Retirement income planning is one of the most important and
most challenging aspects of financial planning for your clients. Will they be
able to generate the level of retirement income needed to support their desired
retirement? Will they be able to meet their retirement income goals without
running out of money?
Lifetime Income
Lifetime income refers to income sources that will last for
your lifetime. This means that this income is not subject to the ups and downs
in the stock market or the direction of interest rates. These are fixed streams
of lifetime income that your client can count on through thick and thin.
What Are Lifetime Income Options?
Social Security and a pension are good examples of lifetime
income options. Your clients cannot outlive either of these assets; they
provide income for their lifetime. Depending upon the annuitization option,
pensions can provide lifetime income to a spouse as well. There are survivor’s
benefits for Social Security as well.
Over the years the number of employers offering pensions,
especially in the private sector, has dwindled. There are some who have
concerns about the viability of Social Security benefits as well. Annuities are
another source of lifetime income offered through insurance companies.
Lifetime Income Annuity
As the number of pension plans has shrunk in recent years,
one option for clients looking for a guaranteed lifetime stream of income is
the lifetime income annuity. A lifetime income annuity can provide several
benefits for clients, including:
Guaranteed income for life, including for a beneficiary as
well in some cases.
Diversification of their retirement income sources.
A stable and reliable source of income.
How Does a Lifetime Income Annuity Work?
A lifetime income annuity works much like a defined benefit
pension plan in that it provides a guaranteed income source for life. Your
client’s premiums go toward funding this benefit. There are several types of
lifetime income annuities, including fixed lifetime income annuities, which
provide a benefit that starts immediately or one that is deferred until a
specified date in the future.
A fixed annuity with guaranteed lifetime withdrawal benefit
provides a guaranteed income for life that depends on the date your client
chooses to begin receiving the income.
Both types of lifetime fixed income annuities offer several
payment options that can be tailored to your client’s needs.
Emergency Savings Account (ESA)
Unexpected expenses happen at all stages of your clients’
lives. An unexpected expense can be very disruptive if your client doesn’t have
access to an emergency fund that can be used to cover these expenses.
What Is an ESA?
An emergency savings account is often a liquid savings
account where money is set aside for a “rainy day.” A rule of thumb is to
strive for an emergency fund that would cover six months’ worth of normal
living expenses.
Some people will focus on establishing an emergency savings
account at the expense of putting away enough for retirement out of fear that
they won’t be able to access these funds in an emergency.
In light of this, the Enhancing Emergency and Retirement
Savings Act would provide easier emergency access to money in employer
retirement accounts and IRAs on a limited basis each year for emergencies.
Other legislation making its way through Congress, including the Secure Act 2.0
package, has its own emergency savings provisions.
What Are the Benefits of an ESA?
Having an ESA and emergency access to money in retirement
accounts can help clients meet unexpected expenses without having to dig
themselves into a financial hole. This allows them to save and invest for
retirement knowing they can meet emergencies that might arise. Having the
option to withdraw money in an emergency without penalty could encourage more
workers to participate in retirement plans.
What Is a Personal Pension Plan?
A personal pension plan is a defined benefit plan that allows
small-business owners and the self-employed to save more for their retirement.
They are similar to defined benefit pension plans for larger employers in many
ways.
Are PPPs Available in the U.S.?
PPPs are available in the U.S. through Charles Schwab and a
number of other custodians.
How Does a PPP Work?
A PPP is a defined benefit plan. The contribution amount
will be based on their age, the time remaining until they wish to draw a
benefit and the level of the benefit they wish to draw each year in retirement.
An actuary will be involved in the process as well.
Generally PPPs are geared to those who can make higher
levels of annual contributions — $90,000 or more. Contributions are all made by
the employer and are tax-deductible for the business entity. Contributions must
be made on an annual basis.
Liability-Driven Investing
Liability-driven investing is an investment strategy that
seeks to match investment assets with future liabilities. This is a very common
approach to managing the assets of a defined benefit pension plan and is
becoming an increasingly popular approach for financial advisors managing the
assets of individual clients for retirement.
What Is Liability-Driven Investing?
Using a defined benefit pension plan as an example, the plan’s
investments would be managed to minimize risks and with the goal of being able
to fully fund the plan’s liabilities. These liabilities are the pension
payments that will be due to current and future beneficiaries. This is
calculated annually during the plan actuary’s review of the plan’s funding
status.
In the case of an advisor using liability-driven investing
to meet the retirement income needs of an individual client, the advisor would
review the future liabilities of their client and design an investment strategy
to meet those future liabilities.
The Liability-Driven Investment Benchmark Model,
Explained
The liability-driven investment benchmark model essentially
generates a benchmark for the portfolio based on economic scenarios, projections
and the optimization of the investment strategy being used. Based on these
assumptions and the associated liabilities, this can provide the financial
advisor with a benchmark target for future dates.
Tontines
Tontines are a form of pooled retirement investment that
resembles an annuity in some respects. They have not been used in the U.S.
since the early 20th century, but there has been talk of reviving them in the
U.S.
Moshe Milevsky, a finance professor at York University in
Toronto and consultant to financial industry companies, is collaborating with a
firm to offer a 21st century tontine.
What Is a Tontine?
A tontine is a longevity protected income solution whereby a
group of individuals contributes to a common fund. Once the individuals enter
retirement, the fund begins to pay them a retirement benefit. As fund
participants die, the payouts adjust to the number of remaining beneficiaries
in the fund.
Are Tontines Legal?
Tontine insurance — a related but different product — was
banned in the state of New York during the early 20th century after an
investigation into abuses tied to the policies. As regulation became more
restrictive, insurance companies chose to stop using tontines.
