Money Matters: Is your retirement a Jenga tower?

The market bounces back after suffering its worst 4th quarter open since 2008. No one seems to agree on what’s next.

Last time, we were talking about why we believe 401(k)s and other tax-qualified (tax-deferred) plans are not the best way to save for retirement. At the heart of this opinion is the market. How can one possibly bank their entire future on something as mercurial as that? No one, and I mean no one, has a handle on what will happen tomorrow, let alone five, 10, or even 20 years from now.

The market is trading at all-time highs, and this has been a record bull run. But really, who cares? Gravity is an immutable force. There are two reasons we believe a modern annuity is superior to the market for retirement income. The first is what I like to call the “Jenga Effect.”

Think of a Jenga® tower. As people pull blocks from the bottom, they are added to the top, so it keeps on getting taller and taller until the inevitable happens: it crashes. That’s the market. As it goes higher, the summit becomes more and more untenable until it inevitably corrects. That can be a short-lived dip or a significant event that will ruin lives and retirements. We have no idea what it will look like. Not even the so-called “experts.” For every expert I can find who warns the bull end is near and you should lock in your positions, it seems there is another who is screaming, “buy, buy, buy,” at the top of their lungs.

This is not to disparage one of my favorite games. The whole point is to weaken the base so your opponent will cause the tower to fall. But is that really the model you want to use for retirement income? Do you really want to bank your future on the wobbly tower of blocks, or would you rather bank on gravity? Personally, I choose gravity.

Okay, it’s a metaphor and not really gravity, but it’s the closest I can come to a force as solid, predictable, and durable as gravity. It’s the most solid and steadfast financial sector in the world. It’s based on a risk class that is measurable and predictable. It is based on a risk pool, not a risk dividend. And it has worked for thousands of years, having its beginning during the time of Julius Caesar, when retired military were provided lifetime retirement incomes known as “annua.”

Instead of becoming more and more precarious as the balances go higher, annuities become more and more solid. How? Because every year, your gain is locked in and becomes part of the principal. Think of a brick structure as opposed to a Jenga Tower. As more and more bricks are cemented in, the structure grows higher and higher without seeing its foundation weakened. With an annuity, you own your gains without having to divest or sell, which is what you must do in the market to lock in your positions.

OK, that’s all great, but there are other financial products that let you keep your gains such CDs, treasuries, etc. Why not just go with one of them? That’s where the second aspect of annuities comes in. The thing that makes them unique: the pooling of life expectancies. This is critical for lifetime income. The reason this is so critical is because as individuals we have no idea how long we are going to live, so we must guess at how long we must make our money last.

If we guess too short, we run the risk of running out of money, the number-one fear in retirement (by a two to one margin, more people fear running out of money more than they fear death). If we guess too long, we could be short-changing ourselves during the remaining years of our life, giving up a better retirement for a future that never materializes. This is the single most important problem with the 401(k). Pensions, annuities, Social Security, etc., leverage this unknown to our benefit among a large group of people. Individual plans, including 401(k)s plop it right on our head like a falling piano.

The annuity, however, pools the risk by calculating the life expectancy of a group. What that means is they can know, with scientific precision, exactly what point half the people in the group will have died. That’s called life expectancy. Armed with that calculation, they can determine with pinpoint accuracy how many years they can afford to pay out income. Then they simply divide the amount of money you paid by the number of years you are expected to live, discount it by the amount they need to operate, and you get the rest for as long as you live, no matter how long that is.

When you pair solid accumulation that allows you to own your growth without having to cash it in with a rock-solid calculation of how long you are expected to live, you have the financial equivalent of gravity. This double benefit really does provide advantages way beyond the sum of the parts. It’s the financial planning definition of synergy.

Or, if you prefer, think of annuities as the financial planning peanut butter cup. Both chocolate and peanut butter are truly great on their own but put them together and you have a combination that can’t be beat.

Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, he services Greater Boston and the New England areas. He is author of five books, including “Tell Me When You’re Going to Die,” which deals with the problem unknown lifespans create for retirement planning. It and his other books are available on Amazon.com. He can be heard every weekend on the “Free to Retire” radio show on WCAP and WFEA, and he conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. You can reach Steve at 603-881-8811 or at www.FreeToRetireRadio.com.