After the S&P 500 lost 35% in 2000 and 38% in 2008, financial advisors have had to think twice about how they win their clients post-retirement income.

Usually that leads to talk about asset allocation. But more important than that are the sequence and volatility of market returns, says Jim Otar, a Thornhill, Ontario-based financial analyst and planner: Large losses early in the retirement withdrawal phase, many have learned the hard way, can dismantle even the best-planned asset-allocation strategies.

Otar's research on systematic withdrawal rates over 111 years from 1900 through 2010 suggests that clients need a stable source of income, besides Social Security, to limit the impact of a downturn. "As withdrawal rates increase and the portfolio life shortens, the importance of asset allocation diminishes and is replaced by the effect of inflation," Otar says.

Otar sought to determine how better management decisions might influence a portfolio, factoring in systematic withdrawals, the sequence and volatility of returns, inflation, rebalancing frequency, portfolio cost and the potential alpha-or returns in excess of the risk-free rate of Treasury bills.

When someone is taking systematic withdrawals from a portfolio, its total return is much more affected by how the market performs and how much prices swing from day to day, month to month and year to year. The results of Otar's research, assuming a 4% withdrawal rate, show that the sequence of returns and how much prices move up and down contribute 32% to the total return of a portfolio. Inflation can contribute 21%, asset allocation contributes just 20% and money management skills contribute 11%.

The challenge to advisors, the research suggests, is how to plan and invest clients' assets so they have the income to maintain lifestyles and leave an estate to loved ones. Some say you need to anchor your clients' portfolios with insurance, like an immediate annuity, a lifetime withdrawal benefit or a deferred immediate annuity that pays guaranteed income later on in life. Others argue that systematic withdrawals from retirement savings investments will do the trick.

For example, research by Wade Pfau, an associate professor at the National Graduate Institute for Policy Studies in Tokyo, found that in 56 rolling 30-year periods from 1926 through 2009, an annual systematic withdrawal plan from a mix of 65% stocks and 35% bonds succeeded over any of the rolling periods. But for systematic withdrawals to work, retirees must avoid overspending during the first 10 years of retirement and they must keep investment expenses and taxes to a minimum.

Others believe you can't count on drawdowns. Peng Zhou, Ph.D., an actuary with Sun Life Financial in Wellesley Hills, Mass., conducted a study in 2003 at the University of Connecticut and found that the goal of income and estate preservation is achieved by setting up an optimal portfolio based on risk, return and the probability the money doesn't run short during retirement. In a paper Zhou presented to the Society of Actuaries, he wrote that financial advisors should consider several types of insurance products for a retirement plan. The plan should include investments in stock funds, immediate annuities and deferred income annuities, which allow the policyholder to pay regular premiums and receive income later in life. In addition, he recommends long-term care insurance and a declining one-year term insurance policy so that the retiree can cover any gap in estate value in the event he or she dies early.

"A well-crafted investment and immediate annuity strategy can create both longevity risk protection and greater estate value than a pure investment strategy," he says. "Estate value preservation and longevity risk protection can both be accomplished using immediate annuities."

His University of Connecticut study, Stochastic Modeling of Post-Retirement Financial Planning, shows how mutual funds and insurance can work together to limit investment risk and preserve an estate's value. Zhou assumed that a fixed immediate annuity would pay out 4%. Variable immediate annuities, as well as mutual funds earned a 5% annual rate. He then factored in taxes. He assumed that the risk of ruin occurred when a client's mutual fund investments dropped below the required estate value at death.

The results of his research, based on Monte Carlo simulations, show that the best mix of assets includes a 25% to 45% allocation to immediate annuities, deferred income annuities and/or a ladder of immediate annuity contracts. Today, only about 2% to 4% of retirees' assets are in immediate annuities.

If you wanted to minimize the probability of ruin, you would invest more money in a fixed immediate annuity. Take a 65-year-old male, with a life expectancy of 19 years, assets of $1 million and annual expenses of $50,000. Our subject wants a minimum estate value of $100,000. To achieve a 0% probability of ruin, he would invest 75% in a fixed immediate annuity and 25% in mutual funds. This, Zhou says, is essentially a risk-free investment. The estate at the end is worth $928,000.

