The U.S. government recently issued guidelines for the ownership of annuities in 401(k) plans, patching what had been a big hole in many workplace retirement offerings: How to secure an income after you stop working.
The thinking is that many American workers have no idea how to invest for their goals and even less how to invest for income with success. So, for the first part plans moved toward target-date funds and now, with annuities, they can start to address the second.
Efforts to make American retirements more predictable and secure are welcome. However, one should be very careful with any product that offers to solve all your problems in a single decision. The reason is fees.
Some target-date plans, for instance, are extremely cheap and effective. Others lard in fees that are sure to drag down your long-term results. Likewise, certain types of annuities can be cost-effective and useful. Many, however, are sold mostly because they pay fat commissions to the advisors who sell them.
You can invest smartly for income in retirement — if you understand asset allocation. While annuities offer guarantees, you have to remember that the risks you face in retirement go beyond just outliving your money.
An annuity is best thought of as an insurance contract. The annuity seller invests your cash and takes the risk that the market might not perform and that you might live longer than the actuarial tables indicate.
To account for those risks, the “guaranteed” return has to be lower than the market might otherwise provide, and there has to be room in the incoming investment flow to pay the managers.
If you instead own a portfolio and manage it for income, you don’t pay those management fees, just very low index fund fees. From there, what matters is estimating your years in retirement and working backward.
If you think it might be 30 years, go ahead assume a bit longer. A good retirement income asset allocation will provide current income but also hold some stocks in order to offset the effects of inflation.
See, stocks are inflation fighters, have been for decades. While your holdings of shares might be lower than when you worked and needed to grow the principal, your need to grow that pot doesn’t diminish completely.
As you age and start looking down the road toward the end of your plan, you can reduce that exposure and increase your income-producing holdings accordingly. But it will probably never be zero.
Building a low-cost, appropriately risked retirement asset allocation is not that hard to do. Done right, it can provide you with years of low-cost, reliable income.