Redefining the Provision of Retirement Advisory/Pension Planning Services - Part 2
Suppose the saver learns that she has a 54% chance of achieving her desired income in retirement. Like a high cholesterol number, that relatively low probability serves as a warning. What can she do to improve her outlook? There are only three things: Save more, work longer, or take more risk. These are, therefore, the only decisions a saver needs to think about in the context of retirement. And those choices have immediate impact because if you increase savings, your take-home paycheck is going to be smaller. If you decide to retire at a later age, you will have to explain that decision to your family and loved ones.
The income-focused dialogue between investment provider and saver should continue right up to and after retirement. Typically, employees start thinking more seriously about their detailed preferences closer to the actual date of retirement. By this time, they have a much better sense of their health status, their ability and willingness to continue working beyond retirement, what dependent responsibilities they have, whether they have other sources of income from, say, a working spouse, where and how they want to live, and the other things they’d like to do with their savings. They may no longer want to stick to the default of investing all their retirement pot into an annuity because they may wish to be able to realize a lump sum at some stage.
Close to retirement, the provider and the future pensioner need to refine the goals. A good framework in which to do this is to divide income needs into three categories:
Category 1: Minimum guaranteed income.
Income in this category must be inflation-protected and guaranteed for life, thus shielding the retiree from longevity risk, interest rate fluctuations, and inflation. Government benefits, such as Social Security, and any defined-benefit pensions would be included in this category. (DB plan payments with no inflation adjustment should be treated as if they were falling at the expected rate of inflation.) To increase the amount of guaranteed income above and beyond those benefits, the pensioner would have to buy an inflation-protected life annuity from a highly rated insurance company, the “safe” asset described above. A graded annuity whose income payments grow at the expected rate of inflation can also be used when inflation-protection is not available. The annuity could provide a joint survivorship feature for a spouse but would provide no other death benefits or payouts.
Opting for guaranteed income comes with downsides. Annuities are inflexible and allow for no liquidity to alter the income stream if circumstances change, if there is an unanticipated need for a lump sum of money, or if the retiree wishes to make bequests. With reason, therefore, some people are uncomfortable using all their assets to purchase a risk-free annuity, especially if they have no additional non-pension savings that can provide them with some flexibility. For this reason, they ought to consider trading off some—but not all—guaranteed future income for alternatives that offer more flexibility.
SOURCE: Internet/Harvard Business Review