Posted on 02 November 2012
By Mark Miller
The decline of defined benefit pensions in the private sector, along with rising reliance on 401(k) and IRA accounts, has left millions of Americans to answer a critical retirement planning question on their own: how to be confident they’ll have sufficient income support in retirement.
Who better to answer the question than an actuary — and one who is passionate about educating us all on retirement security? That’s Steve Vernon. An actuary by background, he’s a full-time retirement educator, blogger and author — and one of the sharpest experts I know on retirement planning.
Steve’s new book, Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck, offers specific answers to the questions. It’s packed with sensible, specific advice, offered up in plain-spoken, easy-to-follow prose.
I recently asked Steve five questions about the challenges Americans face paying themselves in retirement — and his recommended strategies.
Q: Why do you call generating retirement income from savings one of the most critical retirement planning challenges?
A: During the past two decades, there’s been a tremendous shift in employer-sponsored retirement programs, from traditional pension plans that pay you a monthly income for the rest of your life to account-based plans such as 401(k) plans, cash balance plans, and IRAs. This places a tremendous responsibility on individuals to invest their own retirement savings and use that money to generate a retirement income that will last the rest of their lives, no matter how long they live and no matter what happens in the economy
Surveys show that employees are struggling with these issues and need help. For example, a recent survey from Wells Fargo revealed that the median response to how much savings is needed for retirement is $300,000, when the actual number is far higher. Even worse, “10 percent” was the median response to the question “What is an appropriate amount to withdraw from your retirement savings each year?” Many experts recommend a withdrawal rate of just 3-1/2 to 4 percent.
Other surveys show that most retirees don’t have a formal plan for withdrawing from their retirement savings and simply withdraw what they think they need to cover their living expenses. The inevitable result of all these trends is that at some point, we might have millions of elderly people who have run out of retirement savings.
One big problem is that most employers don’t provide options in their 401(k) plans or other defined contribution plans that help their employees use that money to generate ongoing retirement income. Many are looking to the government to provide guidance on how to deliver retirement income options. But I’ve been advocating to employers that there are sufficiently robust retirement income options already out there and that there are existing guidelines they can follow to help their employers plan for retirement.
My mission at this stage in my life is to do whatever I can to help individuals and employers prevent the unfolding tragedy.
Q: What are the methods people can use to generate retirement income?
First, don’t consider your retirement savings as a pot of money you can use as you see fit to spend on living expenses. Instead, think of your retirement savings as a generator of a monthly paycheck, and set up this paycheck to last the rest of your life. Then, live paycheck to paycheck. We used this financial discipline while we were working, so let’s keep that discipline in place when we’re retired.
There are really just three ways to generate a lifetime retirement income. I call these methods “retirement income generators” or RIGs for short.
RIG #1 is to invest your money and live on the interest and dividend payments, never dipping into the principal. This method generates the lowest amount of retirement income compared to the other RIGs, but it has the most flexibility and is the most conservative.
RIG #2, which I call “systematic withdrawals,” works like this: You invest your savings and withdraw principal and interest cautiously to avoid running out of money. This RIG involves the most ongoing time and attention from you.
RIG #3 is to buy an immediate annuity from an insurance company, which promises to pay you a monthly income for the rest of your life and then to your beneficiary, if you choose a joint-and-survivor annuity.
Each RIG has its pros and cons, and each has a variety of permutations. More importantly, each RIG produces a different amount of retirement income.
Q: What strategies do you recommend?
A: I advocate that you should learn about the pros and cons of each of the three RIGs, and choose the RIG or combination of RIGs that best fits your goals and circumstances.
If I knew nothing about you, I’d suggest that you estimate your basic living expenses for rent, mortgage, utilities, food, insurance, and so on, and then cover these expenses with reliable sources of lifetime income, such as Social Security and an immediate annuity. Then invest the rest of your savings and use RIG #2 – systematic withdrawals – to cover your discretionary expenses, such as vacations, hobbies, and gifts. This way, if the market melts down again or you run out of money, you’ve got your basic living expenses covered, and you don’t need to move in with your children.
Q: How does an individual choose the best method of generating retirement income to best meet their circumstances?
My new book Money for Life describes a systematic way to pick the RIG, or combination of RIGs, that works best for you. In summary, you need to determine the personal importance of each of the LIFE goals:
Flexibility and the potential for an inheritance
Exposure to market meltdowns
Your answers will guide you to the RIGs that are appropriate for your goals. Then determine how much retirement income these RIGs might generate. If they don’t produce enough income to meet your needs, then you’ll have to start making tradeoffs in your life, which can be a healthy process.
Q: What is the role of financial advisors in the retirement planning process?
A: Because most 401(k) plans don’t provide retirement income options, as I previously noted, individuals are on their own to generate retirement income from their retirement savings. As a result, they may decide to turn to financial planners.
The trouble is, many planners are paid in a way that conflicts with the best interests of their customers. For instance, they may guide clients to retirement income solutions that pay high commissions or have high expenses, rather than the option that best meets the needs of individuals. And many financial advisors may have experience and expertise with investing but not with generating retirement income, which is a related but different skill.
Your goal is to look for advisors who are paid to have your best interests at heart, and who have taken the time to obtain formal training on generating retirement income.
I believe that realistically assessing your financial resources will lead you to making important life decisions, such as how long to work, where you will live, and how you can manage your living expenses to meet your monthly income.