How to Set Your Asset Allocation in Retirement

Retirement asset allocation is the strategy of managing your investments to meet both income needs and risk tolerance in retirement. Unlike your working years when you might have favored aggressive growth, retirement typically calls for a more nuanced approach. You’ll need to consider factors like your expected longevity, other income sources such as Social Security or pensions, healthcare costs, and your desired lifestyle. Finding this balance is essential for maintaining both your financial well-being and peace of mind throughout retirement.

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Balancing Risk, Reward and Income Needs in Retirement

Building a retirement asset allocation comes down to managing the balance between risk, reward and income generation. In retirement, this balance becomes more nuanced compared to the accumulation phase. 

Retirees need to prioritize capital preservation while also ensuring their investments generate sufficient income and maintain a degree of growth to keep up with inflation. Holding a high percentage of equities can lead to market volatility affecting your savings, while too few equities may result in inadequate growth to offset inflation.

Fixed income investments like bonds play a central role in retirement asset allocation planning. U.S. Treasury bonds, municipal bonds and high-quality corporate bonds typically offer lower risk and more predictable returns compared to stocks.

Allocating a sizable portion of a retirement portfolio to fixed income can provide a sense of stability, especially during periods of market downturns. Laddering bond maturities is one method that can help mitigate interest rate risk.

Using a Glide Path

A common strategy to achieve this balance is the “glide path” approach, where equity exposure is reduced over time in favor of more stable assets such as bonds and cash equivalents. The “Rule of 110” is a popular glide path rule of thumb that suggests the percentage of equities should be 110 minus your age, with the remainder invested in fixed income or other stable investments. For instance, a 70-year-old retiree might aim for 40% in equities and 60% in bonds or cash equivalents.

Of course, this is a basic rule of thumb. Individual factors like risk tolerance, health, and retirement goals should also be considered when determining an asset allocation in retirement. Following the Rule of 110, here’s what retirement asset allocations could look like at different ages:

Adjusting Your Asset Allocation Throughout Retirement

Asset allocation is not static and should be revisited regularly throughout retirement. Factors like age, health status, life expectancy and changes in financial goals necessitate periodic reassessment. As retirees age, it is often advisable to shift to a more conservative allocation, with a greater emphasis on fixed income and less exposure to equities. This gradual shift can help protect savings from market volatility when funds are most needed.

However, retirees also need to be wary of being too conservative. With longer life expectancies, there is the risk of outliving one’s savings. A strategy that adjusts asset allocation in response to market conditions and personal milestones can offer a balanced approach, combining growth opportunities with income stability.

Addressing Longevity Risk

While fixed-income instruments like bonds can help retirees preserve their capital, growth-oriented assets like stocks also play an important role in a retiree’s asset allocation. That’s because they can help mitigate longevity risk – the risk of outliving your savings.

According to the actuarial data used in the Social Security Administration’s 2024 Trustees Report, the average 65-year-old American man can expect to live to around age 82, while the average woman can expect to live until approximately age 85. However, retirees may want to consider overestimating their life expectancies, especially if they are in good health, to reduce longevity risk. 

Depending on your age and health at retirement, you may consider planning for 30 years’ worth of withdrawals from your retirement accounts. This means that you’ll need a large enough nest egg to last you for years to come and a withdrawal rate that won’t deplete your savings while you’re still alive. 

The Bucket Strategy

The Bucket Strategy to retirement income planning helps retirees manage risks associated with market volatility, generate steady income and ensure their assets last throughout retirement by aligning investments with their spending timeline.

This approach divides a retiree’s assets into multiple “buckets,” each designed for different time horizons and levels of risk. Typically, the approach consists of three buckets:

• Short-term bucket: Holds cash or very low-risk investments, like money market funds or short-term bonds, to cover living expenses for the next one to three years. The goal is to provide liquidity and avoid selling investments during market downturns.
• Medium-term bucket: Contains moderately conservative investments, such as intermediate bonds and dividend stocks, to generate income and preserve capital over a three- to 10-year period.
• Long-term bucket: Includes growth-oriented investments like stocks, meant to outpace inflation over 10+ years and ensure financial security in later retirement years.

When markets are up, retirees can take gains from the long-term bucket and allocate them to the short-term or medium-term buckets to maintain stability. During downturns, they can use the funds in their short-term bucket to avoid selling investments at a loss.

Annuities

Purchasing an annuity is another way to potentially reduce or eliminate longevity risk. Annuities can provide guaranteed income for life, reducing the risk that retirees will exhaust their savings. There are different types of annuities, such as immediate, deferred and variable annuities, each with unique features that can be customized to fit a retiree’s needs. However, these products can be complex and have significant fees associated with them. 

Delaying Social Security

Lastly, delaying Social Security benefits can also help address longevity risk. Social Security benefits increase substantially when you delay claiming. For each year you postpone benefits beyond your full retirement age (up to age 70), your monthly payment grows by about 8%. This permanent increase can significantly boost your lifetime income if you live into your 80s or beyond. The enhanced benefit also provides inflation protection through annual cost-of-living adjustments.

Maximized Social Security benefits can establish a solid income foundation for your later years. This guaranteed income floor covers essential expenses regardless of market performance or economic conditions. When combined with other guaranteed income sources like pensions or annuities, delayed Social Security benefits help ensure your basic needs remain covered throughout retirement.

Building a Tax-Efficient Plan

Tax considerations are another critical component of retirement asset allocation. Different types of investment accounts are taxed differently, and understanding how to manage withdrawals for tax efficiency can help extend the longevity of retirement savings. 

Qualified accounts, such as traditional IRAs and 401(k)s, are taxed as ordinary income when withdrawals are made, whereas Roth IRAs and Roth 401(k)s offer tax-free withdrawals. Taxable brokerage accounts may also have favorable capital gains treatment.

A tax-efficient withdrawal strategy can involve drawing from taxable accounts first, allowing tax-advantaged accounts to continue growing. The order in which assets are sold can have a significant impact on overall tax liability. Additionally, retirees can consider Roth conversions in low-income years to reduce future required minimum distributions (RMDs) and potentially lower their tax burden over time.

Bottom Line

As you transition into retirement, knowing how to set your asset allocation becomes crucial for financial security. The right mix of stocks, bonds, and other investments can help protect your nest egg while providing the growth needed to sustain your lifestyle through retirement years. Remember that your allocation should evolve as you age, typically shifting toward more conservative investments while still maintaining some growth potential to combat inflation. Consider working with a financial advisor who can help tailor your portfolio to your specific needs, risk tolerance and retirement timeline.

Retirement Planning Tips

• Building an appropriate asset allocation and creating a retirement income plan can be complicated. Luckily a financial advisor can potentially help with both. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• In addition to your pension or retirement plan, here are five additional ways to get guaranteed retirement income.

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