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There is a slowing growing movement to offer annuities within 401k plans, mostly through target date funds. They purchase the annuity gradual starting around age 50 or so or in a lump sum. 401k Plan provisions determine other options. I think it’s a good and much needed option for the great majority of workers.
But my question is, how important to you is a regular income stream, at least to cover all basic living expenses. I know many HD folks like the flexibility of DIY withdrawals, but for many, income security may be most important.
For me, knowing my income is just like a paycheck is essential. I’m not a DIY guy.
One of the smartest things I did upon retirement was to get an annuity. I worked for the state so I got a low cost annuity that covered 15 years. No inflation hedge. If I died my wife got it, if she died, my grown kids got it. This allowed me to invest my other assets much more aggressively (no question of whether I should withdraw 4% or 5% or how to balance my holdings) which has proved over the last 7 years a very good thing. I retired at 71 and figured that if I could not invest well enough to support myself after age 86 I had not learned anything. 86 was about my life expectancy anyway.
The ability to select an annuity as a 401(k) option is in principle very positive. The devil is in the details. One issue with annuities in general is the prevalence of excessive (and prepaid) fees. Another issue is the discount rate/earnings expectations formula for calculating the payout. In the retail annuity world, both of these can abused to the point that they become predatory in nature. Where that occurs, they usually conspire to penalize the annuitant greatly. Only if these two negatives can be eliminated or made truly fair will the 401(k) annuity work.
I would expect, to protect themselves at least, prudent plan sponsors would be very careful when selecting the annuity option to include in their plan and to communicate the full picture to plan participants. In addition, offering in the group market allows insurers to be more flexible than in the individual market.
Having a defined-benefit pension in retirement would have a major impact on whether annuities would be desirable for someone whose “pension” was a defined-contribution plan, like a 403 (b) or 401 (k).
I actually had two pensions from two previous employers,
both of whom offered me a cash-out offer shortly after I turned 55. One from
Ford Motor Company. It was $296.00 per month with a 50% survivor’s benefit. Thesecond was from Mitsubishi Motors of America. It was almost double at $597.00per month. It also had a 50% survivor’s benefit. Together, they totaled@$114,600. I took the cashouts and deposited the funds into a rollover IRA.
As I was approaching retirement (self-selected) at age 70, 2020 happened, and I put off retirement FOMY! As you know, the market in 2020 recovered, in record time, but it reminded me of a lesson I had been discussing with students academically, which I now understand in reality. The concept of the sequence-of-returns risk. It is not just an academic theory.
My employment contract was renewed for an additional 5 years in 2021, so I figured, “Why not stay for another 12-18 months and stuff money into my 403b Roth account?’ Then came 2022? Recovery wasn’t quite
as fast, and the lesson from 2020 about the sequence-of-returns risk was
brought home again.
The good news is that in 2023, right before the late spring market drop, I bought a series of income rider annuities. Three of them were paid for with Roth money from my 403(b), establishing tax-free income for life, with joint-life survivor benefits and an LTC rider as well. The fourth one was paid for through a rollover from my rollover IRA.
As 2023 was drawing to a close, I had built up what JL Collin refers to as “FU Money.” That gave me pause, and cause to reconsider my current situation, and I decided I would retire, for real, this time. After giving 90 days’ notice, I established my final work day as 1 January 2024. Why not 31 December 2023? Because that date took me into a new year, entitling me to one final Roth 403 (b) contribution to be matched by my employer. In addition, it gave me a final paycheck, an additional payment for 300 hours of unused vacation (maximum allowable), and a payment for a contract job completed just before YE 2023.
Today, my wife and I are enjoying retirement, secure in the knowledge that our guaranteed income far exceeds our retirement expenses, for the next few years anyway, with minimal income tax due. In the words of Beldar Conehead, “Life on Earth is good.”
