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If you were to define a Goldilocks retirement – one that’s just right – it would go something like this: Amass enough of a nestegg to live comfortably for as long as you happen to live. Spend that money with freedom knowing you’re not going to run out. And, perhaps, leave a little something for the people (or causes) you love.
Sounds great, right? Unfortunately, there are a couple of big problems with that happy scenario explains Michael Finke, a Research Fellow with the Alliance’s Retirement Income Institute and Professor of Wealth Management, Frank M. Engle Chair of Economic Security at the American College of Financial Services. Problem #1: Most people are completely unaware of how long they’re going to live — underestimating is a particularly gnarly issue. And problem #2: When you don’t know how long retirement is going to last, it’s tough to spread your money out over what could be 20, 30, or more years.
So, how do you solve for both, simultaneously? Finke, one of the leading retirement income experts in the country, offered us a few ideas.
WATCH YOUR MONEY MAP: FOR A GOLDILOCKS RETIREMENT: SAVE, INVEST, ANNUITIZE
Cop To Your Likely Longevity
Most people will achieve something close to the average mortality rate for people in their age group, which is why these rates are averages. The problem is that people who have enough money to worry about things like mortality will live longer than average. That includes people with money in defined contribution plans like 401(k)s. “These people tend to be higher earners, richer, and better educated,” Finke says. Among them, a healthy 65-year-old man will live to 88 or 89, a healthy 65-year-old woman to 90. “The bottom line: If you are looking at your parents and saying: Well my father lived to X, I’ll probably live to X, you’re not giving yourself enough years. Add on”.
Acknowledge That There’s a Desire To Preserve Principal
Consider two similarly situated retirees. Both have about $500,000 in wealth, but one has the money in a pension and the other has it in a retirement account with a diversified portfolio of investments. Does one of those individuals spend more money than the other each year? Surprisingly, the one with the pension spends twice as much. That was the finding from a paper entitled Guaranteed Income: A License To Spend co-authored by Finke and David Blanchett, also a Research Fellow in the Alliance’s Retirement Income Institute, and Managing Director, Head of Retirement Research for PGIM DC Solutions. Why the difference? Finke points to 2022. If you have a plan to withdraw a particular amount from your portfolio each year and the market tumbles, are you still going to do that? Likely not. “The instinct against pulling out the capital is so strong that they end up denying themselves,” he says. (According to one 2018 study, about one-third of retirees are able to actually grow their assets during the first 18 years of retirement.) On the flipside, if you’ve taken a chunk of that money and used it to buy a protected lifetime income stream, you can spend it because — like your Social Security check — you know there will be another arriving the very next month. It’s important to recognize that there are only three sources of protected lifetime income available today – Social Security, pensions (if you’re one of the few lucky ones to have one), and annuities.
Get A Grip On Your Goals
After spending decades saving and investing for retirement, there’s no arguing with the fact that most people like and want to spend. According to the 2023 Protected Retirement Income & Planning Study from the Alliance for Lifetime Income, both advisors and their clients say that being able to spend their money safely is the second most important attribute of a retirement plan. (The first, by the way, is having a plan where they don’t outlive their savings.) Unfortunately, for many reasons, including the fear of running out of money, actually spending your savings— even when you’ve save a lot— can be hard. Finke has developed a goals-based process that helps people think more rationally about this.
You start by having a conversation about how much of your wealth you want to pass along vs. how much you want and/or need to spend annually, in addition to the money you need to preserve for emergencies. Once you’ve got a number for the former, you can solve for that with annual gifts, for example, or by purchasing life insurance to satisfy the bequest goals. “The rest of the money is yours to spend,” he says. But you have to ask the question: “Of the amount you’re spending to fund your lifestyle, how much is truly inflexible? If you take on the longevity or investment risk yourself, you may have to cut back on your spending. If you want to create a moat around your spending, then you have to use insurance.” That insurance is called an annuity, which acts like a personal pension to give you a reliable stream of income you can’t outlive.
Turn Your Focus to Income
So, why don’t more people include annuities in their retirement portfolio? The good news is that more are, with sales of annuities hitting records last year and continuing to climb this year. But not as fast as economists like Finke believe they should be. That’s why they refer to “the lifestyle retirees give up by failing to annuitize as the annuity puzzle,” Finke and Blanchett write in their paper. Getting people to behave differently, Finke believes, will require a mindset shift. He believes we need to do a better job of focusing the attention of savers and investors on accumulating chunks of future income rather than a big lump sum. The addition of annuities into 401(k)s and other defined contribution plans “as a default is where we have to go,” he says. He envisions an extended glide path for target date funds that will automatically annuitize a certain percentage of savings while giving people the ability to opt out. “You’ve got to automate this as much as possible because most of us aren’t good at this,” he says. “Otherwise, it’s cruel.”
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