The reports are stunning. Nearly 75% of America’s Baby Boomers are approaching retirement with major concerns over their ability to fund their retirement. Studies indicate that 45% of American’s will not have accumulated enough savings to provide adequate income in retirement. Whatever happened to retirement planning? The sad reality is that most people don’t plan to fail; they simply fail to plan adequately.
It’s likely that many of today’s retirees had some sort of plan for retirement. But it is also possible that many pre-retirees were lulled into complacency as they watched their 401(k) plans and home equity balances balloon during the 1990s and early 2000s. For many pre-retirees that was their retirement plan. Then, when the bubble burst in 2008, they found themselves back where they started fifteen years ago. Certainly no one expected that their retirement savings and home equity would be halved overnight, but then planning is about anticipating the unexpected.
Retirement planning became more difficult, and more important, when defined benefit plans began disappearing. At one time as many as 40% of American workers were covered by defined benefit plans which were, in essence, a guaranteed retirement income plan. As long as a person remained employed, these plans provided a high degree of predictability and security.
When these plans were replaced by defined contribution plans, such as 401(k) plans, the responsibility for retirement income shifted to the individual. The amount of income that can be generated from a defined contribution plan is now based solely on the level of contributions made and the rate of return earned.
So, now proper retirement planning requires making sound and reasonable assumptions about how much one can save and what the expected rate of return on savings will be over time. It also requires that careful attention be given to retirement income needs based on a desired lifestyle. Assumptions, goals and needs must be realistic and the retirement plan must be reviewed regularly in order to make adjustments as changing financial circumstances dictate.
For most people, their retirement savings account will be their only source of income outside of Social Security. While Social Security does provide a minimal safety net, the more prudent planning approach is exclude it when planning your income needs so that your Social Security payments become an income cushion. Plus, if you are able to delay your Social Security payments until age 70, your payments will be much higher.
The tax code provides all retirement savers with a number of incentives to save early and save a lot. All workers have access to a qualified retirement plan. Most employees have access to an employer sponsored plan, such as a 401k or a SIMPLE IRA. And, workers not covered by an employer plan can set up an IRA. Most of the plans allow contributions to be made using pre-tax dollars, and the earnings in the plans are allowed to grow tax deferred. A Roth IRA takes after-tax contributions, but the withdrawals at retirement are tax free. It should be the goal of every worker to maximize their contribution to these plans to take full advantage of the tax benefits while accumulating their primary retirement income source.
With the loss of defined benefit plans, the predictability and security of retirement plans have been lost. One of the obvious solutions is to save as much as you can in your retirement plans and plan your future using sound assumptions for investment growth, inflation and your income needs. Still, with the responsibility now squarely on the shoulders of individuals to provide their income, anxieties can run high, especially when the markets take their wild swings as they have in the past.
To inject a greater degree of predictability and security in their retirement plans, many people are adding annuities to their investment portfolio. The unique characteristics of annuities can give people the same degree of predictability and security as did defined benefit pension plans. Annuities can accomplish this in two ways: During the accumulation phase, annuities can provide guaranteed returns and preserve principal; and during the income phase, annuities can provide a guaranteed stream of income that cannot be outlived.
Investors don’t have to sacrifice good returns on their investment for this increased security. There are different types of annuities that can suit the varied investment preferences and risk tolerance of most investors. Fixed annuities offer guaranteed fixed rates of return with minimum rate guarantees. Indexed annuities offer the opportunity to generate rates of return tied to the gains in a stock index without downside risk. And, variable annuities enable investors to invest as they would in their 401k plans choosing from among various stock and bond investment accounts. While variable annuities do entail market risk, many of them include an option for earning a minimum rate of return should the market decline.
So, annuities can add stability to an investment portfolio during the accumulation phase. It is in the income phase, at retirement, that annuities provide the greatest degree of predictability and security. When income is desired, all annuities can be converted to a guaranteed stream of income. Most annuities include inflation protection riders that ensure that your income will retain its purchasing power.
A retirement planning strategy should include building a diversified portfolio of investments that, working together, reflects your investment objectives, priorities, preferences and risk tolerance. It is important to invest for growth while maintaining some stability in your portfolio so that it is not completely exposed to the risks associated with anyone type of asset.
Annuities, with their predictability, rate guarantees and principal protection, can be one of the better portfolio stabilizers. Then, when it is needed the most, at your retirement, annuities can provide the ultimate security of a guaranteed income stream that cannot be outlived. While they may not be right for everybody, all serious retirement planners should give annuities careful consideration for their retirement income strategy.