The Benefits of Lifetime Income
Written By: Cal Burgess, Retirement Servicing Group
Today the traditional pension plan, or defined benefit plan, is a dream from the past. Outside of state or federal government jobs the pension is pretty much nonexistent. According to Forbes a 2010 survey by consulting firm, Towers Watson, found that between 1998 and 2010, the proportion of Fortune 100 companies offering pension plans fell from 67 percent to 17 percent. Instead, employees today count on their deferred compensation plan for retirement, which is causing their retirement age to be bumped back by several years. This change in retirement planning is keeping businesses afloat while sinking the dreams of the traditional pension plan.
Most deferred compensation plans, assuming the same rate of return as the S & P 500, have yielded a negative return from 01/01/2000 to 01/01/2012. This trend is putting the retirement dreams of today’s average worker further out of reach. The last decade is commonly referred to as the “lost decade”, and volatility is expected to continue for the next several years. How do you combat this problem? Simple; you do it with financial guarantees.
The traditional pension plan was an American dream. Years of hard work could be replaced with a guaranteed income stream in retirement. The comfort of knowing that there will be a paycheck in your mailbox each and every month during your retirement years gave workers highly desired incentive.
The concept of the traditional pension plan revolved around company pooled funds that were withdrawn monthly from an employee’s paycheck. Typically, after X amount of years worked the employee could expect Y amount of income during retirement (usually the longer you worked the more income you received). During the income distribution phase (the employee’s retirement years) the checks came in and the cycle could not be altered. Since these pensions had no cash value, the longer you lived the more you were paid out; and at death the income stopped (unless there was a spousal extension put into place). This payout stream is commonly known as annuitization.
Throughout the late 1980s and the 1990s annuitized payment steams started to receive a bad rap. Retirees were starting to live longer than ever before due to advancements in the medical field, and like technologies. One of the downfalls of the increasing longevity was the skyrocketing costs of health care and assisted living. Retirees frowned at the idea that they could not get to any of their cash value outside of the income they were receiving. As retirees lived longer their living expenses increased, causing annuitization to fall under scrutiny.
To resolve these issues, the insurance industry gave birth to the Lifetime Income Benefit Rider (LIBR). The LIBR gave all of the promises of income with all of the needed aspects of liquidity. This unique concept allows for an income stream guaranteed for life, while giving the policy owner the flexibility of stopping and restarting the income at their discretion.
Lifetime income allows the investor to know what payment they are eligible for down the road. In order to calculate the eligible income on year X, LIBRs come with an income account value (IAV). The IAV is not a cash value, only a formula used to calculate the income at a set future date. One IAV allows your funds to grow at 7% each and every year (IAV interest rates fluctuate depending on the policy). Depending on what age you decide to take income at will determine on how much of a payout you will receive each and every year. For example, for a 65 year old who wants to take income at age 70, the income account value will grow each year at 7% regardless of how the market performs. At the age of 70 a set percentage of the total IAV will be used in order to formulate a payment. This set percentage of distribution increases the older you get. Typically, the longer you wait to take income the more income you will be eligible for.
Many investors today are protecting their deferred compensation plans with a promise of an income stream that they can never outlive. Many 401ks, or 401k equivalents, are being converted to an Individual Retirement Account (IRA) without a taxable event in order to receive Lifetime Income.