(Editor’s Note: This story is part of a partnership between Chasing the Dream and Next Avenue.)
A generation ago, all 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, of course.
So nowadays, when you plan your retirement, it helps to take responsibility to create a pension-like substitute from a mix of options you can combine and customize to meet your needs. Unfortunately, financial advisers often limit those options to stock and bond mutual funds, combined with a “withdraw the money until it runs out” strategy. That’s far from a pension, especially for low-income workers.
As a specialist in retirement income management, let me give you an example of what I recommend instead.
What Martin Wants and Needs for Retirement Income
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 the 15 years until traditional retirement age, Martin wanted to make sure he and his wife would be financially secure for the rest of their lives.
Martin has done a good job 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. (With an immediate annuity, you make a lump sum payment to an insurer and begin receiving monthly checks, typically for the rest of your life. With a deferred-income annuity, the money you turn over is invested for a period of time and taxes on investment gains are deferred until you start taking withdrawals.)
Martin understands that he needs some cash on hand for immediate spending and emergencies and is reasonably confident that the stock market will offer attractive returns over the long-term.
What to Understand About Pension-Like Income
To generate “pension-like income” from his of mix of accounts, however, he needs to understand the tax treatments of each; the fees he will pay and the risk characteristics.
For Martin, like similar younger boomers and older GenX ers, 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 deferring or lowering his taxable income (and in the process, lowering his tax rate) and by lowering fees. 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. Although many advisers traditionally concentrate only on investment risk, Martin and I also examined income risk.
To create pension-like income, Martin can incorporate immediate and deferred income annuities into the mix; balance his income objectives with his legacy goals and decide how much investment risk he’s willing to take with his legacy once his income objectives are met with the 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.
Importantly, we can also account for the expenses that are likely to increase in the second stage of retirement, when health and living circumstances might change. That’s when a deferred income annuity can help, by providing income starting at age 80 or 85.
If you want to create a pension-like income in retirement, don’t be afraid to use the services of a financial adviser. But choose one who knows about income annuities and income risk management.
As Martin found, doing the upfront 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.
This story is part of our partnership with Chasing the Dream: Poverty and Opportunity in America, a public media initiative created to stimulate a deeper understanding of the impact of poverty. Major funding is provided by The JPB Foundation. Additional funding is provided by Ford Foundation.
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