The bad news is pretty bad: While your parents or grandparents may rely on a pension for much of their retirement income, today pensions are on the verge of extinction in the private sector. The good news, though, is that you can take control of your financial future and build retirement income streams for yourself.
A history lesson
First, it's worth noting just how much things have changed.
American Express in 1875 introduced the first private pension in the United States. (There wasn't a great need earlier, as most companies were small and often run by families.) Private pensions grew in popularity over the following decades, aided by occasional legislation supporting the trend. The Great Depression, which wiped out many people's savings, made the value of pensions even clearer and helped usher in Social Security. By 1980, 46% of American private-sector workers were covered by a pension.
Today, though, very few private companies offer pensions, as most have shifted from the "defined benefit" (pension) model of employee retirement plan to the "defined contribution" model (typified by the 401(k)), in which employees contribute to their own accounts. Employees can choose how the money is invested, and in many cases they end up with far less money in retirement than they would have received through a pension.
So what can you do? Well, you can take full advantage of the retirement savings opportunities available to you, such as 401(k)s and IRAs. That's easier said than done, of course, because you should ideally sock away 15% or more of your income, maxing out these accounts and perhaps saving more on the side. For 2014, the contribution maximums for IRAs and 401(k)s are $5,500 and $17,500, respectively, with additional "catch-up" contributions allowed for those 50 and older -- $1,000 for IRAs and $5,500 for 401(k)s.
Also consider dividend-paying investments, which can provide regular income. Many big blue-chip companies offer significant payouts. If you have a $250,000 portfolio of stocks with an average dividend yield of 4%, you'll collect $10,000 annually, and the dividends of healthy, growing companies tend to increase from year to year. It's not a guaranteed pension, but it's not bad if you've accumulated enough of a nest egg to generate significant income.
You should also be strategic about Social Security -- particularly with respect to when you start collecting benefits. Research the topic thoroughly, as there are sound reasons to start early (more years of payments) or late (fatter benefit checks). If you're married, there are several strategies to consider that require coordinating when each spouse starts receiving benefits so that you can maximize your monthly payout.
You can spend money now for money tomorrow. Photo: Flickr user Steven Depolo.
The most pension-like option: fixed annuities
There's another alternative to consider, and it's compelling: immediate annuities. Many of the negative things you've heard about variable annuities and indexed annuities are true, but immediate annuities offer a lot more to like. With an immediate annuity, you hand over a big chunk of money to an insurance company in return for a monthly check -- for the rest of your life! See the appeal? It's like buying your own pension income. This income doesn't come cheap, though. Here are some examples of what you might expect to receive, derived from an online annuity calculator:
- If you're a 50-year-old man in New York, $100,000 can buy you monthly income of about $400. You'd come out ahead in 21 years, and all additional income would come at no further cost.
- If you're a 70-year-old woman in California, $100,000 can buy you monthly income of close to $600. In 14 years, you'd be in the money.
- If you're a married pair of 65-year-olds in Colorado, $100,000 can buy you monthly income of about $470 per month. You'd get your money back in just under 18 years, and the rest would be gravy.
Naturally, plunking down $400,000 would get you four times as much income. And the upfront cost varies based on your age, gender, location, and other factors.
You might also get a good deal by buying an annuity now that begins payment in 10 or 15 years -- a "deferred" annuity, also referred to as "longevity insurance." This can play a critical strategic role in your golden years. Imagine, for example, that you believe your nest egg will last from retirement at age 65 until you're 80. You might buy longevity insurance now that begins paying you at age 80. Thus you'll never run out of money, and the annuity will cost far less because you're buying it early, and it will cost the insurance company less, too. Or, if you're still many years from retirement, you can buy a policy now that begins paying when you expect to retire.
Photo credit: LendingMemo.com
Of course, there are some reasons for caution when it comes to immediate annuities. For one thing, once you buy the annuity, the money is gone, and you can't spend it on anything else. You might end up leaving less to your heirs than if you'd kept the money in dividend-paying stocks.
Your payments also might not keep up with inflation, even if you pay more for annual increases. One drawback to fixed-annuity income is that it won't keep up with inflation unless you pay more or receive less. In our example above, the 50-year-old New York man who opts for a 2% annual increase in his monthly check in order to keep up with inflation will start out with about $300 per month, not $400. (Inflation, by the way, has historically averaged about 3% per year.)
Interest rates matter, too, because we're in a prolonged period of low interest rates, which means annuity quotes are on the low side. Thus you might consider "laddering" your annuity investment. If you planned to spend $400,000 on a fixed annuity, you might spend $100,000 on one every few years, hoping for bigger payouts if interest rates rise. (Payouts will rise because you'll be older, too.)
The insurance company you buy from also matters. Annuities are not protected by an agency such as the Federal Deposit Insurance Corporation, so a failed insurance company can wipe out that guaranteed income. (This is why many are advised to seek out the highest-rated companies and perhaps split their annuity purchase between several companies.)
One way or another, since you probably don't have a pension, you'll need significant income in retirement. Give immediate annuities some consideration, along with the alternatives noted above.