Note: This story is sponsored by The Alliance for Lifetime Income.
If everything old is new again, it’s never been more true than with retirement planning. Remember pensions? Those old things that provided guaranteed income in retirement, but that companies have phased out almost completely over the last few decades in order to save money? Turns out, having an income stream you can count on is kind of nice to have once you’re retired. Not only does a guaranteed income help assuage your fears of running out of money (which most of us fear more than death, seriously) it also acts as a hedge against market fluctuations so you can rest a little easier the next time 2008 comes knocking. We checked in with experts to find out how best to move out with the old and in with the new as retirement approaches.
The Old Formula (And Why It Wasn’t Working)
“When companies couldn’t afford to give their employees pensions anymore, they took them away and just threw 401(k)s at them, without giving their people any education or training,” says Marlo Stil, managing partner at The Wealth Consulting Group in Rancho Mirage, California. “At the same time, these employees never gained an understanding of the importance of having guaranteed income in retirement.”
The vast majority of employees who were given 401(k)s weren’t told that those plans alone probably weren’t going to equal a sustainable retirement plan — while Social Security will be of some help, it isn’t going to be enough to keep most retirees afloat every month. “The baby boomers are the first generation that will be mostly reliant on defined contribution plans (like 401(k)s) to maintain their lifestyle in retirement, but the big question is: Can we get used to successfully spending that money in our retirement plans?” asks Michael Finke, Ph.D., dean, Chief Academic Officer of The American College of Financial Services and Alliance for Lifetime Income Research Fellow. “If we spend too much, we’re going to outlive our savings.”
And spending too much is all too real of a possibility in a down market — if the market tanks during your retirement, and your income depends on you taking money out every month, you’re going to be drawing down on your portfolio before it’s fully recovered — meaning that every withdrawal is going to represent a substantial hit to your overall asset pool.
Unfortunately, down markets are inevitable, Stil says, which means having all or even most of your money invested directly in the markets can be dangerous. “Not only is the down market a problem, but so is investor behavior during the downturn — people panic and sell, and then they don’t get back in the market in time to benefit from the upswing, if ever,” she says.
The New Formula (And Why You Should Consider It)
Imagine putting yourself in a position where you wouldn’t have to or worry about losing your retirement security because of a down market. Retirees with pensions have long enjoyed that feeling, Stil says. “My clients who had pensions fared the absolute best during the Great Recession. They didn’t stress about what was going on economically; they got out and played golf and did their own thing. It had very little impact on them, because a big chunk of their retirement was guaranteed.”
When Stil saw that, she began recommending that her clients add annuities with protected income streams to their overall retirement plans, so that they would have a leg up the next time a recession reared its head. “We have been adding them as a protection against the inevitable, and down markets are inevitable.”
Having a 401(k) and/or an IRA is a wonderful, essential thing, but having an annuity alongside those accounts that can cover your fixed expenses can help take the some of the mystery out of how much money you should be drawing down from your accounts every month, Stil says. “You can’t draw on your accounts based on how much your mortgage and monthly expenses are. It’s the other way around! You have to build your mortgage and expenses around what you can afford to draw down. But making those projections for how long your money needs to last can be tricky, which is where an annuity can come in.”
Implementing the New Formula
Remember the old “Choose Your Own Adventure” books? Think of annuities as a “Create Your Own Pension” adventure. When paired with your other retirement accounts like a 401(k) and IRA, annuities have a unique place in your portfolio of retirement options in that they can ensure you always have money for your fixed expenses, no matter how much the market fluctuates, Finke explains.
If you and your financial planner decide an annuity is right for you, sit down and look closely at your monthly budget, and sort out which categories are flexible and which ones are inflexible, Finke advises. “Focus on your lifestyle. We all have basic expenses like housing, health care and food. If we can’t cover those things with Social Security alone, then what do we do? You can build a plan for funding those inflexible expenses with a simple annuity, that will guarantee income as long as you’re alive.”