

6 Ways to Generate Lifetime Income in Retirement

Today, many more Americans bear full responsibility for saving for their own retirement. Unfortunately, the days of heading into retirement with a guaranteed monthly pension check provided by an employer lie in the rearview mirror.

More than half of global retirement assets now sit in defined contribution (DC) plans such as 401(k) accounts. For those accounts, workers must choose to set aside a portion of each paycheck to accumulate a nest egg to rely on in retirement.

But how do you ensure that nest egg lasts for the rest of your life? Nobody wants to see the money run out too soon, but many have not given much thought about how to make their savings last a lifetime.

The transition from accumulating savings to creating an income stream in retirement presents challenges. Individuals must know the options available and understand that decisions regarding how they choose to invest their savings — along with economic factors such as interest rates and inflation — can affect their monthly income in retirement and how long their assets will last.

The Georgetown University Center for Retirement Initiatives (CRI) recently partnered with Willis Towers Watson to study potential solutions to generate retirement income in defined contribution plans. The results clearly show how some of the available types of lifetime income options balance priorities differently and can be used, alone or in combination, to meet individual retiree needs.

#1: Immediate Annuity

An immediate annuity mimics the behavior of a pension by providing a fixed amount of income every month for the life of the retiree. It is the simplest and most-direct approach to converting a retirement nest egg into a steady income stream to meet monthly expenses.

All of your retirement savings would be transferred to an insurance company or other provider.  You exchange future control of savings for monthly guaranteed income. It removes uncertainty and ensures that funds will be available consistently throughout retirement, but you often give up the ability to access your savings to pay for future unanticipated needs.

#2: Laddered Bonds

Unlike an immediate annuity, a laddered bond enables you to convert your savings into cash if needed. Investing in bonds of staggered maturities (“laddering” them) provides a stable stream of income through regular payments of principal and interest from the bonds while maintaining access to your savings.  

The nearly risk-free nature of bonds provides peace of mind while maintaining flexibility, but the annual income generated is not guaranteed and is likely to be somewhat lower than an immediate annuity. In addition, like an immediate annuity, you surrender the potential for higher returns if your money were invested in the stock market.

#3: Target Date Fund with Systematic Spending

Increasingly popular Target Date Funds (TDFs) adjust the mix of stocks, bonds, and cash over time from more-risky to less-risky as you approach your retirement date. A TDF with a systematic withdrawal plan provides an income stream while keeping assets liquid and invested, and creates the potential to generate higher returns.

However, you lose the certainty of the monthly income because market volatility may require adjusting withdrawals to reduce the risk of depleting your savings too soon.

#4: Managed Payout Fund

For the benefits of a simple TDF with less risk, retirees could consider managed payout funds. This option invests in both stocks and bonds while reducing the downside potential by providing monthly withdrawals equal to a fixed percentage of the account balance.

While this approach can do more to prevent you from running out of money too soon, there is uncertainty in exactly how much income you will get and what assets will remain, based on market performance.  

#5: TDF with Deferred Annuity

For retirees who want the opportunity for growth by keeping funds invested in the stock market, a TDF with a deferred annuity could be the solution. This approach sets aside a portion of the retirement nest egg to invest in an annuity that begins to pay a guaranteed income when you reach age 80, for example.

The TDF would provide liquidity and additional investment potential in the early years of retirement, while putting a guaranteed income safety net in place for the remaining time. The risk lies in managing your nest egg until age 80 so you do not run out of money. Some of the other options, such as a managed payout fund, could help bridge the gap until the deferred annuity payments begin.

#6: Guaranteed Minimum Withdrawal Benefit (GMWB)

While the most-complex of the solutions explored, a GMWB can offer more-balanced benefits for retirees. It combines continued wealth accumulation potential with guaranteed income to meet a variety of individual needs by tying a variable annuity to an underlying investment like a TDF.

The GMWB requires very strong market performance to outperform an immediate annuity, but it also incorporates the best elements of other plans to offer the potential for additional benefits and flexibility.

Any Lifetime Income Solution is Better than None

A recent MetLife study found that one in five individuals who took a lump sum distribution from their retirement plans ended up spending it all in just over five years. That leaves those retirees with nothing more than a Social Security benefit for the rest of their lives — unless they return to work to make ends meet.

Workers should seek to implement a lifetime income solution to meet their retirement spending needs, rather than taking an ad hoc approach to spending down a nest egg in the golden years. Since the challenges and needs of individuals and families are unique, how they manage post-retirement income will differ.

Providers must make lifetime income solutions more readily understandable and accessible, and workers should be educated and encouraged to use these options to ensure a comfortable retirement, not one that ends up with an empty bank account years too soon.  

You might also like

Comments are closed.