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Pros and cons of retirement income options

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Despite near-constant reminders, Americans aren’t really good at saving for retirement. And they’re likely to be just as bad at stretching their savings to last the entirety of their golden years. It’s a problem that has the government weighing whether to require plans to offer an option that can generate retirement income for their workers.

The Government Accountability Office recently solicited opinions from the financial community — and the general public — about ways to enhance the retirement security of citizens. At issue: Should the government force financial companies to offer lifetime income options that give retirees a predictable stream of retirement income for the remainder of their lives?

The financial community is split down the middle on the issue. Some are in favor, saying it can alleviate a significant and growing problem. Others note that if worded poorly, enforced lifetime income options could wrestle control of workers’ financial future away from them.

What are they?

There’s nothing new about a lifetime income option. Many insurance companies, and some investment houses, currently offer them in the form of immediate annuities. After investing a lump sum, you’re eligible to get a fixed percentage of that amount per year for the rest of your life once you hit a certain age.

So, for instance, if you have $100,000 in the annuity and you get a 5 percent rate, you’ll get $5,000 of retirement income each year going forward — even if you live longer than 20 years.

Consumers, though, haven’t been too enthusiastic about the investment option. The concern has been that if you put, say, $100,000 into one of the accounts and die before it’s paid back to you, your heirs may get nothing. If you live a particularly long time, though, you could get back more than your original investment.

Other plans lock you in — not allowing you to withdraw your money prior to retirement, even in the event of a financial crisis.

In general, financial advisers, such as Jim Holtzman, a CFP and CPA with Legend Financial Advisors in Pittsburgh, aren’t exactly anti-annuity. They do say, however, that the amount people should invest in a lifetime income option account comes down to spending needs. The payout should be enough to cover your projected monthly living expenses. Beyond that, other investment vehicles should be considered.

“It’s complicated, but you have to structure a portfolio that makes sense for the client,” he says. “Part of the reason this (debate) is coming up is pensions have (basically) gone away. Also, in the last 20 years, we’ve had two bubbles burst in the market. That’s going to cause concern for a lot of people who were approaching retirement.”

Loss of control

The problem with these plans is the loss of control. Rather than putting people in charge of their own finances, it asks them to trust the government or their employer’s retirement plan provider.

Given the state of Social Security and the financial services industry, people aren’t real eager to do that.

Sensing that, some annuity providers are changing their plans to offer more flexibility. Prudential, for example, offers IncomeFlex, a plan allowing people to choose different strategies to control the investments.

It works like this: Investors are guaranteed a percentage of their initial investment, but can choose (and change among) one of several asset allocation portfolios — some aggressive, some conservative. If the investment gains value, their monthly payouts increase, but if it loses money, the minimum payment doesn’t change.

Prudential representatives say the key to success with this plan and the idea under consideration by the government is reducing financial hazards while increasing financial security.

“This proposal is all about taking the risk for the liabilities that individuals have and transferring them to a private entity, which is much better positioned to bear it,” says Mark Foley, vice president of Prudential’s Innovative Simplicity product group in Hartford, Conn.

One of the biggest concerns about the government’s suggestion is the lack of detail.

“Conceptually, consumers could benefit from this, but I think there are a lot of questions that need to be answered,” says Holtzman. “What’s the cost structure? Who’s on the hook for it if things don’t work out and the company goes bankrupt? Would it be something the Labor Department would handle and fund?”

Logistical considerations

On a smaller scale, what happens when workers move from one job to the other? Would their plans be transportable? Would there be fees for doing so? Or, what happens if an employer switches plans?

No one knows. And no one is willing to hazard a guess at this point.

Transparency is another concern: The varying number of annuities (and payout plans) makes it hard to do an apples-to-apples comparison, leading opponents to claim that some people may actually end up worse off.

Proponents and opponents of the government’s proposal do agree on a few things, though.

No one seems to want this to be an all-or-nothing option. Consumers, say both sides, should not be forced to annualize the entirety of their savings. And both note that the discussion about lifetime income options will have one beneficial aspect, regardless of the direction the government chooses: It helps educate people about the option and causes them to think about their own retirement income plans.