How a mix of investments can help provide income and growth potential in retirement.
Just as your life has likely been nothing like your parents’, your retirement probably won’t be either. It’s no longer as simple as signing up for Social Security, collecting your pension, and settling back. You will probably be more active, live and work longer, and for income, need to rely more on what you’ve saved. And that means ensuring that this income has the potential to last for your lifetime and to weather rising health care expenses, inflation, and market ups and downs.
While this may sound overwhelming, it doesn’t have to be. A Fidelity Target Income Mix® (see graphic below) can help you cover all the bases. It utilizes three types of income-generating investments: fixed-income annuities, variable annuities, and a portfolio that includes stocks, bonds, and short-term investments. Your mix can be made up of one, two, or all three types in various proportions, based on your preferences.
"Each component serves a purpose," explains Chris McDermott, CFP,® and senior vice president of retirement and financial planning at Fidelity Investments. "Together, they can help provide a stream of income, some protection from inflation and market volatility, and potential for growth. First and foremost, you'll want to make sure your day-to-day expenses are covered and that you don’t outlive your income and assets."
In addition to determining the mix of investments that is right for you, it's also important to think about timing. Even if you are not retiring for a few years, you may choose to make a few investments now so that you have the potential to lock in some additional security and give yourself a head start on retirement.
Why these three?
We believe it makes sense to use guaranteed income1 from fixed income and certain types of variable annuities, in addition to your Social Security or pension income, for some protection to help ensure that your essential expenses (food, utilities, health care, and other must-haves) are covered. Then you can position your investment portfolio for growth as well as use it for your discretionary spending (vacations, hobbies, and other nice-to-haves).
Let's take a closer look at each of the three building blocks.
1. Fixed-income annuities: guaranteed income
A fixed-income annuity is a contract with an insurance company that, in return for an up-front investment, guarantees to pay you (or you and another person) a set amount of income either for the rest of your life or for a set period of time. The income could start immediately or on a future date that you select. Why do we suggest including one in a Target Income Mix? It's straightforward: fixed annuities, along with Social Security and/or pensions, provide guaranteed income to help meet essential expenses. The insurance company is obligated to make payments to you for a specific time frame you select, or if you choose a lifetime option, the payments will occur as long as you or your spouse live. With either the defined period or lifetime option, payments will continue to occur regardless of what happens in the financial markets.
There are two things that a typical fixed-income annuity won’t provide: access to the money you invested and growth potential. You give up access to the savings you used to purchase this type of annuity, which may be a problem if an unexpected expense crops up. And you forgo any market growth potential for this money. That's why we believe a fixed-income annuity should be only a portion of your Target Income Mix.
We generally suggest you consider a fixed-income annuity with a cost-of-living adjustment (COLA) to help protect your income payments from inflation. For example, if you add a 3% COLA to your annuity, your income payments will increase by 3% every year. Although a COLA will require additional assets when purchased, it may be worth it for you to have some inflation protection.
Although annuities have been maligned in the past for being expensive, complicated, and inflexible, much has changed. There are many low-cost annuities from well-established and financially strong companies.
Before investing, consider the investment objectives, risks, charges, and expenses of the fund or annuity and its investment options. Call or write to Fidelity or visit Fidelity.com for a free prospectus or, if available, a summary prospectus containing this information. Read it carefully.
IMPORTANT: The projections and other information generated by Fidelity’s Income Strategy Evaluator (ISE) tool regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Estimates of potential income and assets illustrated by the tool are in future dollars and are based on data entered, product attributes, and Income Strategy Evaluator assumptions, including market performance assumptions based on hypothetical scenarios using historical data. Other investments not considered by Income Strategy Evaluator may have characteristics that are similar or superior to those being analyzed. Numerous factors make the calculations uncertain, such as the use of assumptions about historical returns and inflation, as well as the data you have provided. Our analysis assumes a level of diversity within each asset class consistent with a market index benchmark, which may differ from the diversity of your own portfolio. Results may vary with each use and over time. Fund fees and/or other expenses will generally reduce your actual investment returns and, other than the applicable annual annuity charges for the variable annuity, are not reflected in the hypothetical projections generated by this tool. For specific assumptions about the variable annuity, fixed income annuity, and investment portfolio components, please see disclosures below titled "Variable annuity assumption", "Fixed-income annuity assumption", and "Investment portfolio assumption."
A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, make a qualified first-time home purchase, suffer a disability, or die.
Information regarding hypothetical retirement income plan example: Results generated by the tool are not intended to predict present or future values of actual investments or actual holdings and results may vary with each use and over time. Essential expenses are matched with annuity income at an assumed 0% return level and total expenses (essential and discretionary together) at the 50% confidence level. The average market conditions (50% confidence level) are used to match the total income need. Rates may change daily.
Variable annuity assumption: The variable annuity is assumed to be a joint-life variable income annuity with a 10-year guarantee period, 3.5% benchmark rate of return, 0.60% annual annuity charge, and a 100% survivor benefit at the death of either annuitant. The illustration assumes an asset allocation that becomes increasingly conservative over time, consistent with the asset allocation schedule of the Fidelity® VIP Freedom Lifetime Income® Portfolios.
