As life expectancy continues to increase, what can you do to make your money last longer?
Douglas Goldstein, CFP®, cross-border investment advisor, speaks with Steve Vernon, researcher at the Stanford Center for Longevity and author of Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years. Get an overview of the various long-term income options available to you when you retire.
Three things to do in 2017 to become financially secure
Douglas Goldstein, CFP®, director of Profile Investment Services, Ltd., shares three simple steps that you can take this year to stay financially secure. Find out what these steps are on today’s financial podcast.
Follow Steve Vernon at www.restoflife.com
Read the Transcript
Interview With Steve Vernon
Steve Vernon, author and research scholar, shares his thoughts on Social Security, pension plans, and annuities. He also talks about ‘the trap'. What is it and how can you avoid it? Find out more.
Douglas Goldstein: I'm very excited to have on the show, Steve Vernon, who wrote a fascinating book called Money for Life: Turn Your IRA and 401K into a Lifetime Retirement Paycheck. He's also a research scholar at the Stanford Center on Longevity. You may also have seen his articles on MoneyWatch. Steve, most people are afraid they're going to run out of money during their life. Is there a solution to that problem?
Will You Run Out of Money During Your Lifetime?
Steve Vernon: People should look at their retirement savings as a generator of a lifetime paycheck. The problem that I see a lot of people doing is that they look at their savings and they think it's a lot of money. They think of their savings as a checking account. They can just write checks and spend to meet their daily living expenses. When people do that, they often run out of money. What I advocate is that you look at your savings as a generator of a monthly paycheck, then all you do is spend that paycheck each month. It puts some discipline on us and we've been used to this discipline all our working lives. We have a paycheck coming in, and we know that we can't spend more than that paycheck, and so really we're setting up that same financial discipline that we've had all of our working lives.
Douglas Goldstein: The problem is that a lot of people are worried that if they save a couple of dollars and then they put it in the bank, they'll only get 0% percent on it. How can they see that as a paycheck?
Steve Vernon: If that's what you're doing to generate your paycheck, you won't see much of a paycheck. There are several different ways to generate paychecks and each of them has their pros and cons. Retirees, or their advisors, need to pick the right methods that are good for them.
Douglas Goldstein: By definition, once you take money out of the bank and you move it to some other investment, you are exposing yourself to more risk if you're expecting to get more return. Is that something you just have to get used to or is there some other way to look at it?
Steve Vernon: The way I look at it is that you need to shift your focus. While you're saving and working, you're looking at investment risk and trying to build a retirement portfolio. However, you need to shift your focus to generate income when you're in retirement. There's one strategy I like. Think about what your basic living expenses are: utilities, food, rent, mortgage, and you cover those with retirement income generators that will last the rest of your life. These won't go down if the stock market goes down. For the rest of your savings, you can invest and draw down, and that may cover your discretionary expenses like travel and hobbies and maybe even spoiling your grandchildren.
Douglas Goldstein: Let's go for the first one. What sort of tool is it that you can really rely on to cover those basic expenses for your whole life?
What Are Some Good Tools To Help You Retire In Peace?
Steve Vernon: There are a handful of tools. The first one is Social Security. That's something that won't go down if the stock market goes down, and it is guaranteed for life. There are methods you can use to optimize the amount of Social Security payments you will get over your life. The first thing I say to people is optimize your Social Security payments.
Douglas Goldstein: What else do you have?
Steve Vernon: Some workers have a traditional pension plan at work or even a cash balance plan. They have that option to get a lifetime paycheck from their employer's pension plan. Those aren't quite as common as they were nowadays, compared to the prior generations. I'm sure a number of our listeners probably have those benefits. That's the second best way to get a lifetime paycheck; through your employer's plan at work.
Douglas Goldstein: Social Security, a fixed pension and ...
The Lump Sum Payment Trap…
Steve Vernon: Before we go off of that, let me just say some pension plans offer a lump sum payment instead of that lifetime monthly check. That's a trap for the unwary. A lot of people think that that lump sum looks pretty big and they take it. It usually has less value than getting that monthly check from your employer's plans.
Douglas Goldstein: Why do you say that?
Steve Vernon: The regulations that the IRS allows employers to convert a monthly pension into a lump sum, happen to be in favor of the pension plan, and they don't produce as generous of a lump sum as dictated by current market conditions.
Douglas Goldstein: Just to clarify, you're not talking about a 401(k) plan, which a lot of people are used to. You're talking about some sort of defined benefit plan, meaning a plan which they've said, "We will give you, let's say $800 a month or you could have $200,000 today."
Steve Vernon: Exactly. I'm not talking about the 401(k) plan; I'm talking about defined benefit plans.
For me, the advice is almost always to take that monthly check from that defined benefit plan, even if they offer you what looks like a large lump sum. If you took that lump sum and tried to buy an annuity that would pay you a lifetime check, you couldn't buy back the check you could have got from your pension plan.
