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Dueling Desires

Richard Connor  |  February 17, 2021

MANY YEARS AGO, when I first developed an interest in financial planning, I read as much as I could on the subject. I distinctly remember being in a bookstore—remember them?—and looking at the myriad of personal finance books. Two stuck out.

The first book purported to show how to maximize your spending throughout retirement and die with nothing. The second book purported to help with the opposite strategy—leaving millions to your children. The stark dichotomy struck me then and it’s stayed with me ever since.

Indeed, among my family, friends and old colleagues, I’ve noticed the same twin desires at work in their retirement planning. They want to maximize their retirement income, but they also want to leave a legacy to their children. This often manifests itself in their concern about “leaving money on the table” if they die early in retirement. It’s an emotional response, reflecting our well-documented tendency to be loss averse. We spend our adult life working hard to accumulate retirement savings. Once we get there, it’s hard to let those assets go.

This instinct can impact three crucial decisions: whether to take a lump sum rather than guaranteed monthly pension payments, when to claim Social Security and whether to use part of our nest egg to buy income annuities. My contention: The choices many folks make could end up backfiring—leaving them with both less retirement income and a smaller estate.

Pensions. Like me, a number of my friends and former colleagues are eligible for traditional defined benefit pensions. We know we’re part of the lucky few, as those without pensions frequently remind us.

My old employer’s pension plan has an attractive “early retirement subsidy” that allows retirees who meet certain criteria to retire with a full pension at age 60, instead of 65. Retirees are eligible to take their pension as either a monthly annuity or a lump sum. The lump sum calculation, however, doesn’t include the early retirement subsidy. Result: For a 60-year-old retiree, the present value of the subsidized monthly annuity is about 33% larger than the lump sum.

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To me, the choice seemed obvious: Take the higher valued monthly annuity. It’ll provide steady income for my wife and me. But what seemed obvious to me wasn’t obvious to my old colleagues: They expressed the concern that, if they and their spouse die early in retirement, their children will get nothing if they opted for the monthly pension.

Social Security. Folks raise similar concerns about Social Security. Many financial planners believe retirees should delay claiming Social Security to get the largest benefit possible. This is especially true for married couples. By delaying the main breadwinner’s benefit until age 70, the couple will lock in the largest possible payment for both the retiree and the surviving spouse.

Boston College’s Center for Retirement Research has an excellent paper that explains how delaying Social Security is akin to purchasing an income annuity. More recently, the researchers there released another paper attempting to quantify the value of delaying. Both studies clearly show the financial value of claiming Social Security later—and yet many retirees take benefits early, fearful they’ll die young and “leave money on the table.”

Income annuities. Sold by insurance companies, these have the potential to play an important role in our retirement income plans. Last year, HumbleDollar’s James McGlynn published an excellent article describing how he’s integrated annuities into his retirement income plan.

Single premium immediate annuities—so called because you make a single investment in return for a predictable income stream—can be used to generate lifetime income or to cover a specified number of years. I’m considering buying them to provide income from age 65 until I claim Social Security at age 70. I’m also considering buying a qualified longevity annuity contract—a form of deferred income annuity—to provide income later in retirement. Both of these require giving a chunk of our portfolio to an insurance company in return for a guaranteed income stream.

Locking in a hefty amount of guaranteed income, whether from a pension, Social Security or income annuities, can greatly strengthen a retirement plan. On top of that, if you have guaranteed income to cover your regular expenses, you can take more risk with your portfolio by investing a higher percentage in stocks. Over a retirement that might last 20 or 30 years, that should mean better portfolio performance and potentially a far larger inheritance for your children.

In other words, avoiding income annuities, claiming Social Security early and opting for a lump sum payout from a pension plan might seem like the best strategy for leaving a legacy and generating a healthy amount of retirement income. But there’s a good chance that just the opposite will turn out to be true—and that, by locking in a healthy steam of guaranteed retirement income, you’ll end up leaving more money to your kids.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.

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