Maximizing retirement income is very important for retirees. Most people will get Social Security, and maybe if they are lucky they will get a pension (although pensions are becoming rarer each year). But these sources of income may not be enough to cover your necessary expenses.
This is an issue that you should be concerned about if you are approaching retirement. It’s so important that in the July-August 2014 issue of Harvard Business Review, Nobel laureate Robert C. Merton wrote about it.
He believes that 401(k) plan sponsors and administrators are striving after the wrong goals. The administrators are managing these plans with the goal of increasing your account value and giving you the biggest returns.
Wait a second! What’s wrong with that, you may ask? Isn’t growing my money the best thing you can do with it?
Well, I agree that growing your money is a lot better than not growing it (or even losing some of it). But what Mr. Merton is getting at is how to prepare people for retirement. He understands that income in retirement is very important. He believes that the 401(k) plans should be managed to maximize income in retirement.
He believes that the amount of sustainable income an employee can get in retirement is more important than account balances and annual returns. So instead of your 401(k) quarterly statement showing only your account balance, it should also show the amount of income that balance could provide in retirement.
And not only that, but Merton also believes the plan administrators should be investing not just in the typical stuff like equities and bonds, but also in inflation adjusted deferred annuities. After all, annuities are the best way to get another lifetime income source. Merton argues that if employees have the ability to convert their 401(k) at retirement into an income stream that (along with Social Security) replaces their salary, then why not do it.
This makes sense to a certain degree. The reason we expose our investments (like our 401(k) accounts) to risk in the market is because we want them to grow, or give us a return. We want our account balance to be big enough to support our income needs in retirement. So if, at retirement, your balance is big enough to give you an inflation adjusted income replacement, why continue to expose your investment to the risk of the market?
Why you can’t rely on a former employer to take care of your retirement income needs
Things used to be different. Retirees used to not have to worry about income in retirement back when pensions were more common. But employer pensions are not provided as a retirement benefit to employees as much anymore. Defined Benefit plans are now less common. Defined Contribution plans are more popular now.
Before we go further, let’s define what these two phrases mean:
Defined Benefit means the benefit the employer will pay you in retirement is defined. If you are supposed to receive a check for $1,000 each month, then that is what you receive. It is the employer’s responsibility to make sure it has invested assets properly to be able to support that defined benefit of $1,000 a month. This is a pension that lasts the rest of your life.
Defined Contribution means you contribute to a retirement account, like a 401(k). The employer defines what he is willing to contribute to your account. They often times will match what you put in, up to a limit. So if you put in 6%, the employer may match and pay you an additional 3% into your retirement account. The contribution is defined.
Now, whether or not that 401(k) grows enough by the time you retire to give you a sufficient income, that’s not the employer’s responsibility. All the employer does is make sure you have a responsible plan sponsor that offers you a choice of investments for your 401(k) funds. Then the employer may match your contributions. After that the employer is off the hook.
So why is this Nobel Laureate concerned about retirement income?
The reason this is so important for you to know, is because with the rise of 401(k) plans retirees are now the ones responsible for making sure their income needs are met in retirement. You can’t throw that responsibility on to your old employer like in the past. Employers wanted to get away from that responsibility. And most have done so by getting rid of Defined Benefit pension plans.
As employers began dropping the responsibility of providing retirement income through pensions, the retirees had to pick up that responsibility. So you need to plan accordingly and understand how to take care of your income needs.
401(k) plan sponsors could help in other ways
Robert Merton makes some convincing arguments about how 401(k) plan sponsors and administrators should be managing employees’ retirement funds. He believes plan sponsors should have their retirement funds managed in such a way as to maximize their income in retirement. This would benefit workers tremendously. I hope he is successful in getting this idea to catch on with plan sponsors. With employer pension plans becoming less available, retirement income planning from 401(k) sponsors could really help current workers that are on their way to retirement.
Do you have any questions about how to maximize your retirement income?
If so, then feel free to reach out and I’ll help point you in the right direction. You can ask a private question through email [my email address is here]. I try to respond to emails as quickly as possible.
In the meantime, you can take your first steps in maximizing your own retirement income with my free report “How To Retire Worry Free On Guaranteed Income For Life.” [CLICK HERE to receive it] You can learn the basics of designing your own retirement income plan. You don’t have to wait for 401(k) plan sponsors and administrators to catch on to this idea. You can begin taking steps now to have a better retirement.
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