Main Street money: What’s in a name? Three basics to retirement income
About a year ago, Stanford University released a study about retirement planning in a defined contribution world. It concluded there were three basic threats to retirement. They are:
1. Inadequate savings. Various studies show that roughly half of all older American workers (age 55-plus) have less than $100,000 in retirement savings, not close to adequate for a traditional retirement …
2. Leakage. According to one study, an estimated one-fourth of defined contribution accounts experience an outstanding loan, hardship withdrawal, or early withdrawal upon job separation…
3. Generating retirement income. Only half of all defined contribution plans offer any options for converting balances into periodic retirement income, and typically fewer than one in five plans offers guaranteed lifetime payouts.
I would contend that there are several other basic threats, including market risk, taxes, inflation, etc., but these were beyond the scope of the study.
One of the things I really liked about it was the terminology they used. I like it because we get so hung up in labels. For example, you almost can’t talk to anyone about annuities without coming up against very strong opinions, usually founded on nothing except what people have heard from TV, their barber, or Uncle Charlie. That’s unfortunate, because it stands in the way of people doing a critical analysis of their retirement solutions.
The Stanford study focused on point number three, generating retirement income. As pointed out above, only half the plans available provide any avenue of turning them into income, and only 20 percent offer guaranteed lifetime income. I find this stunning. Think about it. More than $13 trillion sits in defined contribution retirement plans, yet most provide no way to actually retire on them. A huge trillion-dollar industry exists around depositing the money, but no way to spend. It’s almost as if they don’t want us to use it.
In identifying the solution to these issues, the Stanford researchers explore a new class of retirement tools it dubs, “Retirement Income Generators,” or “RIGs.” I think this is brilliant because it achieves a couple of really important ends.
It defines the objective: generating income. The objective was never to “grow the nest egg.” That’s Wall Street’s endgame. As long as the pile of money keeps on getting bigger and bigger, Wall Street’s fees do, too. As soon as you start withdrawing money, so does Wall Street’s cut. By changing the name to Retirement Income Generator (RIG), you put the emphasis clearly on what the objective of retirement savings should be.
It removes negative and emotionally-charged labels. For some reason, the word annuity has taken on a negative connotation. That’s unfortunate because, what’s so bad about guaranteed lifetime income? Especially when the income is more than you could have gotten elsewhere.
It pulls together the assets that achieve the desired outcome in a single group. That allows us to think about them together and provides more likelihood that they will be used most efficiently.
Dealing with the last item first, these are keys to retirement success. What are the things that can go into the category, Retirement Income Generator? Outside dividend-paying stocks and interest-bearing deposits, we have Social Security, pensions, structured settlements and annuities. The stocks and interest accounts are currently very expensive with regard to their return, so we need to rely on the others, which isn’t necessarily a bad thing.
Retirement Income Generators share certain qualities. First, they all rely on life expectancy as their primary asset class. This does a couple of things; it takes the success of the plan out of very risky market forces that have nothing to do with the objective and puts it squarely on the objective: having income you cannot outlive.
Second, because they are based on life expectancy, the longer you wait to take income, the more you can get. This is important because it provides the mechanism to sequence them in the most efficient way, based, once again, on a metric you can count and plan on. Again, nothing else does that. Market assets are valued based on their daily trading values, and interest accounts are based on prevailing interest rates. Both are tenuous at best, and the struggles many people are having with retirement planning now are because of that.
Life expectancy, on the other hand, is a known. While it is getting longer, it’s a very slow change. With life expectancy, we can calculate output in a way that can be counted on over the long haul with great accuracy. It provides a hand-in-glove solution to a nearly universal problem.
Knowing all of this and understanding how RIGs are connected and how they work together provides the ability to combine them in ways that really do add up to more than the sum of their parts. When you focus on the core objective of creating the most robust and safest income stream for life, things tend to fall in place. For example, questions like, “When should I take my Social Security?” become much easier to answer: “When it allows everything to work together to generate the highest possible lifetime income.”
All that in a name. Who knew?
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.