You are saving money in your 401(k), 403(b), IRA or other retirement accounts so you can have an income in retirement. Unfortunately, “defined contribution” plans do not guarantee you a lifetime income nor do you get a guarantee against losses if you selected market investment choices. Most retirement-minded people would much prefer to have a defined benefit plan that guarantees a lifetime come; however, most companies no longer sponsor such plans because they are too expensive. But, wouldn’t it be nice to have this lifetime income guarantee like your father and grandfather? You can easily create your own defined benefits plan to provide guaranteed lifetime income. Here’s how!
You are generally permitted to remove your money from an employer-sponsored retirement plan when you retire, quit, die, become disabled and maybe borrow from your money if you have a financial hardship. On rare occasion your employer will be enlightened about ERISA regulations and know about In-Service, Non-Hardship Withdrawals provisions. Such provisions, when made available by your employer, permit withdrawals regardless of age, without triggering taxes (must be trustee-to-trustee transferred), while still working and participating in the same employer’s plan. The ISNHW provisions have only recently been brought to the forefront because of litigation associated with the high fees, losses and fiduciary lapses. Ironically, many large firms have added this flexibility to their plans as a litigation-prevention device. Most small businesses have not taken action because they are unaware of the provisions and those responsible for alerting them (outside third-parties who manage the money or administer the plan for the employer) have not done so. The notice has been withheld because (a) the parties advising the small business are unaware or (b) they do not want to lose fees which are based on the amount of money in the plan. If money is withdrawn from the plan, third party fees are likely to be reduced. But, unless you can get your money out of your employer’s retirement plan, you cannot take steps to convert it into a guaranteed lifetime income. If you wait until you retire or quit to move your money, it may be too late because the market values could drop precipitously at any time. Of course, they could also rise precipitously at any time. This “not knowing” is the “risk” that could ruin your retirement.
Assuming you can get your money from your employer’s retirement plan (and if you can’t you need to hand your employer a copy of my book “Tapping Into Your 401(k) Money Before Retirement”), how do you turn it into a guaranteed lifetime income? If you face a risk you do not want, or cannot, manage, what do you do? You transfer the risk to an insurance company. Insurers are professional risk managers who use sophisticated mathematical methods to assure they make a profit. Whether they are insuring cars, homes, lives, wellness, businesses or race horses, they price their services based on the probability of loss. The policyholders who are not losers (their house did not burn, their car was not wrecked and they remained healthy) subsidize the losers. For example, if you have life insurance and live longer than expected (you lost because you may not have needed the life insurance) you will be helping pay death benefits for those who died prematurely (from an insurance standpoint, they won…ouch!). The same is true when guaranteeing a lifetime income. Let’s see how this works.
Living too long is called “longevity risk” and all of us face it in retirement. In exchange for the payment of money, a life insurance company will pay you a guaranteed lifetime income. How much monthly income you receive will be based on the amount of money you paid, your age (the older you are the more income you’ll get), your gender (women will get less than men because they are expected to live longer), the level of interest rates (the higher the rates the more you’ll get for a given amount and age), and other factors. If you determine that you need $50,000 a year in retirement and only $20,000 is assured from Social Security, you’d have your financial advisor shop insurance companies for a policy that paid you an income of $30,000 a year regardless of how long you lived. Once you purchase the policy, you’re assured of an income for as long as you live – guaranteed by the same insurance companies that insure your home, car, life, health and everything else of value. Of course, a married couple can purchase a joint-life policy and you may even be able to add an inflation rider than will adjust your income as prices rise. Since a large number of retirees are transferring their longevity risks to insurance companies, the predictability of large numbers allows them to manage the risk and make a profit. Those that die too early subsidize those that live too long, and the insurance company prices their services to make a profit. This is the same principle used for home, cars, boat and health, and is the foundation of all insurance.
You generally purchase policies to address longevity risk by buying an annuity with a guaranteed lifetime income benefit rider. Not only are you assured of a lifetime income, but you retain the flexibility of being able to change your mind and get all or some of your money returned. Insurance for longevity risk is the latest insurance product to be offered to the public and demand is growing rapidly with the increasing number of retirees. The reason for the rapid growth is because the greater fear of most retirees is running of money before death, and everyone wants a defined benefit retirement plan rather than the defined contribution plan sponsored by most employers. If you haven’t talked to your financial advisor about creating your defined benefit retirement plan to assure you and your loved ones a guaranteed lifetime income, you need to call and ask for a meeting. There is no way to lose: if you die prematurely you’ll be subsidizing those that live too long but you’ll be in a place where “money worries” are a thing of the past; if you live too long you’ll never run out of money. I’d say that’s win-win and something you need to consider. Ask your financial advisor about insuring against longevity risk.
Shelby Smith, Ph.D.
July 2009
TheRetirementPros.com
I have never been a fan of annuities no matter how they are presented. They add increased costs, do not normally protect against inflation, do not necessarily do a better job investing than the average investor does, and can be twice as confusing as investing prior to retirement was.
People should keep their money where they can get it should they need it. Once its annuitized, any change in financial circumstance is simply impossible to address without penalties, fees and added costs. Roll it over to an IRA or a Roth and keep it close.
The only sure way to ‘insure’ yourself from longevity risk and ensure you won’t run out of money is to set your retirement investment focus on a 4% withdrawal rate while you are still working and diversify for your age. Do those two simple things and you will not need to worry about outliving your money.
Paul, I couldn’t disagree more. It is obvious you’re not “up to speed” on the new generation of annuities. The “old specie” required annuitization for a guaranteed lifetime income whereas the “current generation of annuities” does not. In recognition of baby boomers added on top of an exploding retired population, insurance companies have changed annuities to address the fear of outliving your retirement money, i.e., longevity risk. You can trigger the guaranteed lifetime income rider without giving up the flexibility of changing your mine and stopping, restarting or even withdrawing lump sum. The one thing you are missing is the “no loss” feature of annuities. The 4% withdrawal scheme you mentioned has been totally debunked in recent years, so obviously you of the “old school”. With your plan you have market risks, fees (unless you provide your services at no charge) and you still have not addressed longevity risk.
To remind you, longevity risk is the risk of living too long – and regardless of how much money you have in “diversified” places there are lots of reasons you can run out of money before you run out of breath: market losses and medical emergencies to name a couple. If you’ll be so kind to compare a fixed index-linked annuity with a Guaranteed Lifetime Income Benefit with a diversified portfolio of whatever market securities you want to select over the period 1995 to present, you’ll clearly see the advantages I’ve spoken about. While I agree that early in your life market risks are just fine because you’ll have time to recover unfavorable market development, such luxury is not available as your enter the red zone or retirement because you simply may not have time to recover as the past two decades as proven. The “4% rule” and “in the long run you’ll do better in the market” are simply no longer reliable…sorry.
Shelby Smith, Ph.D.
Having a policy that covers you for the length of your lifetime is important. People are living longer and healthier. Let’s face it, the older you get, the more security you need. Options become more and more limited as we age so the more guaranteed income the better. Th ISNHW provisions are another option that can help with retirement planning. It is good to know the all the facts before you make a decision.
Bobby, We are in total agreement. The greatest fear of most retirees is outliving their money…and the insurance industry has the answer for those willing to consider all their options. The ISNHW provision for 401(k) plans is going to becoming a hot topic in 2010 when many high income workers want to convert all or some of their 401(k) money to Roth IRA but find out it is not available for transfer.