by Laura Evans
Anyone could face issues with their retirement in today’s economic environment. If you are one of the few who still have a pension at your workplace, you should consider yourself fortunate. Private-sector defined benefit pension plans are becoming more and more uncommon for today’s workforce.
Gone are the days when someone worked for 40 years with the same employer and started receiving more combined income from Social Security and pension payments in retirement than they did during their working years. Personal savings were merely a supplement to the guaranteed Social Security and pension income streams, as opposed to a primary source of income. When pensions were the dominant retirement income source, only a small portion of income would be affected if your retirement savings balance dropped precipitously (i.e. during the dot-com bubble of 2000-2002 or the global financial crisis of 2008-2009). With the Fed looking poised to raise rates and turmoil abroad, many are concerned about what the near future may hold in terms of the impact on their retirement and investment dollars.
Today, the retirement income burden increasingly lies more on the employee and much less on the employer. Let’s look at some numbers to bring things into a clearer perspective.
Let’s assume a family’s monthly income needs are $9,000 per month. If a husband and wife both earned the same income over the years and each collected $2,000 a month from Social Security and $2,000 per month from pension income, the remaining income shortfall of $1,000 per month could be funded by personal savings as long as enough money was saved prior to retirement. The monthly Social Security and pension checks all have cost-of-living adjustments that can help keep up with inflation.
Fast-forward to today’s retirement income conundrum for the same family without pension income. The combined $4,000 Social Security checks would still be there (as long as Social Security stays fully funded beyond 2034, which is the projected year from the 2021 Social Security Trustees report when benefits will decrease to approximately 78% of the amount if Congress does not address the issue), but the remaining $5,000 per month of income with cost-of-living adjustments would need to come from personal savings and investments.
What if the lost decade returns when I retire?
Remember the late 1990s when investing in the stock market seemed like much less of a risk? How about the subsequent 10-year period that included three bear market corrections in 2000-2002, 2008, and 2009? This “lost decade” period beginning in 2000 was a stressful time for many savers, and it was even worse for the many retirees facing Required Minimum Distributions (RMD) during the same time period. Imagine the stress of being forced to withdraw money out of at-risk qualified retirement accounts when account balances decreased by 43% during the first three years and 38% or more during year nine (fortunately, RMDs were forgiven for 2009).
How do I make sure I don’t run out of money in retirement?
Much has been written regarding “safe” portfolio withdrawal rates. Depending on the study, some experts such as David Blanchett from Morningstar recommend 2.8% as a safe withdrawal rate for retirees “wanting a 90% probability of achieving their retirement income goal with a 30-year time horizon”. However, others still recommend a maximum of 4% as a safe withdrawal rate for a portfolio.
For those looking for an alternative to a pension, the Single Premium Immediate Annuity (SPIA) is increasingly being used to mirror pensions and provide guaranteed lifetime income that either one or two individuals will not outlive. Payout rates can vary by age, length of payout, single or joint lives covered, and other factors. For anyone over age 60, the amount needed to fund an immediate annuity is much less than the amount necessary to fund other types of investments using the widely recommended 4% “safe” portfolio withdrawal rate. So, assuming a guaranteed 6% payout rate, $1 million can be placed into a Single Premium Index Annuity to guarantee income of $5,000 per month for two lifetimes. Then, the remaining amount of personal savings and investments can be saved in whatever account fits your goals. In theory, this is supposed to work, but reality can be a different story.
What about inflation?
Based on the 108-year average of 3.25% inflation, by the time a 60 year-old couple reaches age 82, over twice the monthly income is needed to keep up with inflation. More recently, the annual inflation rate in the USA accelerated to 7.9% in February 2022, the highest since January 1982. Where does that additional money come from? If savings and investment accounts produce adequate returns and no market corrections happen during retirement, there is a chance those funds could come from their savings and investments alone (if there is a large enough pot of money to draw from that can weather any storm). But what if you don’t have a huge war chest? What if you prefer guaranteed income that keeps up with inflation? If a pension is not a part of your plan, is there another way to guarantee income other than the SPIA?
Enter the Income Rider
Another investment option that can often be a more suitable replacement for a lost pension is an income rider on a Fixed Index Annuity (FIA) with either inflation-adjusted income or income that increases when the account earns interest. With this optional rider, the same $1 million can duplicate the SPIA income, plus increase with inflation. The main difference is that in a FIA, you can wait multiple years to start income withdrawals from the annuity instead of immediately, based on what is currently available in the marketplace. What options are there to fund the years before turning on the rider’s stream? You can draw from savings, work a part-time job, tighten your belt, and/or reduce expenses. If it means not outliving your money, can you afford not to do it?
When your working career ends and retirement begins, the game changes. It becomes much less important to grow your money than to make sure you do not outlive it. Retirement is full of choices. It’s about managing risk the best way you can and rolling with the ebbs and flows that life throws at you. You can remove a huge burden from your shoulders if a guaranteed income stream, indexed for inflation, is part of your retirement plan.
The Evolution of Life Insurance
Another option for retirement income could be the use of a life insurance policy’s cash value. The days of thinking life insurance only provides a benefit if you pass away are long over. An income strategy becoming more popular is placing funds in a life insurance product such as an Indexed Universal Life, or IUL, with the idea being to put more funds into the policy than the minimum necessary to keep the policy in-force. Depending on the performance of the policy’s indexes to which you choose to allocate your dollars, this can build up the cash value within the policy faster, and it is done over a period of time prior to retirement. Once you’re ready to retire, you begin borrowing from the policy’s cash value in the form of loans, oftentimes all the way to age 100 and beyond. And because it is a life insurance policy, these loans are income tax free. You can not only use this strategy for retirement, but for any other expenditures, such as to supplement a 529 college savings plan for a child going to college. And many of these policies come with living benefits, allowing access to a portion of the policy’s death benefit for chronic or critical illnesses, helping mitigate the impact of some healthcare emergencies on your retirement savings.
If you do not have both a traditional pension plan and Social Security to provide that increasing income, you may consider an annuity from a highly-rated company to provide guaranteed income you cannot outlive. The best place to look for assistance is from a fully independent broker or fiduciary that will have your best interest in mind and access to insurance companies offering hundreds of annuities and life insurance options to choose from, not a short list of annuities that many financial companies limit their representatives to offer.
Retirement income can be a complicated process. Facing it with added guaranteed income that includes increasing payments can help take the guesswork out of what future interest rates, retirement account returns, and inflation hold, giving you the freedom to spend more time in retirement focusing on the things that truly matter in life.
Since 1999, Beckett Financial Group founder JB Beckett has provided clients with trusted and valuable counsel in Columbia, Greenville, and all throughout the Palmetto State. The BFG Team of specialists – ranked in the Top 1% of Insurance and Financial Advisors in the United States for the past seven years – has extensive knowledge in the areas of retirement income planning, annuities, life insurance, under-65 health insurance, Medicare options, estate education, business consulting, and community involvement, making them a leading destination for financial solutions. It’s your money and your future. Now, it’s your move.