When planning for retirement, you must forecast sources of income. Social Security is the most commonly known income source in retirement. You pay into social security via a tax during your working years and receive a benefit upon full retirement age. You can learn more about what benefit to expect by visiting www.ssa.gov.
A source of income that is less common now is a defined benefit plan or pension. Many companies used to pay into a pension fund on behalf of their employees during their career and then you were guaranteed a pension benefit for your lifetime. Due to interest rate fluctuations and longevity, it has been harder for companies to maintain pension balances over the years that offer lifetime payouts. Many companies have frozen their existing pension and most do not offer a pension at all.
This leaves the supplemental funding source for income in the hands of the employee/ individual. Most of us invest in a defined contribution plan or 401k. With this type of plan, you determine how much to contribute annually and select the investments yourself or with the guidance of your advisor. The goal is to grow the retirement account to a value from which you later receive income. This retirement bucket value isn’t guaranteed and can fluctuate due to market conditions creating uncertainty. Some folks have business distributions or rental income that creates an income stream. This can also fluctuate.
As retirement planners, in the ideal scenario, we suggest you have multiple sources of income and that some of it is guaranteed. The retirement plan industry agrees and they are taking steps to move in that direction.
“For investors who don’t want to wait until they leave their plan to take advantage of the guarantees available through annuities, a number of other insurers have developed insurance products designed to function as investment options within defined contribution plans. With these products, you contribute to the investment option while you’re working, and then receive a guaranteed stream of income after you retire.” – Randy Myer, WSJ
This option should be weighed against taking a lump sum of your 401k plan at retirement and creating a guaranteed income stream through the purchase of an annuity. Annuity products should only be used in the context of a larger plan. The products are nuanced and carry varying bells, whistles and associated costs. It is important to look at all of the details with your financial advisor before making a purchase to ensure it is in your best interest.
Brandon Cabaniss, CFP®
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