Lifetime income is possible (and necessary)
By Peter “Coach Pete” D’Arruda
Capital Financial Advisory Group, LLC
“When I was young, I thought that money was the most important thing in life; now that I am old, I know that it is.” – Oscar Wilde
When 401(k) programs began replacing traditional pension plans in the early 1990s, the masses thought it was a great idea. After all, employees got to manage their own money. The 1990s rocked when it came to returns. Workers thought that 10 percent annual returns would continue for life. This sure beat the pants off the old pension plans, which locked them into a fixed income for life.
Employers were happy, too. They found pension plans costly. This was their ticket out. They were all too happy to provide matching funds. After all, it was a corporate tax write off and, with plan statements showing increasing balances during the 1990s, companies were engendering positive employee relations. Those in the legislature who created the groundwork for defined contribution retirement plans thought they had come up with an answer to happy retirement.
Today, there is no longer such euphoria over 401(k)s as the pathway to a secure retirement among employees, and some experts are beginning to feel that the experiment was all a big mistake.
What’s the problem? There are several.
- Many employees don’t contribute enough to their plan.
- Employees experience a financial emergency, borrow from their plans and don’t repay the loans.
- Too many people take early distributions and get hit with penalties and taxes.
- With employees able to make their own investment choices, many try unsuccessfully to time the market.
- When companies hit hard times, some eliminate their matching programs.
- 401(k) plans don’t provide guaranteed incomes. When money runs out, it’s gone.
What a retirement plan should do
For a retirement income plan to be worth its salt, it should (a) provide income you can’t outlive, and (b) cover expenses you can’t live without, like health care and housing. This is one of the reasons why many retirees are turning portions of their underperforming 401(k) retirement accounts into income annuities, which allows for a portion of your retirement savings to become a stream of income, guaranteed for as long as you (and in some cases, your spouse) live.
Even with a conservative withdrawal strategy from an equities-based retirement fund, you may run out of money in your lifetime, because there are no guarantees. Why the 4 percent rule no longer works
For decades, the conventional wisdom on Wall Street when it comes to income during retirement has been to follow the 4 percent rule. This strategy typically suggests that you park your savings in an equities-based account and withdraw 4 percent per year and then rebalance the account each year using a 60 percent/40 percent mixture of stocks and bonds over a 30-year period.
When you do the math, in order to have a $40,000 per year income, you would have to start with $1 million. That’s a problem. Most people don’t have a million-dollar nest egg. I understand the idea behind the theory, but it only works when the market behaves well. Lately, that has not been the case. Also, with life expectancy on the rise, who’s to say that 30 years is enough? One more thing: nothing is guaranteed. I think this is one reason why seniors are seeking out income annuities. The dollar amounts are guaranteed.
The truth is, the economic landscape is constantly changing. What worked 20 years ago just doesn’t work today. What worked two years ago, might not work today. If an income that you cannot outlive is not built into a retirement plan, then it is not a retirement plan. It should have a financial cruise control feature, or it’s not a retirement plan. It’s a wish. It’s a hope. It’s what might happen instead of what will happen.