Workers understandably fret about the shift from traditional pensions to 401(k)s and similar defined-contribution plans. The investment risk is now almost entirely on their shoulders, as is the responsibility of figuring out how to make their savings last 30 years or even longer.
But what if it isnt that complicated?
I recently explored employers efforts to address their workers retirement income issues. Here, Ill explore another concept: A strategy for creating lifetime retirement income, developed by the Stanford Center on Longevity in collaboration with the Society of Actuaries, that could appeal to financial planners, employers and do-it-yourself retirement savers.
Heres the idea: Just as retirement savers need to be diversified and consider how their savings are allocated so their money doesnt disappear in a market free fall, people in retirement need diversified sources of income.
The studys authors call these retirement income generators, or RIGs. Those RIGs or, at least, information about them should be part of employers retirement plans, according to Steve Vernon, a research scholar at the Stanford Center on Longevity and a co-author of the study.
Just like you have an investment menu, you should have an income menu, Vernon said.
What would such a menu look like? Below is an overview of one possible menu, based on a retiree with savings in the $200,000 to $1 million range. This is the way to pensionize their defined-contribution accounts, said Vernon.
Setting the floor
One part of the retirement-income menu, Vernon said, should focus on sources that guarantee the ability to cover essential expenses including housing, food and utilities at a minimum. Generally, those sources are Social Security benefits and an annuity of one type or another.
The crucial characteristic of these income options is that they mustnt be subject to stock-market risk. Without some guaranteed income, retirees are too likely to pull out of the stock market when a downturn inevitably occurs, putting their long-term plan at risk by pulling their savings out of the market before it recovers.
Thus, making the most of Social Security benefits is Menu Option No. 1. A smart move for many people is to delay benefits until age 70, maximizing the payout for their later years. Part of the Stanford Centers solution is for employers to work with retiring workers to help them figure out how to optimize their Social Security benefits.
One way to do that, for retirees for whom delaying benefits makes sense, is to use a portion of their retirement savings to cover essential expenses, setting aside money in a money market account or stable value fund to cover what their Social Security benefits would have been between 65 and 70.
For example, a 65-year-old who would have received $18,000 a year in benefits would set aside $90,000 in liquid funds. That is what youre going to draw down over the next five years, Vernon said, covering you until Social Security kicks in.
An annuity to cover costs
The second step is Menu Option No. 2: guaranteed income in the form of some type of annuity, aimed at retirees whose monthly Social Security benefit doesnt cover their monthly essential expenses.
The retiring employee would buy an annuity to cover the difference between their Social Security income and their essential monthly expenses.
Vernon suggests using an annuity bidding platform such as IncomeSolutions.com, which some employers already offer to their workers. (Of note for do-it-yourselfers, Vanguard offers annuities via the IncomeSolutions website for people whove rolled over their money, and Fidelity has its own annuity platform.)
Setting up long-term savings
The next step in pensionizing retirement assets focuses on investible assets, from which comes the income that covers discretionary expenses and allows for some flexibility with regard to market conditions. (Think discretionary as in: If the market tanks, you reduce or stop payments from that account until the market recovers, go out to eat less, and postpone vacations or new cars.)
This is Menu Option No. 3, Vernon said: Employers help retirees create systematic withdrawals from their invested savings, including required minimum distributions once they reach 70 1/2.
Before that age, employers (or the companies that manage their plans) would offer some type of systematic withdrawal based on a percentage of savings, such as a 3.5% fixed rate or a rate that fluctuates based on market conditions.
For retirees who dont have enough saved, there are additional sources of income to consider, including working part time and taking out a reverse mortgage.
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Not so fast?
If its that simple, why arent more employers offering this type of retirement income menu?
One hurdle, some say, is the fiduciary risk faced by employers. Many fiduciary committees are risk-averse and that translates to keeping your plan plain-vanilla, said Robert Melia, executive director of the Institutional Retirement Income Council, a nonprofit research group funded by financial-services companies.
That has, I think, in some way stifled some of the retirement-security [solutions] from really moving forward, said Melia, who often met with employers and plan sponsors to discuss retirement-income products while a longtime executive at Lincoln Financial.
A bill introduced in Congress last year, the Retirement Enhancement and Savings Act of 2016, if it is adopted, might ease employers concerns somewhat.
It gave a very easy legislative safe harbor that would make it quite easy for an employer to go through a fiduciary process to evaluate a guaranteed product and adopt it within its plan, Melia said. The bill is still active in the Senate but its prospects for passage are unclear.
Separately, said Melia, as more employers embrace the idea of financial wellness, the idea of retirement income will start to resonate. The thought process goes, How does financial wellness increase productivity, take stress off employees, create a better work environment? Melia said.
In his experience discussing income products with employers, Melia said, None of them are against retirement security. Theyre all very, very much in favor it. But what you had to do was put it in terms of why its beneficial to them as an employer in helping them create win-win strategies a win for the employer and a win for the employees in offering advice, products and solutions.
Vernon would like to see employers get on the bandwagon and offer more retirement income programs as part of their plans. Right now, not a lot is happening and thats frustrating to me, he said.
In the meantime, he suggests, retirees should consider income strategies on their own.
Retirees really do need to spend some time learning about what their options are, and developing this portfolio that Im talking about, Vernon said. Dont look for the one perfect thing, because it really doesnt exist.
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Andrea Coombes is a personal-finance writer and editor in San Francisco. Shes on Twitter @andreacoombes.