Is it you … or the kids?

A few weeks ago, I had the opportunity to attend the launch party of a book called Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income for Life, written by Dr. Moshe Milevsky and Alexandra MacQueen.

The authors use “pensionize” as a verb, which in their definition is to:

  1. convert money into income you can’t outlive, or
  2. create your own personal pension, a monthly income that lasts for the rest of your natural life.

What they are using as the gold standard of pensions is a defined benefit pension plan –– that is, one offered by a corporation or government that will guarantee you a steady, inflation-adjusted income for as long as you live. Unfortunately, defined benefit pension plans have been in decline lately. So, unless you’re a government employee, it’s unlikely that you’ll be able to participate in one of these plans.

Will it be the Kids or You?

My take on this is that when you approach retirement – by that I mean moving from the accumulation phase of savings to decumulation or income phase – a fairly substantial economic tradeoff factors into the pensionize question. Essentially, you have two choices:

  • At one end of the spectrum, you can choose to have a greater financial legacy, perhaps building a nest egg to pass on to your children or charity.
  • At the other end is retirement income sustainability. If this is your goal, you would choose to create your own personalized pension plan to ensure that your future retirement income is very sustainable and will provide for you for the duration of your life.

The trade-off between the two is that you have to weight your decision one way or the other. To characterize the trade-off at the extreme ends of the spectrum as described above, it’s either you or it’s the kids.

Each Approach Takes a Different Investment Strategy

From an investment strategy viewpoint, increasing the financial legacy aspect of your retirement nest egg entails using more “growth” types of strategies. These strategies still involve a balance of cash, bonds, stocks and real estate; however, you would take income or cash flow out of that pool on a regular basis. If you have a goal of increasing your financial legacy, you would have to achieve an average return that is higher than your withdrawal rate. For example, a 7% average return and a 2% withdrawal rate would mean you were meeting your income needs, but overall the portfolio or nest egg would still be growing at 5% per year. This kind of strategy comes with no guarantees, although some of the actual specific investments might have guarantees, i.e., government bonds.

The investment strategy for achieving retirement income sustainability really translates into more guaranteed types of investments. There are a few ways of achieving this: one of the easiest to explain is an annuity. An annuity is a contract with an insurance company. You give them a pool of money and they agree to pay you a monthly income for as long as you live. The trade-off is that once you buy an annuity, you don’t get your principal back: in consequence, there is no financial legacy or nest egg left over.

Two Key Time-Frames to Consider this Issue

I think there are a couple of time frames when people might want to take a careful look at this issue. The most obvious is the “retirement risk zone,” which is the 5-7 years around someone’s actual retirement date. The second, and perhaps less obvious, group who might want to consider this issue is much younger. While it’s not common for younger clients to look at guaranteed types of products or strategies for retirement, the economics of some of these strategies can be very attractive.

Keep in mind that there is a trade-off. The choice is between a greater financial legacy or higher retirement income sustainability. Different factors – such as personal preference, risk tolerance and legacy goals – play a part in this decision.

Ultimately, though . . . it’s really one or the other.