That’s a great point about the Jan 1 vs Dec 31 separation date. My husband is still working and has been approved to go to half-time on October 1. We’ll max out his 401K contributions for 2026 but decided that starting in 2027, we’ll only contribute enough to get the employer match. We already have arguably too much money in our tax-deferred retirement accounts, and we can use the extra take-home pay given our recent home purchase and his 50% drop in income.
But now I’m thinking that when he does completely retire, it should be on January 1 of whatever year so that he can make that final contribution and grab the employer match. His firm also has a $1000 annual “wellness credit” that can be used for a wide range of things. He can use that on January 1, too.
Does his 401k have the option of an after tax contribution with match? I used that for a few years. Wish I had done more. It counts as part of RMD, but of course not taxable as far as contributions go.
Sounds like a plan that worked. As far as the “for the next few years anyway” goes, I assume you have a plan to deal with inflation from your investments.
We still run a surplus from a pension and SS each month and at our ages that’s unlikely to change, but if necessary we will start dipping into interest and dividends that now equal about 20% of our base income.
Rental property can be an alternative way to generate an income stream in retirement. It has other challenges, but maintaining control of the underlying asset and a level of inflation protection are valuable.
There sure are different points of view on this. I admire those who feel comfortable simply managing investments and withdrawals as their income. Far too scary for me.
My view is likely tainted a bit having had a pension since I was 18 and in addition calculating the pensions for retiring employees, later managing the plan and negotiating changes with the unions. I saw the power of an income stream, but I also learned the impact of inflation.
We provided seven ad hoc COLAs when I managed the plan, but stopped ten years after the 401k went into effect feeling the company match was a form of advanced COLA and expected employees to use it …and told all 10,000 employees that repeatedly.
I understand the value of that income stream but I guess it’s not important to me or I’d have it. We have some steady income but not enough to fully cover expenses. For now, content to wait until 70 for Social Security to have more. And my wife taking hers at 62 will add a bit. Otherwise we take from assets.
We have the same plan for Social Security, which means that next year we’ll have Sharon’s Social Security check plus the first check from my very small pension. We’re still mulling over the decision to buy an income annuity. I can’t ignore Jonathan’s conviction that it is a wise choice.
Agreeing it can be a wise choice, I’ll add this. One of the reasons we haven’t pulled the trigger on an immediate annuity is reluctance to create excess income. On top of our small steady income stream we realize additional income as desired, generally by selling assets or doing Roth conversions. If we also had an annuity coming in every month, it would remove the space we have to do this. So while I understand the value of a steady income stream, for now I prefer the flexibility of taking what income we want when we want it.
Well. Michael, the good news is the older you are when you purchase the annuity, the higher the payout, as a general rule. In addition, Annuities purchased with Roth Dollars are income tax-free.
Like David and you, we have similar goals and are following a similar plan. Thanks for sharing your thoughts.
Excellent plan Mike. On July first before the markets open I will sit down and calculate our income as of the end of the first half of the year. Since we don’t have a budget, and have paid in advance for quite of bit for our trip to the UK in September, and are doing Roth conversions while trying to stay in the 12% tax bracket I have a lot of balls in the air.
I go through a similar drill later in the year.
If you had the annuity, wouldn’t you stop selling assets? If you bought the annuity with after tax dollars, much of the payment wouldn’t be taxable income.
We might stop selling assets, or we might still want to sometimes. For example, we might want a large sum, beyond monthly cash flow, or we might want to exit a taxable position. And regardless, we’d still want to be doing Roth conversions.
If we did buy an annuity it wouldn’t necessarily be with after tax dollars. I Having that taxable account gives immediately accessible money without the same tax bite as we’d create taking a large sum from a Traditional IRA or 401(k).
Different strokes for different folks. For us, I will take the S&P 500 over any 20 year period, rather an annuity. To me the cost of an annuity is too high, as an annuity is an Insurance product. If you are disciplined, you can make a steady withdrawal from your fund. Compounding is your friend, and inflation is the killer. Annuities provide protection for those that cannot do it on their own.
