Retirement Income Planning

The Retirement Income Planning Disconnect

When I began writing and publishing Retirement Income Visions™ almost five years ago, retirement income planning was a relatively new concept. What people thought was retirement income planning turned out to be traditional retirement asset planning in most cases.

While the distinction between retirement income and retirement asset planning has gotten more attention in the media over the last five years and has come to the forefront for financial advisors with The American College’s establishment of the Retirement Income Certified Professional® (RICP®) designation two years ago, the importance of implementing a retirement income plan hasn’t caught on yet with most pre-retirees.

According to a TIAA-CREF survey, 72 percent of retirement plan participants said that either their plan didn’t have a lifetime income option or they weren’t sure if their plan offered one. While 28 percent said that their plan offered a lifetime income option, only 18 percent of plan participants actually allocated funds to this choice.

This is despite the fact that 34 percent of retirement plan participants surveyed said that the primary goal for their plan is to have guaranteed money every month to cover living costs and another 40 percent wanted to make sure that their savings are safe no matter what happens in the market. Furthermore, while 74% are concerned about security of their investments, only 21 percent expect to receive income from annuities.

Given the fact that fixed income annuities are the only investment that’s designed to provide guaranteed lifetime income, there’s an obvious disconnect and associated lack of understanding between what pre-retirees want and what they’re implementing when it comes to retirement planning. A large part of the problem is attributable to the fact that employees are relying too much on their employer’s retirement plan to meet their retirement needs. See Don’t Depend on Your Employer for Retirement.

Most employers today offer a 401(k), or defined contribution plan, to their employees vs. the traditional defined benefit plan that was prevalent several years ago. The latter plan is designed to provide lifetime income beginning at a defined age whereas a 401(k) plan is designed to accumulate assets, the value of which fluctuates over time depending upon market performance.

Since an income tax deduction is available for contributing to a non-Roth 401(k) plan and the maximum allowable contribution level is fairly generous for most employees, the incentive to seek out lifetime income options in the marketplace is limited for most retirement plan participants. This is the case even though people like the idea of lifetime income and their employer’s retirement plan doesn’t usually offer this option.

As the marketplace becomes better educated about the importance of having a retirement income plan, this is reinforced by the next stock market downturn, and employers increase the availability of lifetime income options, the disconnect between the desire for, and inclusion of, sustainable lifetime income in one’s plan will lessen over time.

Retirement Income Planning

Where Have All the Pensions Gone?

If you aren’t receiving a pension from a former private sector employer, there’s a pretty good chance that your employee benefit package doesn’t include this once-cherished perk. According to a study by Towers Watson & Co., as of May 31, 2011, only 30% of Fortune 100 companies offered a defined benefit plan to new salaried employees. That’s down from 37% at the end of 2010, 43% in 2009, 47% in 2008, and 83% as recently as 2002. This is a far cry from 1985 when 90% of Fortune 100 companies offered a traditional pension plan to new employees.

While defined contribution plans, predominantly 401(k) plans, have replaced defined benefit plans in the private sector, the pension aspect is lacking in the majority of such plans today. Specifically, with limited exceptions, these plans generally don’t provide for a predetermined monthly payment that an employee can expect to receive beginning at a specified age for the rest of his/her life and his/her spouse’s life if married.

Furthermore, to the extent that a 401(k) plan is available, the future accumulation value of a participant’s account is unknown. It’s dependent upon several variables, including number of years of participation, IRS-imposed employee and employer contribution limits, employee contribution amounts, potential employer matching contributions, investment offerings, performance of chosen investments, participant loans, and potential plan distributions.

The inability to provide for a known monthly lifetime income upon retirement is not unique to employer-sponsored plans. It’s also common to employee and self-employed retirement plans, including, but not limited to, traditional IRA’s, Roth IRA’s, and SEP-IRA’s.

In addition, the nature of many investment vehicles, whether held inside or outside a retirement plan, don’t lend themselves to plan for a predictable known future lifetime or joint lifetime stream of income. Whether you’re talking about a savings account, CD, bond, stock, mutual fund, or exchange traded fund, this feature is generally unavailable.

Finally, a discussion about retirement income wouldn’t be complete without mentioning Social Security. Social Security is a wonderful provider of monthly retirement income for those individuals who qualify to receive it. Of all non self-funded plans, it comes closest to duplicating the pension aspect of a defined benefit plan. Unlike most defined benefit plans, the monthly benefit can increase as a result of cost of living adjustments. Unfortunately, the uncertainty that surrounds the Social Security system makes it difficult to plan for this benefit, especially for younger individuals.

Given (a) the scarcity of traditional defined benefit pension plans, (b) the inability of 401(k) plans, employee and self-employed retirement plans, and many nonretirement investment vehicles to provide for a predetermined monthly lifetime income beginning at a specified age, and (c) the inadequacy and uncertainty of the Social Security system, it behooves each and every one of us to create our own pension plan.