The variable income annuity values reflect the deduction of the annual annuity charge. The 0% rate of return is equivalent to a -0.60% return after this charge is reflected. Fund fees will also apply and are not reflected.
The amount of each payment from a variable income annuity is not guaranteed and will fluctuate based on the performance of the selected investment option.
Benchmark rate of return: The benchmark rate of return is one factor used to determine a variable income annuity’s initial and subsequent payments (note that it is not a guaranteed rate of return). Assuming withdrawals are not taken from the contract date to the first annuity income date, and from one annuity income date to the next, then annuity income will (a) increase if the annualized investment return for the contract is greater than the benchmark rate of return, or (b) decrease if the annualized investment return for the contract is less than the benchmark rate of return. The annualized investment return includes the contract's fund performance minus the annuity and fund fees. This is true for this hypothetical scenario but may not apply to all variable annuities.
Fixed-income annuity assumption: The fixed-income annuity is assumed to be a joint-life income annuity with a 10-year guarantee period, 3% cost of living adjustment, and a 100% survivor benefit at the death of either annuitant. In order to arrive at the estimate, the best quote available as of January 19, 2012, was used from among the fixed-income annuities distributed by Fidelity Insurance Agency, Inc.; these annuities are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. Rates may change daily.
Guarantee period: A guarantee period is a feature available on certain fixed and variable income annuity contracts. A contract with a guarantee period provides annuity income through a specified date, even if no annuitant lives to the end of the guarantee period. If no annuitant lives to the end of the guarantee period, each beneficiary will continue to receive income for the remainder of the guarantee period (note that certain annuities give the beneficiary the option of choosing a commuted value as a lump-sum benefit instead). A contract with a guarantee period will provide lower annuity income on each annuity income date than an otherwise identical contract without a guarantee period.
Investment portfolio assumption: Illustrations of investment components are based on a balanced target asset mix. The balanced target asset mix is composed of 35% domestic and 15% foreign stocks, 40% bonds, and 10% short-term investments. Domestic stocks are represented by the S&P 500® Index; bonds by U.S. intermediate-term government bonds; and short-term assets are based on the 30-day U.S. Treasury bill. Foreign equities are represented by the Morgan Stanley Capital International Europe, Australasia, Far East Index for the period from 1970 to the last calendar year. Foreign equities prior to 1970 are represented by the S&P 500® Index. Historical returns for the various asset classes are based on performance numbers provided by Ibbotson Associates in the Stocks, Bonds, Bills, and Inflation (SBBI) 2007 Yearbook (annual update work by Roger G. Ibbotson and Rex A. Sinquefield). It is not possible to invest directly in an index.
Generally, among asset classes, stocks may present more short-term risk and volatility than bonds or short-term instruments, but may provide greater potential return over the long term. Although bonds generally present less short-term risk and volatility than stocks, bonds contain interest rate risk (as interest rates rise, bond prices usually fall, and vice versa), the risk of issuer default, and inflation risk. Finally, foreign investments, especially those in emerging markets, involve greater risk and may offer greater potential return than U.S. investments.
The results are calculated based on how the hypothetical portfolio may have performed in a certain percentage of simulated market scenarios. These percentages are called confidence levels. The average market and down market results are based on 50% and 90% confidence levels, respectively. This means that in 50% of the market scenarios tested, the hypothetical portfolio performed at least as well as the results shown for the average market; similarly in 90% of the market scenarios, the hypothetical portfolio performed at least as well as the results shown for the down market.
The retirement planning information contained herein is general in nature and should not be considered legal or tax advice. Fidelity does not provide legal or tax advice. This information is provided for general educational purposes only and you should bear in mind that laws of a particular state and your particular situation may affect this information. You should consult your attorney or tax adviser regarding your specific legal or tax situation.
1. Guarantees are subject to the claims-paying ability of the issuing insurance company.
2. Investing in a variable annuity involves risk of loss—investment returns, contract value, and, for variable income annuities, payment amount are not guaranteed and will fluctuate.
3. Fidelity Income Strategy Evaluator is an educational tool.
4. In the Wilson's hypothetical example we assumed that, of the $600,000 in assets, $350,000 is held in tax-deferred assets [Charles's 401(k)], $200,000 is held as tax-free assets (Marsha's Roth IRA), and $50,000 is held in a taxable account (joint assets). Their effective federal tax rate is 13.6%. Their effective state tax rate is 5.3%.
5. A guarantee period in an income annuity provides annuity income through a specified date, even if no annuitant lives to the end of the guarantee period. For more information, see the guarantee period definition above.
6. A benchmark rate of return is one of the factors used to determine a variable income annuity's initial and subsequent payments (it is not a guaranteed rate of return). For more information, see the benchmark rate of return definition above.
Some insurance products are issued by third-party insurance carriers, which are not affiliated with any Fidelity Investments company.
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