Allan Roth wrote a great piece about these funds for Morningstar:
https://www.morningstar.com/funds/hidden-risks-income-life-target-date-funds?ck_subscriber_id=2905772259&utm_source=convertkit&utm_medium=email&utm_campaign=The%20Investors%20Newsletter%20-%2022225143
I agree with his conclusions: lifetime income is esssential – and annuities are a lousy way to get there because they offer no protection against the ravages of inflation and much of their income comes from return of principal. A TIPS ladder + equities is far superior.
Excellent thought piece.
A guaranteed level of income is important, and as a society, we have affirmed that belief through Social Security. Between my Social Security payment and small pension, I don’t worry about income.
Annuities are becoming more mainstream investments in some 401k plans but have always been an option for rollovers. Both Fidelity and Principle, the two largest 401k plan providers, offer annuities directly on their website. Not advertised, but available.
My concern with in-plan annuities is they are hybrid investments that become an annuity when you take distributions from the plan. Most start with a target date fund and add an annuity withdrawal feature as the only distribution choice. Plan providers do not want to lose the assets, so they add an annuity distribution to maintain the assets while providing lifetime income.
Ask yourself three questions; what good, for what people, at what cost. When I apply that frame to in-plan annuities, very mixed results occur. While the annuity may be good for some, it is not the one size fits all solution regulations seek.
But I believe you have skimmed the edge of this issue. Many people want $1M net worth by retirement, and that’s fine. But $900k in home equity doesn’t produce income. As to the DIY choice, most people do not invest for total return and or have a cash management strategy like a pension fund or an annuity company. Those concepts are not taught in schools or by 401k plans. An annuity is the simple way to derive income from a pot of money and solves the issue for many. It creates a rigid framework for the many that can invest independently.
But the biggest gamble is an early death if it is a single life annuity, and you have a spouse.
That’s why I have a 50% JS on one part of my pension and 75% JS on the other (non-qualified) part plus two years expenses worth of paid up life insurance.
I’m not sure this is needed in a 401k, which is already tax deferred. If a person wants an income stream, they can annuitize it when they retire
The problem is that most employees either don’t know what an income annuity is, or at least don’t know the differences between annuities. Their advisors won’t sell them an income annuity because of the loss of assets to manage, and a very low commission from selling the product.
I think doing so gradually over several years may be a lot less scary then plopping down $500,000 with an insurance company.
We have been ensuring a regular income stream in the future by delaying our Social Security claiming for the past 7 1/2 years, ie delaying since we were eligible to claim early at 62. I consider delaying claiming the equivalent buying a guaranteed inflation adjusted annuity, which generally unavailable, or quite expensive, on the open market. During these past years, due to a strong market, our portfolio balance is virtually unchanged, while our net worth has increased due to the rise in housing costs, this despite our utilizing our portfolio to fund all expenses. When we do claim our Social Security, that, plus my small (<1K) pension will cover the vast majority of or expenses supplemented by portfolio withdrawls. This will allow for significant future growth of our portfolio which is 1/3 Roth, 2/3 traditional. I am also a total return investor. I don’t worry about establishing an income stream. Our portfolio is set at 45/45/10, and I rebalance quarterly by selling back to our target allocations, thus replacing the cash spent. Once we claim Social Security and are no longer withdrawing significant assets from our portfolios rebalancing will decrease to semi annually, or annually. I follow Thoreau’s investing philosophy: simplicity, simplicity, simplicity.
You traded 8 years of risk without the stream didn’t you? What if the market those eight years had been the opposite of strong?
I wouldn’t be too quick to call this risky. 45/45/10 is reasonably conservative. The level of risk really depends on a couple of things left undisclosed – what is their current portfolio withdrawal rate and what is the duration of their bond portfolio. 45% bonds and 10% cash is over 10 years of 5% withdrawals, assuming low duration risk on the bonds sounds pretty reasonable. They could easily manage a significant equity pull back without selling stocks if they are flexible with their withdrawal rate.
Adam,
Thanks for your comments.
