Retirement income theories focus on meeting lifestyle goals or needs

The approach an adviser takes in constructing a retirement portfolio depends on whether the client is content living their early years of retirement modestly or wants to enjoy these days to the fullest, potentially having to cut back in later years, a well-known retirement scholar said. The probability-based school of thought would allow for a certain annual withdrawal rate to accommodate the client's lifestyle spending, said Wade Pfau, professor of retirement income at The American College of Financial Services, speaking at the National Association of Personal Financial Advisors' national conference in Philadelphia on Wednesday. The potential pitfall, however, is that the client could run out of money and then have to live off Social Security, he said. Taking the safety-first approach, on the other hand, would have client funds invested according to whether they must be used for basic needs, emergencies, discretionary spending or legacy goals. For example, 75% of a portfolio may be used to fund an annuity or Treasury inflation-protected securities ladder that pays an income that covers needs, leaving only 25% of assets to be invested to cover the cost of life's enjoyable extras, Mr. Pfau said. "This approach eliminates the upside, but it helps to eliminate the downside, too," he said. Advisers can decide the right approach for clients by asking them about their budget and seeing how they react to suggestions of cutting back on certain lifestyle costs, such as their country club membership, Mr. Pfau said. They also should take an approach that allows for periodic changes, taking into account that some research suggests that discretionary spending declines in the older years. Of course, health care costs are the potential deal breaker with that theory, he said. An adviser subscribing to the probability approach could stave off disaster in declining markets by convincing clients to make some small cuts and adjustments every few years so that at least most of the client's lifestyle standards can be upheld and still have assets last through retirement, he said.