Financial Opinion and Insights

Converting Savings to a Lifetime Income

Jim Lorenzen, CFP®, AIF®

It seems there are more stories in the financial press today concerning people being afraid of outliving their money.  Who can blame them?   And, this concern isn’t confined to just the poor or middle class, either!  Believe it or not, the mass affluent and even the wealthy are concerned, too.  After all, it doesn’t do you much good to have $10 million if you’re consuming $1 million per year… that’s a recipe for disaster, too.

Ever since the market melt-down, many insurance companies have been rushing to market with retirement income products designed to provide a stream of income for life – a concept fairly new to the typical investor.

Most people are familiar with the old ‘pension plan’ most companies used to have.  You worked for a company for thirty years and retired with a pension.  That’s something that’s easy to understand; but, what most people didn’t realize was what was going on behind the scenes:  Companies would be funding the plan based on what their computations indicated  would be needed to arrive at the promised benefit amount.  For example, if an employee’s pension was projected to be $30,000 per year and the computations indicated that enough capital would have to be accumulated to achieve a 4% withdrawal rate, the company would invest to reach a $750,000 target – I’m oversimplifying, but you get the idea.  What the employees didn’t really think about was that the $750,000 would be converted at the end to a stream of income.

Today, most plans are defined contribution plans, i.e., 401(k)s and the like.  So, people are funding their own retirement and ending up with a lump-sum just like the employers of old would; but, the idea of converting that lump sum, or any part of it, to an income stream is a foreign concept to most investors – they weren’t managing pension funds in the old days, so why would they be familiar with the concept now?  Most people see it as giving up liquidity; but, exchanging liquidity for an income stream just might make some sense for part of someone’s nest-egg.

Why do I say ‘part’?  Like anything in life, nothing comes without some kind of risk.  The two front-burner risks an investor should be aware of are these:  (1) inflation, and (2) security.

  1. Does your income replacement product come with inflation adjustments?  How many times and how often? 
  2. The ‘guaranteed income’ is only as good as the insurance company backing it.  Insurance company products should be viewed as “IOUs”… not worth much if the company won’t be around; and don’t be dazzled by the ratings… remember Fannie and Freddie? 

Now, I don’t sell insurance – or anything else for that matter – so, you might want to get a referral to a quality insurance agent to learn more about these.  I would suggest looking for an agent who has a CFP®, ChFC®, or CLU credential.  And, it wouldn’t hurt to do some of your own independent study about these products before you begin talking with them – you’ll at least know what questions to ask.


Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  Additional resources:   IFG Investment Blog. Retirement Plan Insights Archive.  Twitter:  @JimLorenzen.  See IFG on Brightscope.

Written by Jim Lorenzen, CFP®, AIF®

May 15, 2012 at 8:00 am