Here are the answers to the points you bring up:
1) I have not calculated our withdrawl rate, but had a minimum portfolio balance (that has never been reached) that if we hit it my wife (the lower earner would claim Social Security I order to decrease our rate of withdrawls. We have never hit that target and at this point are 300K above it with 1 1/2 years to go so most likely we will be fine. Since our Social Security and my small pension fund will cover the vast majority of our annual expenses after claiming SS our withdrawls will be mostly RMDs,
2) Bond duration I don’t know how to calculate but at least 2/3 short, or short TIPS; 1/3 intermediate term.
3) With our allocation it is highly unlikely that we will ever have to sell some of the equity position unless it is to return to our allocations while rebalancing.
I don’t know. Any involvement with markets has risk- at least more than a guaranteed income stream. And I don’t want to be flexible in my withdrawal rate.
Defined contribution plans with an annuity option are not a new idea. TIAA started offering them around 1920 and still does for millions of employees of schools and health care employers. I sold a 401(k) annuity option to plan sponsors in the mid 1990s. Very few employees chose it, due I think to poor communication of how it worked. I like guaranteed income which for most people is Social Security. I also like the idea of spending up to 25% of your investable dollars on a single premium fixed annuity to cover living expenses. The rest of your money can then be invested for growth. This is just me. Everyone does what they are comfortable with.
I’m pretty sure 401k plans were not around in the 1920s. I think we are talking a little different idea. Recent legislation made it less risky for employers to offer the option. Hopefully that will stimulate more interest.
Excellent post & excellent comments.
An income stream that includes annuities is a good way to go for steady income and peace of mind.
Interesting piece – thanks Mr. Quinn.
Two thoughts.
Firstly, here in Australia our superannuation system has been operating for a period of time where we are just starting to see a significant number of retirees drawn down on their investments. And currently there are not well structured arrangements for retirees to use. I see a lot of talk about our super funds putting together annuity-style arrangements, which I think would be a good thing.
Secondly, we are probably about 10 years away from retirement, and I’m not sure how we will feel once we are actually drawing down on our investments. But I think a possible arrangement for us is to continue to use our fee-only financial advisor to provide guidance and confidence on a “safe spend” rate, without needing to move to an annuity.
People should be honest with themselves about their capacitance for risk, need to take risk and their tolerance for risk, in that order. I understand the appeal of an immediate fixed annuity. Jonathan was even a fan of partially annuitizing, so I cannot disagree with anyone choosing this path. I base my planning on probabilities, not assumptions. For me, my personal situation combined with the risks of future inflation, the possibility of dying early and insurer failure risk led me to not annuitize, and instead create my own income stream. Read Bernstein for details.
My wife Suzie and I liked the idea of fixed income so much that we both converted a portion of our separate portfolios into ten-year annuities, timed to end just as we start collecting Social Security. Was there an opportunity cost? Definitely. Do we care? Definitely not. In our opinion, a guaranteed fixed income that covers all your essentials is the gold standard for peace of mind — particularly when you’ve retired in your late 50s.
👍
I’m glad there are annuities out there and that options for incorporating them into 401Ks are possibly on the horizon for those who want the assurance of a known level or trajectory of income. The more options and self determination the better.
All is good as long as it is never mandated that a worker has to allocate a % to an annuity. Somehow I could see some legislators leaning that way.
As long as the 100% DIY options (which I vastly prefer) remain intact. All is good. Again, options and self determination.
Now let’s find an exit ramp for mandated income stream for all from the broken Social Security morass. Reset it for the next generations to being truly “insurance” for those who need it vs the current income “assurance” for all. Meanwhile, keep the promise to those who have paid a huge opportunity cost to pay into S.S. for “assurance” thus far….or…. at least some of the promise after 2032.
75% or more of the promise will always be there even if nothing if done.
Self determination, all DIY is vastly overrated. A significant percentage of Americans can’t make it with SS, let alone totally on their own. Empowering individuals sounds fine, but in reality it is pie in the sky. All the evidence is right in front of us.
