Previous generations lived differently when it came to planning for retirement. They worked for 30 years before retirement, and they knew how much their monthly pension check would be for the rest of their lives. Plus, they counted on Social Security benefits.
It’s a far different story today. The percentage of employers who still offer a traditional defined benefit plan to new employees fell to 5 percent in 2015, down from 50 percent in 1998, according to a 2016 report from Towers Watson, a global professional services and human resources management firm.
Unlike 30 years ago, employees are their own when it comes to getting through retirement. You may save in company-sponsored 401(k) plans or in IRAs, but you must decide how much to contribute and how much risk to take. Some workers don’t contribute to a benefit plan even when there is an employer match; others invest too conservatively or take a riskier strategy. Still, others use their retirement accounts as piggy banks.
Those are some of the reasons Americans haven’t saved nearly enough for retirement. According to the Economic Policy Institute, nearly half of American families have no retirement savings.
But the new world of defined contribution plans also means that once you save that nest egg, it’s up you to figure out how to turn those savings into a steady income in retirement. And that’s something Barry Bigelow, lead advisor at the Duluth, Minnesota, branch of Great Waters Financial calls “one of the trickiest things in retirement.”
With that in mind, here are some recommendations to help you prepare for that big decision.
Do not make your choice in isolation. “The first step is to recognize that the retirement income decision can be way more complex and is more personal than the savings accumulations decision,” says Dave Gray, head of workplace retirement products and solutions at Fidelity Investments in Boston. He says many people with 401(k)s have had their assets managed to some degree. But that changes when it’s time to take income.
“As you get into retirement, the first thing you have to do is recognize it is complex. You can’t look at it in isolation,” he says. “Look at your investment income choices and tax consequences in context of all your accounts, along with retirement, health care and lifestyle choices.”
Understand your plan’s withdrawal rules. Not all plans have the same features or withdrawal rules, Gray says. “About two-thirds of them do offer some sort of installment or systematic withdrawal that can be leveraged to create a retirement income stream out of your 401(k). But the plan may offer a different methodology or a different frequency. Some allow you to get distributions monthly, others quarterly or annually.” Also, some plans might allow you to take out a fixed percentage, and others a dollar amount, he says.
Roll over your 401(k) into an IRA. If your plan does not allow installment withdrawals, you might consider rolling it over into an IRA, Gray says. “They typically have more flexibility.”
Most 401(k) plans were not built to provide income. They were built for saving. “Employers aren’t in the business of administering lifetime income streams once [their workers] have left the company,” says Ken Moraif, a senior advisor at Money Matters, a wealth management and investment firm in Dallas. “They want you to take your money and go somewhere else with it.”
Create a realistic budget. The only way for you to know how much you will need each month in retirement is to know how much you spend. Bigelow says having a good understanding of your budget is a good place to start. “From there, you want to have at least 80 percent of expenses paid by guaranteed sources of income [such as Social Security, annuities and pensions],” he says.
“What I encourage people to do is sit down with a financial planner and plan out a couple of things,” says Nick Abrams, president and CEO at AJW Financial Partners LLC in Columbia, Maryland. “How much money do you need? Social Security gives you a guaranteed base of income. What is the gap between your income and expenses? Do you have a mortgage? Look at gas and electric and essential expenses. Then look at the discretionary and fun stuff,” he says.
It’s important to consider your total retirement income picture, including Social Security, to make sure you are making smart tax moves, says Kimberly Foss, author and founder of Empyrion Wealth Management Inc. in Roseville, California.
Consider an annuity. An annuity is a fixed stream of payments typically sold by insurance companies that are used primarily as an income stream for retirees. There are many variations, but the two main types are fixed annuities, which provide a set payment, and variable annuities, where payments can vary depending on the stock market. They can pay out for life or for a fixed period, like 20 years. Moraif suggests purchasing a life income annuity if you want the equivalent of a pension, which would pay until death. “It’s lifetime income that would go as long as you live, like a pension. The downside is if you die, it stops, just like a pension. It is essentially structured the same way as a pension, with options,” he says. “You can get income for yourself, or you can accept lower income that would continue for your spouse if you pass away.”
Annuities stir passions in many, mostly because of unscrupulous tactics by some salesmen in the past who sold products to unwitting people so they could collect the commissions. Some also have high fees. Plus, they can restrict your invest options. And the complicated rules around investing in annuities have been made even more so in recent years with different types of hybrids and the option to combine annuities with life insurance. But many financial advisors recommend that guaranteed income be a part of your financial plan, and an annuity might be the way to do that – if you get the right one.
“They have a stigma, good or bad,” Bigelow says. “People who use them have a positive view. People who have heard the horror stories of variable annuities that vanished because of the market or fees have a negative view. But they can be a perfect building block for the single person or the married person.”
Update your plan regularly. Revisit your income plan annually. “Whatever plan you pick, you have to monitor it,” Abrams says. Things may change, he explains. You may sell your house and move to a senior facility. Or you may experience the death of your spouse, which may result in a loss of income. Plus, your kids may move back in. “One of the things most people have to realize is what your plan is today may not be your plan tomorrow. Stay in touch with your advisor and let them know changes to your plan,” he says.
It’s important to establish a “glide path” with your 401(k)s and IRAs as you approach retirement, and make sure you take minimum distributions from qualified accounts before tapping into other sources, Foss says. “What this means is having a strategy in place in the years prior to retirement to prep your investments to provide for your income needs once you start to draw down on the account.”
This is where a qualified financial advisor can really be of assistance and help people approaching retirement prioritize what percentage of assets should be repositioned and how to optimize your withdrawal strategy, Foss says.