There comes a point in every saver's life when it's time to stop saving and start spending. There are lots of calculators to help you figure out how much regular income you'll need once you stop working. But where will this money come from?
The traditional sources of retirement
income, often referred to as the three-legged
stool, belong to a bygone era of Nehru jackets
and Rubik's Cubes. These three income sources
-- company pensions, Social Security and individual
savings -- worked together to create retirement
security. There was little risk of running
out of money -- if these three sources contributed
their fair shares.
"Thirty to 40 years ago
most companies offered defined-benefit pension
plans," says Moshe Milevsky, associate
professor of finance at York University in
Toronto. "Nowadays that's not the case.
And more of us are living to a ripe old age,
so we have to create longevity
insurance for ourselves."
While longevity is certainly a wonderful thing, when it comes to retirement planning, it's a wild card. Without knowing how long you live, it's nearly impossible to fashion a systematic program of income distribution that keeps flowing till your very last day.
Defined-benefit pensions are
a guaranteed source of income, an assurance
that no matter how long you live you will
continue to collect a check. The same is true
of Social Security, which provides inflation-adjusted
payments for life. Current retirees receive
some 69 percent of their incomes from these
two sources, according to the Employee Benefit
Retirement Institute. But today's workers
can expect these two sources to account for
just a third of their income needs.
That leaves individual savings
to assume a bigger role. The only problem
is, "You can outlive your personal savings,"
says Bill Reichenstein, professor of finance
at Baylor University in Waco, Texas.
Milevsky, Reichenstein and others say that future retirees should strongly consider annuitization, a process of converting some savings into predictable income. There are several ways to achieve this, but the goal is to secure a steady check month after month.
"That gives you a floor
of income you can't outlive. You at least
get that," Milevsky says.
A measure of satisfaction
It might also make you happier. According to Constantijn W. A. Panis, manager with Deloitte Financial Advisory Services in Los Angeles, having an income stream that funds at least 25 percent of your retirement spending boosts retirement satisfaction to almost 70 percent.
"People who derived much
of their retirement resources from an annuity
exhibited fewer depression symptoms,"
says Panis about his 2004 study of defined-benefit
pensions. "At any given level of income,
just having a portion of retirement resources
in the form of annuities was perceived as
having more money."
The opposite is also true. The
longer people were in retirement without annuitized
income, the more their satisfaction declined,
he found. Though Panis looked specifically
at defined-benefit pensions, he believes his
results can be applied to other types of guaranteed
lifetime income except Social Security.