As the CEO of a company whose mission is to help people secure retirement, I am obsessed with the unintended consequences of retirement planning and advice that focuses more on assets than income.
It makes sense that the companies that produce this advice and manage the assets, from brokerages like Fidelity and Schwab to robo-advisors like WealthFront and Personal Capital, would promote the asset-first view of retirement because they make billions of dollars on fees from that model. But what if you could build your retirement around income with little to no fees, total transparency, and a built-in hedge for inflation?
How to build your own retirement plan and pension
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I’ve heard experts and actuaries discuss the possibility of building your own pension, and my interview with Kevin Hanney, the Senior Director of Pension Investments at Raytheon Technologies
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The DIY Pension
I first met Glen through the NewRetirement Facebook group. Though he doesn’t have any training as a financial advisor, he was making comments in the group that were insightful, so I reached out to him and discovered that he had created his own super-robust retirement plan that he built himself with some detective work and lots of attention to the details. (You can listen to him tell the story here or read his post on creating a retirement paycheck.)
Glen says he didn’t really start thinking about retirement until he was in his 60s. Before that he had taken the advice of the human resources manager at his work and picked a 401K fund almost at random from a dog-eared binder. A few decades later, he had a good amount of assets, but he asked himself, how am I going to replace my paycheck after I retire?
He had heard that the 4% rule doesn’t work anymore because the risk-free rate of return has tumbled from 5% when the rule was first formulated to less than 1% today. That means even if you have $1 million in risk-free assets at retirement, your income from that investment is less than $10,000 per year. Even if you only need $50,000 per year in retirement income, you’re looking at an 80% shortfall.
The Bucket Strategy
Glen’s first move was to do a clear-eyed assessment of his income needs in retirement. He says this was the hardest part of his mission to build his own pension. “So the first part of it was to get a good handle on our expenses because until then you know, we were fortunate enough that we didn’t have to budget, so we’ve kind of spent whenever we needed to spend,” he says with a laugh. “The first time I did it, it was so painful. I swore I’d never do it again.”
Entering in all his and his wife’s account information was tedious, but once that was done, he had the information to create three income buckets that would pay for expenses, allow him and his wife to do what they want in retirement and to hedge against inflation.
Bucket 1: An Income Floor for Essential Expenses
This bucket is an income engine powered by Social Security and annuities Glen purchased right before he retired.
Social Security is still a great deal for retirees. It is basically an inflation-protected pension that replaces a decent amount of income if you can wait until you’re 70 to withdraw it. Pro tip: the higher inflation indexed income you get by delaying Social Security would cost you about 30% more if you bought an annuity instead.
One of Glen’s biggest moves was to add annuity income to this bucket. At first, he looked at COLA (Cost of Living Adjusted) annuities and hybrid or variable index annuities, but the former reduced their income too much in the early days of retirement, and the latter couldn’t guarantee the income floor Glen wanted.
It was a big decision, to liquidate the assets necessary to buy the annuities to fill bucket 1, and Glen talked to three Financial Advisors to get a second opinion. Surprisingly all of them counseled against this decision, but their math and reasoning wasn’t convincing (you can read more about why that might be the case below). Glen ended up allocating about 35% of his retirement savings to a set of annuities across multiple insurance companies (to avoid concentrating risk with a single insurance company).
Bucket 2: Discretionary Spending
If all your your money is going to pay for essentials, you’ll have a pretty boring life. Glen and his wife like to travel, and being retired means both of them have more time to spend checking out river cruises in Europe or at their time-share in Hawaii.
Glen’s second income bucket covers discretionary spending to pay for the things that make life worth living which they cover with their RMDs (Required Minimum Distributions) which come out of this bucket. In order to be able to draw funds from this bucket for discretionary expenses from assets not impacted by market volatility, Glen set up a 5-year CD ladder to fund his RMDs with about 11% of his retirement savings.
Bucket 3: The Inflation Hedge
The final bucket is an extra insurance policy to cover expenses should inflation tick up and erode his purchasing power. Bucket 3 is invested more aggressively with an 80/20 mix of equities and bonds, since he has his baseline income, discretionary income & RMDs covered by buckets 1 and 2. Since they put 35% of his retirement savings into bucket 1 and 11% into bucket 2, they were left with 54% of their savings bucket 3.
This bucket also includes his Roth IRA, which he finds useful for expenses outside the narrow definition of retirement, like emergencies, college tuition for grandchildren, and estate planning.
The Thing Retirement Planners Won’t Tell You
When Glen was first putting together his DIY pension, he had a hard time getting investment advisors to talk to him about immediate annuities.
“They didn’t have problems talking about variable annuities or some of these other instruments,” he says. “But when I talked about just plain, simple, immediate annuities where there’s no cash or investment,” they tuned out. “To be honest, I didn’t have a single person during that initial period ever tell me that it was a reasonable thing to do. In fact, there was one company that said [a simple annuity] was the stupidest thing that I should ever consider.”
Of course, the investment advisors who work for asset managers are reluctant to advise annuities because they manage assets — that’s what they do. The problem isn’t even that asset managers are trying to do what’s wrong for their clients, it’s just not part of their business model to sell guaranteed income.
Buying annuities isn’t a simple process either. You have to read the fine print to make sure the math works out for you. But using annuities to create your own pension in retirement is not only possible, it’s also a great alternative to traditional plan based on the accumulation and decumulation of assets using the 4% rule.