Recently, I took three phone calls from clients with the same concern: outliving retirement. The conversations echoed each other, “I’ve just realized that I’m a few years away from retirement and I’ve been putting money into a 401(k), IRA, 403(b)) and I’m worried it is not going to last through retirement. My company does not have a pension plan like my parents had. When the money in my retirement fund is gone — it’s gone.”
According to a recent study, “Reclaiming the Future” from Allianz Life Insurance of North America, this is a very common refrain regarding the sentiment of pre-retirees. In 2011, the Allianz study found 35 percent of baby boomers “feel totally unprepared financially for retirement,” and 50 percent were extremely concerned about outliving income from retirement assets.
There are at least four main risks each of us will face in retirement. First, we will all spend more money in retirement than we expect to — plan to spend at least as much as you do now.
Second, inflation of all goods and services will increase retirement spending. Medical care leads the way. According to a Center for Retirement Research study, medical expenses chewed up 16 percent of an average retired couple’s income in 2000, grew to 24 percent in 2010 and is expected to hit 29 percent by 2020.
Third, we are living longer. Since 1935, life expectancy for men has gone from 59 years to 75 years, and for women from 63 years to 80 years.
Fourth, market volatility both during the time retirement assets are invested and when they are being taken out of a traditional investment vehicle makes a huge difference in how long the money will last in retirement.
In 1983, 62 percent of company retirement plans were pension plans (defined benefit plans) guaranteeing a lifetime income to the employee. Today that number is 13 percent and dropping. Employers have deftly shifted the responsibility for income in retirement to the employee by offering 401(k) plans (defined contribution plans) where the employer’s only responsibility is to contribute to the plan if they choose to. The employees are left on their own to figure out how to make the income last during retirement.
We need new solutions to manage retirement risks and to replace what has been lost by this shift away from guaranteed retirement income. One solution enjoying significant acclaim and acceptance today is the fixed index annuity (FIA) offered by large insurance companies. This product offers tax-deferred growth without exposure to market downturns, no upfront fees, a death benefit if you die early and guaranteed lifetime income which can be indexed to grow during retirement to offset inflation risk.
Once the accumulation value of annuity assets hits a higher annual level — a “high-water mark” — it cannot go below it. The same is true of income levels during retirement — only upside changes affect the income — if the index you choose to track goes up, your income will go up. If your index goes down, your income stays the same. The focus in these products is on income — even when the principal is exhausted in the FIA, the income will continue. That’s a real solution to the pervasive fear of outliving ones income.
A common use of the FIA is to purchase it inside an IRA or other qualified retirement fund. This will effectively convert a defined contribution plan to a pension plan with guaranteed lifetime income. Purchasing a stand-alone FIA also makes sense, allowing buyers to control their own retirement funds without interference from the qualified plan rules. There are many flavors available in the FIA world, and like all financial products, a professional familiar with the FIA should be consulted before jumping in.
What has become apparent today is the amount of income you can guarantee yourself in retirement is much more important than what your retirement assets grow to before retirement. Those serious about guaranteed retirement income need to take a hard look at FIAs. Income payments from an FIA are dependent on the claims paying ability of the insurance company that offers them. Given the historical financial stability of large insurers and the financial coverage they maintain for paying claims, there is a high likelihood they will insure a consistent and stable retirement.
Rich is a certified public accountant who works in the area of dynasty estate planning, retirement, and personal finance. He is also the host of "What About Wealth?" on Voice America Radio.