A generation ago, retirees could rely on workplace pensions, along with Social Security payments, to provide guaranteed income that would meet most, or perhaps all, of their living expenses.
That doesn’t happen anymore. When you plan your retirement, you must take responsibility yourself to create a pension substitute from a mix of options that you can combine and customize to meet your needs. Often advisors unfortunately limit those options to investments like stock and bond mutual funds – combined with a “withdraw until it runs out” strategy. That’s very far from a pension.
Martin started planning his retirement with seriousness when he was 50 and had transitioned out of a high-paying job. In addition to finding another job to cover those 15 years until traditional retirement age, he wanted to make sure he and his wife would be financially secure for the rest of their lives.
In short, he is worried about finances and retirement and while he knows he can’t predict the future with 100% certainty, he hopes he can develop a plan that will provide enough security to ease his mind.
Convert nest egg into pension-like retirement income
Martin has done a good job of building his nest egg, with about $500,000 set aside in a combination of a rollover IRA, a brokerage account of stocks and bonds, and cash in the bank. But he wondered how to convert that money into pension-like guaranteed income, and still leave a legacy.
I told Martin to start by working backward from where he wants his future income to be. I explained that immediate and deferred income annuities provide guaranteed lifetime income like a pension or Social Security, but he doesn’t want to invest only in those products. He understands that he needs some cash on hand for immediate spending and emergencies, and he is reasonably confident that the stock market, despite its ups-and-downs, will offer attractive returns over the long-term.
To generate “pension-like income” from his of mix of accounts, he needs to understand the tax treatments of each, the fees he will pay for various investments, and the risk characteristics.
For Martin, like similar younger boomers/older Gen-Xers, the best approach is to consider three types of investment accounts — a low-cost rollover IRA, a no-load variable annuity and a low-cost, tax-managed investment account. These will give him a jump-start by (1) deferring or lowering his taxable income (and in the process lower his tax rate), and (2) lowering fees. In this case “lowering” taxes and fees today means “increasing” income in the future.
The next and most challenging aspect – but potentially the most rewarding – is proper risk management.
But while many advisors traditionally concentrate only on investment risk, Martin and I also examined income risk.
How to manage income risk
Traditional pension plans have several advantages over the individual investor’s resources: teams of actuarial consultants, institutional purchasing power to get low fees, tax deferral on the pension fund’s earnings and most importantly the ability to pool the longevity risk among all the employees.
What can Martin do to create pension-like income?
- incorporate income annuities, both immediate and deferred, into the mix
- balance his income objectives with his legacy goals
- decide how much investment risk he’s willing to take with his legacy once income objectives are met with income annuities
With these decisions made, together we can determine the amount of money to place in each investment account — and the design of the portfolio allocation. While projections and probability simulations provide some guidance, they don’t predict results with certainty – and it’s as much art as science.
Importantly, we also account for the expenses that increase in the second stage of retirement, when health and living circumstances might change. A deferred income annuity might help by providing income starting at the age of 80 or 85.
Move your plan in right direction
Pay the lowest fees you can, manage your taxes, and rebalance your accounts as you convert some to dependable, spendable income. Don’t be afraid to use the services of a financial advisor, but choose one who knows about income annuities and income risk management. And consult Go2Income to analyze the best annuities for your future.
As Martin found, doing that work in the years before you retire provides peace of mind and the confidence that you and your family will be able to live comfortably for the rest of your lives.