The Guarantee Issue
By Sheldon Weiner
Egan, Berger & Weiner, LLC
“Money does not guarantee success,” insists Portuguese football manager José Mourinho.
But how important is guaranteed income in retirement? For most people planning ahead for retirement, guaranteed income makes them feel safer. They want to ensure they don’t run out of money before the end of their life.
The amount you’ll need differs from person to person, but industry standards suggest that approximately 35% to 40% of your current income should be the goal.
So how do you generate guaranteed income?
For past generations, people depended on pensions and Social Security payments to safeguard their retirement and see them through their golden years. We are well aware, of course, of the ongoing problems with the Social Security system. And, while in the 1980s more than 65% of Americans had a pension, less than 20% of retirees have a pension today. This makes us much more dependent on our personal savings, IRAs, and 401(k) plans.
What’s more, the traditional retirement income formula won’t necessarily provide the financial security of the past. Low interest rates, market volatility, and increased longevity present significant risks to our retirement security. Investments may be exhausted earlier than expected.
The continued volatility in the equity markets creates additional challenges as people are living longer—further increasing the chances of outliving your retirement savings.
Consider these options:
1. The accumulation stage. Saving for retirement is a two-pronged approach. You must strive to get the highest rate of return possible, while simultaneously maintaining a comfortable level of risk. In fact, I tell my clients that my goal isn’t simply to get them a high rate of return; it’s to help them meet their goal for monthly retirement income. Sometimes that means we choose a lower rate of return because the risk is lower as well.
2. The distribution stage. In this phase, the emphasis is on trying to maximize your income for as long as possible—growth is secondary.
Note that historically, people withdrew a fixed or adjusted percentage of their retirement funds each year—often between 4% and 5%. Whether or not their portfolio grew, they withdrew only the amount determined at the time of retirement. That way their portfolio continued to grow during good years, and the money was still there to withdraw during the not-so-good years. Some people still use a fixed dollar amount, although it often ignores inflation. Neither of these guarantees can provide guaranteed income for your entire life, so there is a danger of running out of money.
3. The annuity option. Another way to lock in guaranteed income is to buy it by purchasing a delayed annuity. Here, you use a lump sum of money to purchase a guaranteed income for a set period of time, or even for your whole life. You may also make periodic payments into your annuity. This could, however, put you on a fixed income where you don’t receive cost-of-living adjustments. Another popular feature is to buy an annuity with a guaranteed minimum withdrawal benefit rider (GMWB).
Here’s how it works:
- Typically you deposit funds today into the annuity. The insurance company takes a snapshot of your account value each year.
- As the account value grows, you lock in the higher value as an income base.
- When you activate your rider at retirement, you can use either the higher of the current account value or the income base value to generate your guaranteed withdrawal, which can vary from 4% to 6% of the value, depending on the terms of your contract.
4. Cash out. Many people choose to put aside cash for specific periods of their retirement years, such as the first three to five years of retirement, and then invest in short-term instruments for the next 10 years, and then longer-term investments for the following 10 years, and so forth.
What’s the best solution for you?
I like to recommend that clients use a combination of all of these approaches.
- Start by determining how much income you need per month, and then see how much of that is guaranteed through pensions and Social Security. (Typically, if that amount is below 35% to 40% of you monthly goal, we will try to provide the needed guaranteed income through a variable annuity with the guaranteed minimum withdrawal benefit.)
- Use an immediate fixed annuity to accomplish this goal. We do not want the rest of the needed money guaranteed because it tends to take away flexibility. One useful rule of thumb is that whenever you hear the words “guaranteed” think “expense.”
- Estimate how much you’ll need to live for approximately 12 to 24 months, and put that into cash or a cash equivalent. This allows income to be taken out and keeps you from being subject to the everyday ups and downs of the stock market.
- Put the next sum of money into short-term investments, which will be for about three to five years. These include municipal bonds and similar investments. This will help you replenish your income, give you more control, and avoid the volatility that is normal for the stock market.
The bottom line: While some guaranteed income is extremely important in retirement, we caution our clients not to have all of their income guaranteed. While the system outlined above is not the only useful approach, it is one to consider when planning for your retirement years.
About Sheldon Weiner
A founding partner of Egan, Berger & Weiner, LLC, Sheldon Weiner has more than three decades of experience in the financial industry. After graduating from the University of Maryland, and the Hartford Insurance Company School of Advanced Underwriting, he earned the LUTCF (Life Underwriter Training Council Fellowship), and also served as president of Creative Financial Programs, Inc. For more information, and to contact Weiner, send him an email at email@example.com or call 703-506-0030 ×106.