But as annual expenses rise, so does the risk of ruin, and the ending estate value declines. If the 65-year-old man had $63,000 in annual expenses, the probability of ruin would be just over 7%. He would invest 85% in a fixed annuity, 3% in a deferred immediate annuity and 12% in mutual funds. The estate would be worth $250,000 after 19 years.

The same man who wanted to maximize the end value of the estate would need to take a more aggressive stance: A 90% investment in a variable income annuity, 3% in a deferred income annuity and 7% in mutual funds would result in a 5% probability of ruin and an estate value at his death of $1,779,000.

Rising annual expenses, however, would force him into a more conservative stance to keep his probability of ruin at just 5%. If he had $62,000 in annual expenses, he would invest 70% in a fixed immediate annuity, 5% in a variable immediate annuity, 4% in a deferred immediate annuity and 21% in mutual funds. The ending estate value would be $413,000. "A well-designed immediate annuity and investment strategy generally outperforms a pure investment strategy," Zhou says.

Matthew Grove, vice president of retirement income security with New York Life, says financial advisors are showing a strong interest in the use of immediate annuities in retirement plans, looking at both optimization and the risk of ruin to find the right mix of insurance and investments for a client.

More than $300 million has gone into the company's new Guaranteed Future Income Annuity, a deferred fixed immediate annuity launched last August. Policyholders fund the annuity before they retire and get immediate income later when they hang up their spikes. The average policyholder, Grove says, is 58 years old and puts $100,000 into the annuity-but delays the lifetime income until he is about 68.

MetLife's retirement division, meanwhile, offers a product called the Longevity Income Guarantee annuity. Bennett Kleinberg, a senior actuary at the firm, says that the strategy of some financial advisors is to put about 10% to 20% of a 50-year-old's assets into this vehicle. The annuity pays a fixed amount of monthly income to the retiree later at age 85. Because the future income is guaranteed, the retiree can invest more money elsewhere in stocks or feel safe withdrawing from other income sources.

For example, a 65-year-old retiree can put $425,000 in investments and $75,000 in the deferred immediate annuity. He would get $21,500 a year from a 5% systematic withdrawal plan from his other investments starting at age 65. Then at age 85, the immediate annuity income would kick in, replacing the systematic withdrawals from other accounts. This annuity would offer $22,300 annually.

But Kleinberg says it can also be set up so that the annuity income starts before a client is age 85. And if the policyholder dies, joint owner or survivor payout options will ensure that the surviving spouse or another beneficiary will receive the income. Although statistics show that annuities can benefit a retirement portfolio, some financial planners have serious concerns about using these insurance products because of their high internal costs, their surrender charges and the big sales commissions agents make on them.

Anna Pfaehler, a financial planner with Palisades Hudson Financial in Scarsdale, N.Y., is one of those advisors who prefers an old-fashioned investment approach to post-retirement investing. She simply diversifies investment portfolios by asset classes into stocks, bonds and exchange-traded funds, according to each client's age and risk tolerance. She uses dividends and capital gains to meet income needs, and required minimum distributions are taken from retirement plans.

Pfaehler says her properly diversified portfolios, along with strong cash positions for clients' emergencies, has limited their longevity risk. Her biggest concern about immediate annuities is that the policyholders run the risk that an insurance company could fail. Then they would be subject to the payout limits and state insurance guaranty associations.

"Immediate annuity income does not keep pace with inflation," she says. "Even a cost-of-living adjustment may not be sufficient."

She also doesn't use variable annuities because of the high cost of the subaccount funds and the other fees. "Variable annuities have layer upon layer of fees," she says. "We told [a new client] to get rid of a variable annuity that was past its surrender period because it charges almost 3% annually."

Other financial advisors, however, believe that the charges and fees are worth the insurance coverage. Barbara Walker Green, the president of Advance Wealth and Retirement Planning Concepts in Houston, makes good use of annuities with riders that provide for lifetime income and long-term-care coverage.

She often uses split-funded annuities. In these vehicles, an immediate annuity pays a current income stream for a specific term during the early years of a policyholder's retirement. The deferred annuity could then possibly offer a higher future income stream.

"In retirement, most people rely on a combination of Social Security, retirement plans and personal savings income," Green says. "A split annuity strategy can help supplement these income sources and add stability."