These concerns are not without merit. Americans have to save and plan for their own retirement, and many people aren’t saving nearly enough. The days of working for a company for 30 years and then retiring with a company pension and health care for life are long gone. While defined benefit plans, or pensions, are common in the public sector, today they are rare in the private sector.
Even though IRAs and 401(k)s have been around for decades, many workers remain uncomfortable making the decisions that come with them. Adding to the problem is that most employees don’t save enough, and even when they do save, many don’t know how to turn their nest eggs into income when they retire.
Financial planners say clients are less stressed when they are assured of a guaranteed lifetime income, much like that provided by pensions. “For the predominance of the American public, some kind of guaranteed lifetime income is extremely important,” says Eric Bailey, founder and CEO of Bailey Wealth Advisors in Silver Spring, Maryland. “At the end of the day, most Americans need it.”
Ideally, retirees should have enough money coming in from guaranteed income sources to cover essential retirement expenses. “The use of guaranteed lifetime income is to ensure that essential expenses – food, housing, health care and clothing – are met month in and month out without worrying about what’s going on in the market,” Bailey says. For most people, Social Security alone won’t meet those expenses, and another income source is required to cover the gap.One way to achieve guaranteed lifetime income is with a pension. But today pensions are a thing of the past for most private sector employees, though they are still common among state and federal government employees. Another tool to use to get guaranteed income is municipal bonds and Treasuries. “It depends on the size of a client’s portfolio,” Bailey says. “Quality long-term municipal bonds offering low default risk and 5 percent yield on principal offer consistent income that is pretty predictable.”
One way to achieve guaranteed lifetime income is with a pension. But today pensions are a thing of the past for most private sector employees, though they are still common among state and federal government employees. Another tool to use to get guaranteed income is municipal bonds and Treasuries. “It depends on the size of a client’s portfolio,” Bailey says. “Quality long-term municipal bonds offering low default risk and 5 percent yield on principal offer consistent income that is pretty predictable.”
Annuities also promise a guaranteed stream of payments in retirement, though not all financial planners endorse them. “The fixed annuity has the benefit of the old pension. You give the insurance company a certain amount of money and they will guarantee you get income for the rest of your life,” Bailey says. “The downside: It is not inflation adjusted. All your other costs are going up.” Annuities typically require you to give up control over your money in exchange for a steady stream of income.
Some consumers avoid annuities because of a hard-to-shake reputation for high fees. “The average variable annuity has internal fees of 3 percent to 4 percent,” says Mike Piershale, president at Piershale Financial Group in Barrington, Illinois. In the past, some unethical sales people sold high-fee products to people who did not understand them or didn’t need them. Annuities today have an improved reputation and there are more varieties, but they are still complicated financial products and some retirees remain wary. “If the insurance company does go broke, you will lose that income,” Piershale says.
With a fixed annuity you get a set amount of income, whether the market goes up or down. But this type of guaranteed income is expensive to provide, and depends on the riders or structure the insurance company uses to provide the guarantees. “The insurance companies are using hedge strategies to produce these guarantees,” Bailey says. “That costs them money, which they are passing to you.”
Piershale no longer advises annuities to his clients and instead works with them to create a plan to gradually spend retirement savings. He prefers to use mutual funds or exchange-traded funds and create a spending plan that he says achieves the same goal as annuities. “We use mutual funds or ETFs that are well diversified. Instead of paying 3 or 4 percent (in fees) like an annuity, the client pays 9/100ths of a percent,” Piershale says. “If they follow the guidelines, I’ve never had anybody run out of money. And they do better about keeping money for their kids.”
The insurance company generally keeps money left in an annuity when the owner passes away, but your children can inherit money left in other types of retirement and investment accounts. “Even though they will guarantee it, actuaries have it calculated. They are depending on that statistical probability game that the client will die before they hand them back all their principal,” Piershale says.
Bailey also says that annuities aren’t for everyone. He does not recommend annuities to clients with large savings, plenty of fixed income or those whose expenses can be met with Social Security and/or pensions. “One retired client has a pension of $130,000 and his wife has a pension of $50,000 in addition to her Social Security. They don’t need a supplement to that,” Bailey says. “I advise most people to first step back and look at what’s important and when you are planning on utilizing it.”