For most workers a 401k is the better retirement vehicle, yet most people would love a pension.
75% is a “C” grade where I went to school. I’d hate to be dependent on a retirement program with that grade.
For those who, with limited resources can’t develop their own DIY plans, or for those who choose to not invest the time to develop plans; I support the full spectrum of options including annuities as I state above. Again self determination.
My point is that annuitization of 401Ks (partial or otherwise) should not be mandated for those who have the means and willingness to develop their own income streams for retirement simply because another segment of the population is best served by that option.
Meanwhile, there is plenty of pie being eaten by retired DIYers (including on this forum to an above average degree from what evidence I have seen) because they have chosen to let the sky be their limit.
Finally, we are in agreement that the 401K is the better retirement vehicle.
I don’t like the idea of having my money locked up in an annuity.
My Boldin software says we can spend a certain amount every month without worrying about it, so that’s what I plan to go by.
There’s also Social Security to consider, and for me, that’s my annuity. Once we claim SS, that will cover all our monthly expenses, so anything drawn from investments can be spent without worrying about it.
Maybe so, but aren’t you betting your future on assumptions?
Yes, but so is the annuity company.
Dick,
ALL investing decisions are made on assumptions. If you purchase an annuity you are assuming that you will live long enough to get all your investment back, plus a bonus. When you choose to claim Social Security you are making assumptions about how long you are going to live. The biggest known unknown is how long you are going to live.
And, an assumption the insurance company stays solvent.
….and inflation stays relatively tame.
Study after study have concluded that those with guaranteed income streams are happier and less stressed than those without. I think the option to purchase an annuity through a 401(k) is long overdue. I agree that guaranteed streams (Social Security, pension, annuity) should at minimum cover the basics. Ideally, at least in my opinion, a worker has accumulated enough so that he/she/they won’t have to use more than half of those funds for the annuity.
I understand that there are a few bumps in the road. For example, portability issues for workers who change jobs. Also, some employers are reluctant to add plan options that will further confuse workers.
It will be interesting to see how many retiring workers purchase the annuities.
Actually they can be portable. You have a point, many plans have way too many choices. That came from a misguided effort to avoid fiduciary risk when in reality sponsors likely made it worse. There are many areas where too much or any choice is not a good idea- too many people can’t handle or want more choice. Health insurance is the other big one.
Recent articles – sorry I don’t remember where – describing the results of research on retirement spending indicate :
1) retirees concern about running out of money leads to vast underspending
2) those with automatic income streams are considerably less prone to underspend.
That makes sense. Also less stress. It befuddles me that people prefer all DIY. I could never be relaxed in retirement without an income stream. A pension in my case.
Dick,
Everyone who has Social Security has an income stream.
For us it’s been incredibly important knowing we had a secure income stream. It’s conditioned all of our financial decisions before and after retirement. We were late bloomers as to earning and investing. We never had positive net worth until we were in our late 30s!
I know others here were far more savvy and successful about saving and investing than we were, so being DIYers maybe works well for them. I think the average employee is probably more like me than like some HD readers and commenters.
Our path too.
I agree and like me too.
A known and secure income stream is extremely important to us as we got involved in investing relatively late in our working years. Fortunately, we both have pensions with COLA’s and those more than cover our monthly expenses including an automatic transfer to savings. My wife is receiving Social Security and it all goes into a savings account. We refer to the 3rd Wednesday of the month as her “payday” and to the last business day of the month as our “pension payday”!
Dave, we’re with you. Both my wife and I receive pensions on the last day (hers) and the first day (mine) of the month. We also both collect Social Security and with our different birthdates we get them on the 2nd and 4th Wednesday of the month. Having these built in “paydays” is very reassuring to know that the income streams we were used to in our working years continue in retirement to cover our basic expenses.
That’s the way I feel. I don’t have a COLA, but i built that as needed using interest and dividends. Plus my pension and SS are considerably in excess of basic needs. I planned my retirement age to make that happen.