My clients are usually looking for consistency and dependability when we sit and build their retirement plan together.
Who doesn't want to know that they're headed into retirement with a secure and protected stream of monthly income?
However, they often get confused over three of the most commonly discussed options for secure income:
Years ago, many people had retirement security in vehicles known as “Defined Benefit Pensions.” These functioned by offering employees monthly income even after they left their place of employment. Once an employee had worked for a certain amount of time with an organization, they were considered “vested.” At this point, they were eligible to receive benefits when they reached retirement age.
Let’s say I worked 30 years at General Motors and retired with a guaranteed 75% of my final income. This amount was decided by averaging my salary from the highest 3-5 years I was with that company. This payment would come to me each month in addition to my Social Security check.
As you can see, previous generations were in great shape for retirement.
With these pension plans, the employer took care of all of the savings and investing, then guaranteed a lifetime monthly income for their employee after they retired.
Liz Davidson, in her History of Retirement Benefits article states, “By 1970, 26.3 million private sector workers (45 percent of all private sector employees) were covered by some kind of pension plan. Participation held steady for several decades with 43 percent of private sector employees still covered by 1990.”
43-45% of private sector workers and nearly all of public sector workers had some kind of pension during this time!
Retirement planning in America wasn’t perfect back then, but the majority of working Americans had income that would provide for their basic needs throughout their lifetime. Their base retirement income wasn’t tied to the volatility of the markets because it was insured and protected by their employers.
Fast forward to today and we’ve flipped the triangle.
Today, the vast majority of retirement planning is the individual’s responsibility and not the employer’s responsibility. With 401k plans, the employee pays in and sometimes the employer matches, sometimes they don’t. The decision for what to invest in falls on the employee rather than the employer as well. If you don’t choose your investments for your 401k, your money sits in a Money Market account.
Because of this shift, each individual now has to find the best information and the best investments that they can, while also wading through information from all kinds of talking heads who are giving differing opinions and recommendations every single day.
Sadly, the basis of retirement income is no longer secured and insured by an employer.
It’s up to each individual to invest, secure, and protect their future streams of income.
Today, as CNN Money states in their Ultimate Guide to Retirement,
“The percentage of workers in the private sector whose only retirement account is a defined benefit pension plan is now 4%.” They go on to say, “Meanwhile, the few employers that still offer traditional pensions - typically industries with a strong union presence, such as the airline and auto sectors – have been working overtime to cut deals to either reduce or eliminate their plans.”
As you can see, the secure pension is no longer something that Americans can rely on.
So, what do we do?
There are two other protected income streams. However, neither of them are what I’d call an “everything” asset. There are no “silver bullets” in the financial world.
First, there are bonds.
Most types of bonds are secure because you are loaning your money to the government or a corporation, with interest. Of course, there are junk bonds that aren’t secure, AT ALL… but the idea behind bonds is that you’re investing in something secure and once your bond matures, you get all of your money back- plus the interest.
The reason bonds are not really the best option right now is because interest rates are just so low. You’re loaning out your money with the hope of getting that money paid back to you plus interest, but with the low interest rates, your money isn’t even growing at the rate of inflation.
We can all agree that doesn’t sound great. But what about waiting until interest rates go up to invest in bonds? Well… when interest rates go up, bond values go down.
Here’s a little blurb from Investopedia to help nail down what I mean.
“Fed policy initiatives have a huge effect on the price of bonds. For example, when the Fed increased interest rates in March 2017 by a quarter percentage point, the bond market fell. The yield on 30-year Treasury bonds (T-bonds) dropped to 3.02% from 3.14%, the yield on 10-year Treasury notes (T-notes) fell to 2.4% from 2.53%, and the two-year T-notes' yield fell from 1.35% to 1.27%....
The current COVID-19 pandemic has seen investors flee to the relative safety of government bonds, especially U.S. Treasuries, which has resulted in yields plummeting to all-time lows. As of May 24, 2020, the 10-year T-note was yielding 0.64% and the 30-year T-bond was at 1.27%.” (emphasis mine)
What does all of this mean for us?
It means that when people are seeking secured income, bonds give less and less income. When this happens, bonds are, once again, failing to even keep up with the inflation rate.
That leaves us with our last asset for the scope of this blog: Annuities.
Annuities are also not going to be an “everything” asset. However, they will do a better job of securing some form of protected income in order to have your basic income needs handled in retirement, some consistency.
The government has even realized this and that’s why there were provisions about annuities in the Secure Act and the Secure Act 2.0. The Secure Act allowed for 401k plans to invest in annuities. This is of major importance because annuities offer a protected stream of income and other 401k investments don’t have that same layer of protection.
So, what is an annuity?
An annuity is similar to the pension plan because it's insured and protected, and you get a set amount of income from it each month during retirement. However, rather than being run by an employer like the pension, it’s managed by an insurance company.
Do you remember the 60/40 rule?
This is a rule in retirement planning that states “while you are young, you should put 60% of your investments in stocks and 40% in bonds.” This rule is generally accepted. Then we’re told, “As you reach a certain age, you should switch that number and invest 60% in the secure income of bonds and only 40% in the volatile stock market.”
Here's the thing, bonds aren’t keeping up with inflation.
The government realizes that bonds aren’t helping people build a steady stream of income for retirement like they used to. They have the stock option, the mutual funds, the IRAs… those are all great for the investment option, but not the secure option. With the Secure Act, they allowed annuities to be an option in the 401k and Secure 2.0 expands on that.
Taylor Tepper with Forbes Advisor sums it up well when he says, “Many experts believe that annuities, which offer guaranteed payments for a set number of years, are a great way to increase your retirement security and remain underused. SECURE Act 2.0 would make it easier for plans to offer annuities by easing technical RMD requirements for annuity options in addition to making Qualified Longevity Annuity Contracts (QLACs) more appealing by increasing the amount of your retirement savings you’re allowed to use to buy a policy.”
So, in English, what does that mean?
Well, both of the Secure Acts have opened the door to allowing more Americans to utilize annuity options. Many people have been led to believe that annuities are a scam by some bad players, but with the way the policies run today, they are actually an option that can help create a steady stream of income because of the way they are set up and insured. Rather than putting 60% of savings into bonds, it’s worth learning more about the different types of annuity options out there and maybe using that instead of bonds.
The annuity works more like the pension of old, but the difference is that it’s not managed by your employer- instead it’s run by an insurance company. This is actually helpful because one of the reason pensions failed was employers eventually struggled to make good on their promises and if they made bad investments, they were liable for still paying out the money they had lost.
If you need someone to look over your current retirement plan and make sure you have secure and protected retirement income, here is a link to my calendar, let's chat!