Saving only the first step to retirement

Dar Haddix
UPI Business Correspondent
September 23, 2004 11:23 AM

WASHINGTON, Sept. 23 (UPI) -- With millions of baby boomers beginning to retire, longer life expectancies, and the uncertain future of Social Security, people not only need to save but also make sure they have an income for their entire lives, a report released Thursday said.

Defined benefit pension plans -- which guarantee retirees an income for life -- are on the decline, while defined contribution plans like the 401(k) -- which can run out and leave retirees financially stranded -- are on the rise. But life annuities, where retirees trade a lump sum of assets for a guaranteed retirement income, provide retirees with an income that they cannot outlive, said economist Jeffrey Brown in the report, "The New Retirement Crisis," released by Americans for Secure Retirement.

"What this is leading to is a situation where individuals have more opportunity to invest their assets how they want and so forth, but also putting more of a responsibility on individuals to think about how they're going to make their nest egg last over their lifetimes," Brown, an assistant professor of finance at the University of Illinois at Urbana-Champaign's College of Business, and a former senior economist with the White House Council of Economic Advisors, told UPI.

"The idea of providing people a lifelong source of income is an important thing to do and should be an important part of people's portfolios."

Even where individuals are enrolled in defined benefit plans, many are "significantly" under-funded, and the Pension Benefit Guarantee Corporation -- which insures benefits from defined benefit plans -- is facing record deficits, Brown said.

From 1992 to 2001, the number of heads of families that participated in DB plans fell from 59.3 percent to 38.4 percent, while the percent of heads of families with DC plans increased from 57.8 percent to 78.7 percent.

Brown also points out that Social Security provides only about 42 percent of pre-retirement income for the average wage earner (or around $20,000 a year for the average wage earner who is making $50,000 at retirement). That person needs at least another $15,000-$20,000 per year to bring them up to the 70-80 percent of their working income that Brown says they need.

Another consideration for retirees is that Social Security contributes a larger percentage of pre-retirement income to lower-income earners, and a lower percentage for higher-income earners.

People are not only living longer, but spending more years in retirement. On average, retirees today can expect to spend about one-fourth of their lives in retirement, Brown said in the report.

While a 65-year-old woman today can expect to live about 20 more years on average, there is a one-in-three chance that she will live to age 90. In fact, living to 100 is becoming less and less rare. Brown explains that this is the "longevity risk," or not having enough income at advanced age.

Younger workers can make adjustments, including saving more or delaying retirement, but retirees have more limited options. They either live at a lower standard, or go back to work.

Brown said that legislators need to start providing education and incentives for life annuities, not only to make sure that Americans are financially secure during retirement, but also because of the severe fiscal pressures that federal, state and local governments could suffer from a flood of baby boomer retirees overwhelming the system.

"While public policy has provided tax incentives for households to increase retirement savings, virtually no tax or other policy incentives exist to encourage households to convert their nest eggs into streams of lifetime retirement income," Brown said in the report.

"If everyone has some basic level of annuitized income that they can rely on ... it has a beneficial effect of reducing dependence on means-tested anti-poverty programs like the supplemental security income program. This is something members of both political parties should have an interest in addressing," Brown told UPI.

Life annuities can also provide a higher level of sustained income than a similar but non-annuitized portfolio, since annuities pool everyone's resources, so the resources of those who die earlier than expected are used to pay benefits to those who die later than expected.

But annuities are not one-size-fits-all, Brown emphasized.

Individuals should purchase the right annuity from a reputable insurance company. Financial advisors are a good resource in finding the right annuity as well as understanding the terms. Many Web sites allow people to comparative-shop for life annuities.

Some things to keep in mind when choosing an annuity, Brown said, are which people the annuity will cover; how the annuity will pay out; and whether the retiree wants to have some of the assets in the annuity bequeathed to his or her beneficiaries.

For instance, the annuity may cover retiree and spouse, as well as other family members.

While most annuities sold today provide the same payment for the life of the annuity, or payments that go up at a predetermined rate, others provide more flexible payouts, including protection against inflation.

A bill promoting the use of life annuities was introduced in Congress earlier this year. Under the Retirement Security for Life Act of 2004, individuals would not pay federal taxes on one-half of the income generated by lifetime annuities, up to a maximum of $20,000 in excluded income per year, according to Americans for Secure Retirement.

For a typical American in the 25-percent tax bracket, this would provide an annual tax savings of up to $5,000, the group indicated.