Steve Talks About Annuities
Douglas Goldstein: Please tell us about annuities.
Steve Vernon: An annuity is where you buy a contract from an insurance company, and they promise to pay you a monthly check for the rest of your life. There are many misconceptions around this model, and there are so many different kinds of annuities out there. Some people think annuities are expensive. I'm advocating the type of annuities that is basically a personal pension and all you're doing is buying a fixed-dollar monthly check for the rest of your life. Those are competitively priced and you can buy them online. I think it's the next best way to have a lifetime guaranteed income.
Douglas Goldstein: Let's go over a few of the myths there. People think that if you give money to the insurance company, they will agree to pay you a certain amount of money if you're alive, but let's say if you drop dead 10 years later, there'll be nothing left for your family?
Steve Vernon: If you're worried about that, you can buy what's called “a joint and survivor annuity”, which will continue to give a check as long as you or your spouse or beneficiary are alive. You can also buy what's called “a certain in life” annuity, which means they'll promise to pay you for at least 10, 15, or 20 years, even if you die before the 10 or 15 or 20 years. There are ways to protect against that possibility. Here's one last point I'd like to make. Somebody says, "Okay, you take joint survivor annuity and both you and your wife get in a car crash. Now what?" My answer is, "You're dead."
You've covered who you care about, which would be your spouse. But your spouse is dead too, so are you really going to be worried about this when you're dead?
Douglas Goldstein: You're enriching the insurance company as opposed to say, leaving it to your kids or to a charity of your choice.
Steve Vernon: That's a misconception a lot of people have. They say, "I don't want the insurance company to keep my money. Actually, if you die before your life expectancy, all you're doing is paying for the benefits of those other annuity holders who live beyond their life expectancy.
Douglas Goldstein: There's the charity you're doing. You're giving your money to those other people who happen to outlive you. You're right.
Steve Vernon: The insurance company is just the intermediary, and of course they have to make a profit because they are in business. But what the insurance companies do is price these annuities, and they know that some people are going to die early and some people are going to live a long time. They just average out the pricing.
Douglas Goldstein: Are these payments from annuity companies linked to inflation?
Steve Vernon: No. Most of the time they are fixed on dollar amount, but you can buy annuities that are either indexed to increase like 2 or 3% a year, or you can buy them indexed to inflations. That's out there if you want to buy an annuity that does go up.
Douglas Goldstein: I want to go back to something you touched on earlier, which was Social Security. I think you actually recently wrote an article that said that one of the biggest fears that people have about retirement is that Social Security will be reduced or eliminated. Are those baseless fears?
Will Social Security Be Reduced or Eliminated?
Steve Vernon: Let's take those two words, one at a time. Eliminated, I don't think so, and that's a big misconception. Social Security is just a way to tax current workers and pay it out to the current set of retirees. As long as we have people who are working and paying taxes, and as long as we have democracy, we're going to have some form of Social Security. I think it's highly unlikely that that program would ever get eliminated. The benefits may be reduced. You probably have learned or heard that we have a funding challenge with Social Security. To balance the funding problem with Social Security, either the benefits have to be cut back a little bit or we have to raise taxes or some combination of the two. That's probably going to happen.
Douglas Goldstein: Someone out there thinks that Social Security is going to keep pace with inflation, but what you're saying is the opposite - that they might in fact cut it. This could be a real risk for retirees, couldn't it?
Steve Vernon: It's a legitimate fear, but it's just something that you should plan for and not just be totally paralyzed. Under the current law, if the projections hold out, in 2034, retirees' Social Security benefits will be cut by 21%. Let's take that, 21%. That's not even a fourth of your benefit being cut. That's not good news. I'm not happy about it, but it's not zero. You're still getting over three fourths of your Social Security benefit. That would only happen if our political leaders did nothing to imbalance the funding challenges and just let this trust fund run out of money.
Douglas Goldstein: So we can count on our politicians to take care of us?
Steve Vernon: I think they are going to do something.
Douglas Goldstein: I think the pressure is there. I always feel a little bit wary when I'm relying too much on politicians to look for my best interest. I think there's a political imperative to do something, though.
Steve Vernon: Actually, Social Security is one of the most popular governmental programs ever. Even if you look at it generationally, even millennials really like Social Security. The way I think of it is, everybody has got a mother or grandmother or a grandfather. Even the millennials value Social Security. I saw a survey of Tea Partiers who, a majority of them, were approving of Social Security. It's a very popular program. I think that politicians recognize that and they aren't' going to let it evaporate altogether.
Douglas Goldstein: Steve, how can people follow you and your work?
Douglas Goldstein: Steve Vernon, thanks so much for your time.
Steve Vernon: Doug, thank you for having me.