In a recent interview with ThinkAdvisor, Milevsky stressed
that his modern tontine would be far different from the tontines of old. It
will be structured as “a garden-variety mutual fund, which you can purchase but
never exit,” he said. “You get payments for the rest of your life,”
Defined Outcome (Buffer) ETFs
Defined outcome or buffer ETFs allow clients to participate
in a specified level of market upside while providing a level of downside risk.
What Is a Buffer ETF?
Buffer ETFs can be very complex products, but essentially
they invest in a broad market index such as the S&P 500. There is also an
options collar to limit downside risk. This downside protection typically lasts
for a year, and downside protection limits generally range from 9% to 30%. Fund
shareholders would be exposed only to losses exceeding these limits.
Benefits of a Buffer ETF
The main benefit of a buffer ETF is the limits on downside
risk. This can help clients nearing or in retirement balance the potential
impact of a market downturn in the early years of retirement, while still
providing the potential to participate in a percentage of the underlying
benchmark’s upside. The other benefit is that the ETF format allows for greater
liquidity than with annuities or other income-related vehicles.
Reverse Mortgages
A reverse mortgage allows a homeowner to borrow against the
equity in their home. A reverse mortgage can be a component of a client’s
overall retirement income strategy in some cases.
How Does a Reverse Mortgage Work?
Homeowners who are at least age 62 can borrow against the
value of their home and receive payments in a lump sum, monthly or as a line of
credit that they can tap. No loan payments are required of the borrower; the
loan becomes due and payable when the homeowner dies or moves out of the
residence. The federal government requires that homeowners considering a
reverse mortgage participate in educational sessions prior to taking out the
loan.
What Is the Downside of a Reverse Mortgage?
There are several downsides of a reverse mortgage. These can
include the costs and fees associated with the loan. This might not be the best
option for the client if they will be moving soon or if they want to leave
their residence to their heirs as part of their estate. It is important that
you ensure that your clients do not fall victim to a reverse mortgage scam.
While no payments are required with a reverse mortgage,
there are rules that must be followed. Violating these rules can have
consequences, including foreclosure.
What Happens When a Reverse Mortgage Holder Dies?
Upon the death of the homeowner, the heirs will be given a
due and payable notice from the lender. They have the option of buying the home
or selling it to satisfy the debt. They can also turn the home over to the
lender as well.
Benefits of a Reverse Mortgage
A reverse mortgage can be a means for older adults who have
a large amount of their net worth tied up in their home’s equity to generate
extra cash for retirement.
In What Situation Is a Reverse Mortgage a Good Idea?
A reverse mortgage can be a good solution for clients with a
lot of equity in their home and wish to continue living there. A reverse
mortgage can be a good way to generate the extra cash they may need to support
their retirement income needs. A reverse mortgage also works in situations
where there are no heirs or where the homeowner is not concerned about leaving
the home to their heirs.
Inflation-Protected Annuities
An inflation-protected annuity guarantees a real rate of
return that is at or above the level of inflation.
What Is an Inflation-Protected Annuity?
An inflation-protected annuity offers annuity payments that
are indexed to the level of inflation. These are immediate annuities where
payments generally commence within a year. There may be caps on the inflation
benefit, and the terms of any contract being considered must be reviewed before
going forward.
What Are the Benefits?
The main benefit of an inflation-protected annuity is that
the payments will keep pace with inflation over time, at least to the extent of
any payment caps. Inflation is a major enemy of retirees who live largely on a
fixed income.
Qualified Longevity Annuity Contracts
A qualified longevity annuity contract or QLAC can help
retirees preserve a portion of their retirement account balance for the latter
part of their retirement. They can also help defer RMDs on this portion of
their retirement account balance.
What Is a QLAC?
A QLAC is a deferred annuity that is purchased inside of a
qualified retirement plan such as a 401(k) or inside an IRA. Up to the lessor
of 25% of the account value up to a maximum of $145,000 can be used to purchase
a QLAC, and the annuity benefit can be delayed as far out as age 85.
Benefits of a QLAC for Providing Retirement Income
The benefits of a QLAC for your clients can be twofold.
First, the deferred annuity benefit reserves the amount of the annuity benefit
for the latter part of your client’s retirement. This money is protected from
the impact of market downturns and overspending by account holders.
The second benefit is that the amount in the QLAC is exempt
from RMDs until the annuitization begins. This can save on taxes for your
client over time.
One potential downside of a QLAC is that as a fixed annuity,
the benefits do not keep up with inflation. This can be an issue in periods of
rising prices as we are currently experiencing.
Working Longer
Many people of normal retirement age are working longer
either by choice or out of necessity. Working longer can offer some advantages
to those nearing or at retirement age.
How Does Working Longer Affect Retirement Savings?
Working longer can affect your client’s retirement savings
and their retirement income planning in several ways.
Working longer can allow your clients to continue
contributing to their 401(k) or other retirement accounts and delay tapping
into these accounts to fund their retirement needs.
Working longer can have a favorable impact on your client’s
Social Security benefit to the extent that their earnings qualify as one of the
top 35 career earnings years.
Those working at age 72 can defer their RMDs for their
employer’s 401(k) plan if the employer has made the proper elections in their
plan documents. This allows the money in the plan to continue to grow and saves
on taxes that would have been due on the RMDs. This exemption applies only to
this plan, and RMDs must commence once the employee leaves their job.
When Does It Make Sense to Keep Working Instead of Retiring?
There are a number of reasons that your client may decide to
continue working instead of retiring. One reason is that they enjoy their job
and feel they might be bored in retirement without some sort of daily routine
to keep their mind stimulated.
Certainly, needing the money from working is a valid reason.
It could be that the combination of working a few extra years, delaying their
Social Security benefits and adding to their 401(k) is the combination needed
to help ensure they don’t run out of money in retirement.
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