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If you are a full-time employee in the private sector, you probably belong to a 401(k)-defined-contribution fund. In this case, all you can be certain of is how much your employer will contribute and how much you may contribute. A traditional 401k or pension may seem like the way to go because it appears to give security to those who have one. Given that there are variations in the investment strategies for these types of retirement plans, one thing remains fairly constant, your money is subject to changes in the market.

As more and more people retire without defined benefit plans, their own savings, often in 401(k) accounts, will be increasingly important — and investors’ choices about how to use them will be more complex.  While pensions still exist for some retirees, subsequent generations have seen them massively scaled back.

Almost all companies have replaced the “defined benefit” plan, i.e., the company handling all investment and administrative aspects of your retirement, with 401(k)-type retirement plans in which, you, the employee, bear the consequences for investment selection and market volatility.

There is no guarantee of how much money you will accumulate by the time you retire, and there is no guarantee of how much you will receive as a pension.  For instance, the stock market has been dropping and you’re looking at your 401K and investments drop in value.  The amount you receive, even if you belong to the fund for 40 or 45 years, will depend mainly on the investment returns earned by your retirement portfolio in the build-up to retirement.

For one thing, people are living longer, and their money has to last all that time. One in four people who are 65 years old today will live to age 90, and one in 10 will live to 95. You could be looking at 30 years of retirement.  You need to have the safety in terms of predictable income, yet at the same time you may need to have part of your portfolio in risk assets.

Retirees in the past often relied on a simple rule for retirement income: Most people near retirement may have heard of the 4% rule.  Draw down 4 percent of your savings every year and you will be all set. It’s a guideline for turning savings from 401(k) plans, IRAs and other types of accounts into retirement income. It quantifies the amount of money that can be sustainably harvested from savings each year.

But, like many rules of thumb, it doesn’t always work. The retirement landscape has changed. Low interest rates have complicated the picture for savers.  Safe withdrawal rates in retirement are down from 4% to around 2% in the first year of retirement.  The returns of the stock market during fragile periods just before and after retiring can be make-it-or-break-it factors for this type of retirement income strategy.

Another approach is to consider annuitizing some retirement savings. As Americans live longer, more experts are pointing to them as tools to help your money last.  An annuity is really like an additional pension for some people, it adds some stability to where you are getting your income. Putting your money into some type of fixed indexed annuity may be more appropriate. This will allow your money to grow with the market because it is usually directly tied to the Stock Market or the S&P 500 even though there is a limit to the growth.  However, remember that when you invest in the stock market your average brokerage will take a larger percentage off the top before you earn anything.

The real upside of a fixed indexed annuity is that you earn money whenever the market is on the rise, and the market never stays down for very long. With the reset feature of fixed indexed annuities, not only do you retain any money in your annuity when the market goes down but you earn money from the market being low because it has to rise again. You will not waste the time you would have just returning to your original account balance, in fact you will be gaining funds the whole time that the market is on the rise.

In addition to providing more stable income, annuities help offset the risk that investors will outlive their assets. And having an annuity that throws off income reduces the chance that retirees will have to draw on invested savings at a time when the market is weak. Most people don’t want to be paying for basic, necessary expenses out of something that gyrates up and down

People may use the annuity as a method of giving them some confidence in knowing that they are assured of part of their income.  One can consider the purchase of the annuity to be a type of insurance policy that will provide a sense of security. It can help prevent one from outliving one’s savings.

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Wednesday, October 14th, 2015 Wealth Management

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