Eliminating Financial Uncertainty Danger from Your Retirement
One of the biggest retirement dangers is the systematic withdrawal schedule that fails to recognize and address longevity. Life expectancy calculations get re-set at every year, at your birthday. Poor investment returns can deliver a 40k or 403b plan retirees to the retirement danger zone. How can your plan participants avoid the trip to financial uncertainty danger?
Most 401(k) retirement income analyses rely on a systematic withdrawal plan. The idea is to provide a context for those who fear they may experience an income shortfall in retirement, and it’s of particular relevance to those approaching “the retirement danger zone” — the five to 10 years before or after retirement. However, the systematic withdrawal strategy ignores many of the realities retirees deal with today.
To be sure, investment mistakes or a market meltdown during the critical retirement danger zone can drastically alter a 401(k) or similar deferred compensation plan participant’s retirement picture, points out a recent Employee Benefit News (EBN) article. Thus, while the systematic withdrawal plan uses an employee’s lump sum savings and simple drawdown strategy, it may not be all it’s cracked up to be.
One failing of the systematic withdrawal idea is it looks at 401(k) assets a lump sum, as opposed to how much income can be generated from those savings. However, since most workers no longer collect traditional pension benefits in retirement, making their 401(k) savings their primary source of retirement income, it’s more realistic to look at those assets vis a vis their income potential, combined with Social Security, to help an individual maintain their standard of living in retirement.
Another issue is that market performance is not consistent, and can, in fact, be volatile, the EBN article notes. The article provides an example, below, of two employees who each invested $100,000 in their company’s 401(k) tracked against the S&P 500 Index. One employee approached retirement in 2005, while the other did so in 2017. This shows how the market impacted their individual portfolios:
From 2000 to 2004, employee #1’s account declined from $100,000 to $88,000. On the other hand, employee #2 would have seen their account balance more than double — from $100,000 to 201,000 between 2012 to 2016. The only difference here is timing — the market simply performed way better during the time period in which employee #2 retired. Nonetheless, timing and market performance clearly can significantly impact individuals’ standard of living in retirement. Thus, it makes sense that employees are concerned about how the market’s unpredictability may impact their ability to enjoy financial security in retirement.
Perhaps the biggest issue with systematic withdrawal is it does not account for longevity. According to data from Fidelity cited by EBN, for the average 65-year-old couple, there is a 50% chance one spouse will live to age 92, and a 25% chance that one will live to 97. People are living longer, and thus spending more time in retirement, which means the likelihood is also increasing that they could outlive their assets. As expected, this creates uncertainty with regard to how much money they need to save, and what is a “safe” annual withdrawal rate.
EBN brings to light an alternative to systematic withdrawal, called “retirement income flooring.” As its name implies, it provides a “floor” of essential retirement income needed to cover basic living expenses. According to EBN, “It combines promised-based income assets, such as annuities, with Social Security and, for those lucky few, pensions. The income floor is from guaranteed sources so employees would not have to leave their retirement to chance.”
Income flooring solves the issues related to systematic withdrawal: it considers income generated rather than a lump sum. It shows employees exactly how much they would need to invest and the resulting monthly income, taking the uncertainty and guesswork out of the process.
It also eliminates market performance worries. Income flooring enables employees to transition a portion of their savings into “promise-based income assets” five to 10 years prior to retirement. In addition, they can defer income payments until after retirement, and their principal is protected from market fluctuations during this timeframe. EBN notes that plan sponsors can use this approach to help employees plan early and rebalance their portfolios toward promise-based income assets, which allows them to “invest a smaller percentage now to generate the floor income when it’s needed.” In this way, employees can bridge the “income gap” using a smaller percentage of their portfolio, leaving more assets for liquidity, growth and legacy goals.
Perhaps most importantly, income flooring protects individuals from outliving their assets. Promise-based income assets provide payments for life, and in fact, the longer someone lives, the larger their payout. These assets also offer life or joint-life payout options, and a cash refund feature to protect against premature death.
The income floor strategy takes much of the uncertainty and guesswork out of retirement income planning. It’s a viable way to help your employees see the bigger picture, hopefully preventing them from working beyond their planned retirement age and provides them with a strategy to create a stable income stream for life.
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