Today I’d like to discuss what makes retirees happy. To quote The Pension Research Council, 2003: “Research has shown retirees with greater amounts of guaranteed income show more satisfaction, worry less, and show fewer signs of depression”. (1)
Now that sounds like a very sensible statement; however, from speaking with so many people over the years, including callers in to my radio show who have heard me speak about this, it is clear that this concept does not seem to register with many people when it comes to their own money. To not have to worry about money is everyone’s goal I would imagine, but survey after survey has shown that running out of money in retirement is the greatest concern of more retirees than dying is! So where is the disconnect coming from?
The biggest change that has come about in retirement planning in our lifetimes has been the switch from Defined Benefit Plans (Pensions) to Defined Contribution Plans (401K, 403b etc.). Today there are very few people who have a pension, instead most people contribute to their company or government retirement plans. We have been told that is the best way to prepare for the time we are no longer working. But is it really?
A recent study quoted from MetLife found that 21% of respondents who had taken a lump sum rather than an annuity had depleted all their retirement funds within five and one-half years and an additional 35% who still had some left worried that it would run out! By contrast 91% of those who opted for an annuity felt they were financially secure. (2)
Almost everyone you speak with agrees that they want their Social Security check to be there, and those with Pensions expect their check to be there every month as well. These are really looked at as income streams that they are entitled to- and they are. But, 401Ks and IRAs are supposed to do the same thing- create income for the retirement years when we are no longer working. When we are in our working years we contribute to these programs for the express purpose of being able to use them in retirement.
On my radio show I have asked what the purpose of money is and the answer is that there are only two purposes really- for life or for death! What do I mean by that? Well if we are spending our money when we are alive that is income, and if we are not spending it but wanting to pass it on to our heirs then that is for death or legacy. The problem that arises is the shift in outlook that we need to have once we retire. In our working years, we want our money to grow but once we retire we need to switch to the distribution phase. That can be difficult as we have been accustomed to watching our money grow and then there is a fear of actually using it when the time comes to do so. Dr. Michael Finke, CFP®, Chief Academic Officer at The American College of Financial Services explains the critical difference between wealth and income. He states people have trouble spending their assets but not their income. To quote him directly: “Once we start viewing money as wealth, as a stock of money and not necessarily as a flow, then we seem to get less happiness out of spending it than we do from money that’s automatically turned into a flow,” (3).
The biggest problem that people face who have only a certain amount of money to live on for the rest of their lives is making the transition to seeing it as income- even though they want it to produce income. They don’t know how long they are going to live and they are fearful of giving up any of their nest egg in case they might need it for something else. But at the same time, they worry that they could take another 40-50% hit like many of them did in 2001-2002 and again in 2008 and have their retirement destroyed. Financial Advisors often refer to the 4% Rule as a safe way to draw income from a lump sum accumulated at retirement, but even that has been reduced in some studies to as low as 2.8%.4. And with the market at all-time highs and eight straight up years can we really count on the 4% Rule? Looking at the Dow Charts over the last 100 years there have been long recovery periods from some of the Bear Markets it has experienced- as long as 16 to 25 years! (5).
So, to conclude- in order for most people to be happy in retirement there needs to be a transition in their thinking away from the constant refrain of market-based Financial Advisors focused exclusively on accumulation and growth to understand the need to shift to distribution as income as we move into the retirement years. Remember I stated the purpose of money is either life or death. I’d like to explain with a simple analogy. If you planted an apple tree in your yard and someone asked you what the purpose of that tree was would you say, “To Grow” or would you say to produce the apples that you would enjoy eating a few years later when the tree had matured? You might want to share some of those apples with your family and friends as well, but the last thing you would want would be for the tree to grow and then have the fruit just whither on the vine and have no one enjoy it. Growth is the function of getting to the purpose of the tree which is to enjoy the apples; and it is the same thing with your “money tree”– growing your money is only the function to be able to use it later.
Now one more concept using that same analogy- when you plant that tree you hope that it will grow into a big, strong tree and produce a lot of fruit, but you don’t really know if that will happen. Along the way, a lot of things could happen that would affect the trees growth- there could be storms, winds, accidents, maybe some disease that strikes the tree even after you’ve started enjoying the fruit, and then it stops producing the fruit entirely. Of course, this is to suggest that there is plenty of risk leaving your money exposed to the risk of the market.
Well unfortunately we don’t have any way of protecting the apple tree from the forces of Nature that could occur, but we can protect our money from the same sorts of dangers to our retirement planning. Rather than having our money at risk in the market and not knowing what we may end up with or how long our money will last, doesn’t it make more sense to protect our money from market downturns. We can lock in gains from the market when they occur and not have to worry about losing them the next year. But as the market has only averaged a little over 3% (3.115%) a year since May 2000 6. and we are now in the 9th year of a Bull Market we don’t want to rely on market returns to grow our own money-tree. Through the use of income riders, we can have guaranteed growth for income as high as 7% compounded interest a year without any market risk. This will also create a lifetime of guaranteed income significantly higher than the 4% Rule would allow for- it could be as high as 7-8% a year without any fear of running out of money.
Now that’s what makes people happy-try it- you’ll like it!
- Constantijn Panis “Annuities and Retirement Well-Being” The Pension Research Council, 2003 2. Many Retirees Spend Retirement Lump Sums Too Quickly APR 13, 2017 | BY MARLENE Y. SATTER http://www.benefitspro.com
- The American College of Financial Services “Psychology of Retirement Income Satisfaction” October 12, 2016
- William Bengen 4% Rule http://www.retailinvestor.org/pdf/Bengen1.pdf.
- Dow Charts Source: Factset/Chris Kacher
- S & P Return Calculator http://dqydj.com/sp-500-return-calculator