We have a real crisis on our hands. A crisis that involves the very backbone of the nation's private retirement-savings system, the 401(k). That's what Nobel Prize winner in Economics, Robert C. Merton, states in his most recent article published in the Harvard Business Review.
He discusses the one big problem that continues to be overlooked in a 401(k), and that is plan sponsors and administrators are managing these plans with the wrong goal in mind. "The only way to avoid a catastrophe is for plan participants, professionals, and regulators to shift the mind-set and metrics from asset value to income," Merton states.
There is an obsession, he says, within the industry about two things: account balances and annual returns. Merton notes that these metrics are far less important than one other: the amount of sustainable income an employee can expect to receive in retirement. "By disclosing annual income, instead of (or in addition to) an account balance, employers will help employees quickly and easily calculate how much of their annual salary they can expect to replace in retirement, together with Social Security." He emphasizes the need for employers to begin asking employees about their expectations for income needs in retirement rather than their tolerance for investment risk.
But this mind-set is only half the battle. Merton says in order to accurately calculate how much retirement income a participant's 401(k) balance will purchase, the plan sponsor must assume the money will be invested in an inflation-adjusted deferred annuity or long-term U.S. Treasury bonds. "These investments ensure the spendable income that's secure for the life of the bond or annuity and are the very assets that are the safest from a retirement income perspective."
Merton says if these investments are managed well, upon retirement, the employee should have enough money to buy a deferred, inflation-indexed annuity that (together with Social Security) will replace his or her salary in retirement. "Once they achieve their retirement income goal, they'd be foolish to leave their money at risk in the stock market."
LifePro ran an illustration to see if his theory holds up in the real world. We prepared the report for a 55-year-old who invested $250,000 into a limited flexible premium deferred fixed index annuity, the Allianz 222®. Based off of the most recent 10-calendar year period (keep in mind, the 25-year period would not be a good sample because of the inflated interest rates over those years), we conclude that the person will be receiving a steady inflation-adjusted income for life, together with Social Security, to live comfortably based off of their retirement income goal.
The $250,000 has an immediate 15% bonus increase with the product used and a 50% increase each year to the Credited Interest Rate (which is the PIV Credit). Added in with the 5% withdrawal rate (very competitive), Merton's theory holds up to be true.
And if you take advantage of LifePro's new Social Security Maximization program, you can help your clients achieve the comprehensive retirement income planning that Merton emphasizes in his article (Deferred Inflation-Indexed Annuity + Social Security).