might be tilted towards a mix of stocks and bonds that have inflation-hedging characteristics, and its time horizon might also be shortened. Finally, the third bucket meant to address long-term expenses may need to take on an added level of risk.

"Something else to consider is that spending, real spending, actually tends to decline in retirement," Powell says. "I think people sometimes fail to put inflation in the context of what their actual spending will be in retirement."

While inflation may be high today, Powell explains, it will likely moderate in the future. He says it is reasonable to forecast inflation returning to the ballpark of 3% over the course of the next several decades.

"So, income planning requires us to be mindful of the fact that this 3% inflation might not bite quite as much as we expect if people naturally reduce their spending as retirement progresses," Powell says. "We can all read the headlines, but we also need to think about how the bigger picture applies to a person's specific income plans."

The Potential Role of Annuities

Powell says the matter of whether American retirees are underutilizing annuities and other forms of income insurance is a "interesting question."

"My answer to the question is, they may be, especially in certain segments of the population," Powell says. "I once had the luxury of interviewing Bob Merton, a Nobel Prize winner, who said that for the vast majority of middle Americans, annuities and reverse mortgages will be the two products that allow them to have a standard of living that they desire in retirement."

To be more specific, Powell says, there are strong arguments to be made that middle-income Americans could benefit from greater use of guaranteed income annuities.

"For the highest-income, highest-net-worth folks in the world, they may not be utilized at all, but they may not need to be, because folks who are in the upper-income quintiles and the upper-net-worth quintiles have probably more than enough assets to fund their desired standard of living," Powell says. "They can also probably handle more sequence of return risk, perhaps."

For people who might be in the lowest-income quintiles, Powell adds, Social Security is their annuity.

"The research tends to suggest that, for this group, Social Security tends to replace up to 80% or so of their preretirement income," Powell says. "So, there's no big need for an annuity there."

Powell says a big part of the issue is that many Americans preparing for retirement lack a solid understanding of these products and how they are used — and how they're sold.

"As you know, people tend not to buy annuities if someone isn't in front of them proactively trying to sell them an annuity," Powell says. "And so, people still have a distrust of people who are selling these annuities, because there is often a commission associated with the sale of those products. It's also really hard to understand whether what you might need is a fixed annuity or a single-premium annuity, for example, or maybe you need a variable annuity. It goes on and on."

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