How Not to Outlive Your Money

Worried about outliving your assets? You might consider holding off on tapping into Social Security benefits, working longer and… buying an annuity, according to a study from the Government Accountability Office released last week.

The shift by employers from traditional pension plans, which typically guarantee income for life, to 401(k) savings accounts has put more responsibility on Americans for managing their savings and making them last through their retirements. Many could run out of money. That’s hardly news. But in its typical thorough, numbers-heavy style, the GAO brings home the depth of this challenge.

Here are some of the GAO's  findings:

• Today, a husband and wife both aged 65 have approximately a 47 percent chance that at least one of them will live to his or her 90th birthday and a 20 percent chance of living to his or her 95th birthday.
• Almost half of those near retirement are predicted to run out of money and won’t be able to cover their basic expenses and uninsured health-care costs, July 2010 data from the Washington- based Employee Benefit Research Institute show.
• In addition to the risk of outliving one’s assets, the sharp declines in financial markets and home equity during the last few years and the continued increase in health care costs have intensified workers’ concerns about having enough savings and how to best manage those savings in retirement.

Ok. So you probably are hip to this precarious situation by now. But it’s noteworthy that the GAO spent from January 2010 to June 2011 trying to get some hard numbers on these shifts and drill down for some solutions. To do so, they interviewed experts about strategies retirees should take.

For the most part, the possible solutions GAO heard about are not startling revelations.

• For starters, the experts that GAO spoke to recommended annual withdrawals of 3 to 6 percent of the value of the investments in the first year of retirement, with adjustments for inflation in subsequent years. (For more on this, see The Retirement Spending Solution.)
• Next, individuals should delay receipt of Social Security benefits until reaching at least full retirement age, or 66 for those born from 1943 to 1954. Many retirees also should continue to work and save, if possible, particularly those with net wealth, including their home, below $373,000. (For more advice, see The Big Decision: When To Take Social Security.)
• Why it pays to delay. While the Social Security program lets you tap into payments as early as age 62, it doles out full benefits at age 66 and increases payouts for those who wait to age 70. Nearly three-quarters of individuals took payouts before age 65, the GAO said. Monthly inflation-adjusted benefits received at age 70 are increased by at least 33 percent compared with taking them at 66, according to the study. For more on this, go to ssa.gov.

More annuities, please. Finally, the experts proposed that more annuities be available in 401(k)s and other defined contributions plans. (Annuities are insurance contracts that can offer a steady stream of income for life.)

This is the one that trips me up. Policy options proposed by various groups to the GAO concerning income throughout retirement include encouraging the availability of annuities in 401 (k) plans.

Moreover, the financial experts GAO interviewed typically recommended that retirees systematically draw down their savings and convert a portion of their savings into an income annuity to cover necessary expenses, or opt for the annuity provided by an employer-sponsored DB pension instead of a lump sum withdrawal.

For example, middle-income retirees without traditional pensions, having a net wealth of $349,000 to $373,000, including their home, may have to buy an inflation-adjusted annuity with their savings to have enough money for retirement, according to the GAO findings.

The GAO study’s pro/con case for annuities.

“An alternative to self-managing periodic distributions from savings is to use one’s savings to purchase an immediate annuity from an insurance company that guarantees income for life. An immediate annuity can help to protect a retiree against the risk of underperforming investments, the risk of outliving one’s assets (longevity risk) and, when an inflation- adjusted annuity is purchased, the risk of inflation diminishing one’s purchasing power. Researchers have concluded that annuities have important benefits.”

“Annuities provide income at a rate that can help retirees avoid overspending their assets and provide a floor of guaranteed income to prevent unnecessarily spending too little for fear of outliving assets, according to one association. Annuities can also relieve retirees of some of the burden of managing their investments at older ages when their capacity to do so may diminish, which may also make them susceptible to fraudulent sales.

On the other hand, annuities may be inappropriate or expensive for people who have predictably shorter-than- normal life expectancies. Likewise, funds used to purchase immediate annuities are no longer available to cover large unplanned expenses. Also, immediate annuities that provide for bequests have higher costs. There is little consensus about how much income constitutes “enough” retirement income.”

Even with all the caveats and hedges, this pro-annuity advice admittedly makes me a little squeamish. I’ve always been a little leery of buying annuities for a range of reasons, including my worries about the fees that are associated with some of the products, and the fact that you hand over control of a large chunk of your savings to an insurance company.

It made me wonder about the experts giving the GAO folks advice. I’m a skeptic about the world of financial product salesmanship in general. But there’s probably a good reason why employers haven’t touted annuities as a solid choice for their 401(k) savings plans.

The GAO sort of gets it. “Some pension plan sponsors are reluctant to offer annuities for fear that their choice of annuity provider could make them vulnerable to litigation should problems occur,” according to the report.

That could be changing. State Street Global Advisors, a unit of State Street Corp. (STT), which had $166 billion in plan assets at the end of last year, is planning to announce a 401(k) investment this fall that will include a built-in annuity.

And BlackRock Inc. (BLK) has teamed with MetLife Inc. (MET) to offer BlackRock's LifePath Retirement Income Fund, a target-date fund, which replaces the traditional bond allocation with a pool of deferred annuities that’s available to employers for 401 (k)s. As a participant nears his target retirement date, more money is allocated to the annuity. The fund charges 0.7% of the invested account value per year, and seeks to provide at least a 5% annual payout, beginning at age 65 and continuing until death. No companies had adopted it as of July 6th.

Those fees add up and you might not want to make the commitment to annuities well before retirement. Remember, you can always buy an immediate annuity yourself after retirement and outside a 401(k) plan. Low cost, no-commission immediate annuities are now available from the likes of T. Rowe Price, Fidelity and the Vanguard Group.

Financial literacy for all. The experts all agree that it’s essential to promote individuals' financial literacy, especially to better understand risks and available choices for managing income throughout retirement, in addition to saving for retirement. Their suggestions: Additional federal publications and interactive tools, sponsor notices to plan participants on financial risks and choices they face during retirement, and estimates on lifetime annuity income on participants' benefit statements.

Employers as plan sponsors are currently not required to provide notices on the financial risks and choices that participants face in retirement. “With the ongoing shift in pension plans and the transition from lifetime retirement income toward account balances, we believe that this continues to be important,” the GAO report notes.“Absent such a requirement, many more workers may likely face key retirement decisions without sufficient knowledge to decide which choices are in their best interest.”

The truth is without objective information from employers and the federal government, even those retirees who have adequate savings may be at risk of not having sufficient retirement income.

Bottom-line advice: Individuals should consult with a fee-only planner to develop an educated retirement strategy and certainly before jumping into buying an annuity of any stripe. See my post on finding an advisor.

To read the full-blown 79-page report released last week, Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices, Click here.

For more on annuities, go to my colleague William Baldwin’s post here. And read his 2011 Investment Guide piece.

I'm the author of What’s Next? Follow Your Passion and Find Your Dream Job, available here www.kerryhannon.com. To learn about great jobs for retirees, check out my column on AARP. Follow me on Twitter, @KerryHannon