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How To Create Your Own Guaranteed Pension

How To Create Your Own Guaranteed Pension

Many people struggle with choosing a retirement income strategy that assures they will not  outlive their money without assuming significant risks. The optimum strategy is especially elusive for the so-called mass affluent – households with a net worth of $100,000 to $2 million – who would like to maintain their comfortable lifestyle but who may be too timid to invest their money for lifetime income sufficiency. Financial advisors are responding to these challenges by trying to create income strategies that replicate pensions which have all but disappeared. But even those pension-like plans fall short of the absolute pension guarantee of never outliving your income. However, there is a financial instrument that can replicate that guarantee: the Single Premium Immediate Annuity, or SPIA.

How To Create Your Own Pension Plan With An SPIA?

A SPIA is a contract between an individual and a life insurance company to provide a guaranteed stream of income for life, or a specific period of time, in exchange for a lump sum deposit. The deposit is irrevocable, but the income starts immediately and continues regardless of how long you live. Income can be paid on a joint life basis, single life, or guaranteed for a period with a refund to beneficiaries. A rider can be added that can help the monthly payout keep pace with inflation.

Satisfy Income Needs and Create a Family Legacy

While a SPIA could possibly provide sufficient guaranteed income, it would require a lot of capital, which would reduce the amount that can be invested for growth. In addition, there is nothing available from a SPIA that can be passed to heirs. However, an oft-overlooked advantage of a SPIA is its capacity to increase bequests when used in conjunction with an investment portfolio.

Having the guaranteed income from a SPIA can provide retirees with the confidence to keep other assets earmarked for future generations invested for growth. According to a study by Milliman Research, such an arrangement can increase the chances of meeting their retirement income goal from 77% to 95% based on an average life expectancy of 31 years. It can also increase the average bequest to heirs by as much as 41% over a mutual fund-only portfolio. The idea is that while a SPIA and social security cover basic needs, your investment portfolio can pay for your lifestyle comforts and any legacy you want to pass on to your heirs or a charity.

SPIA Case Study: Creating a Personal Pension Plan and a Sizable Legacy Click To Tweet

Case Study: Mass Affluent, Widowed Retiree

Such a strategy works especially well for the mass affluent retiree, whose primary concern is lifetime income sufficiency that will continue to support a comfortable lifestyle while also providing a legacy for her children.

Marilyn, a long-time resident of the Bay Area near Silicon Valley, has led a comfortable life. She survives her husband who ran a successful business. With her children living nearby, she wants to remain in her home, which she owns free and clear. Marilyn is retiring from her job as a business development officer for a technology recruiting firm and she wants $100,000 in retirement income to maintain her comfortable lifestyle.

She has the following assets available for investing in her retirement income:

She expects to receive $32,000 a year from social security, leaving a need to generate $78,000 from her assets.

Although she likes the idea of safety, she knows her assets could not generate enough income if invested purely in CDs. And, fearing a catastrophic market event such as she experienced in 2008, she doesn’t like the idea of relying solely on investment returns to draw down 4% of her assets each year.

Solution: A 40/60 – SPIA / Systematic Withdrawal Plan

A simple SPIA used with a Systematic Withdrawal Plan (SWP) would increase her guaranteed income floor from her $32,000 of social security income to more than $83,000 leaving an income need of just $17,000 to be generated annually from her investments.

Her allocation between the SPIA and an investment portfolio would be 40/60 — $800,000 in the SPIA and $1.2 million in a 100% equities account. A cash emergency fund would be established with $200,000. This reserve is available for unexpected expenses as well as a buffer for her SWP during years when the stock market declines. By accessing her cash reserves, she wouldn’t necessarily have to withdraw funds from her equities account when values are lower.

Here’s how the arrangement would look at the end of her first year of retirement using a single life SPIA from USAA Life Insurance Co.:

By age 85, her guaranteed income grows to $90,000 and her total income is more than $115,000; yet her investment account balance has grown to more than $2.1 million.

Because Marilyn created a high-income floor, the growth on her investment account exceeds her systematic withdrawal each year, allowing her account to continue to grow into a nice legacy for her children and grandchildren.

Akhil Lodha Author
Co-founder & CEO StratiFi Technologies

Building the industry standard for understanding portfolio risk through cutting- edge technology at Stratifi.

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