The Role of Inflation-Indexed Annuities

The decline of defined-benefit pension plans means that the average citizen is now responsible for building a personal portfolio, managing that portfolio, and then, in retirement, deftly withdrawing from that portfolio just the right amount of cash each year for living expenses.

Adding salt to the wound, increasing longevity means we can potentially expect to live several decades after leaving the workforce. These two facts put a lot of pressure on individual investment performance, turning retirement planning into a high-stakes game.

But none of us are born knowing how much cash can safely be withdrawn from a portfolio, and few of us know how to effectively manage investments over the long term.

Plus, the most cost-effective way to provide lifetime income in retirement is through large, pooled groups. (People who die early subsidize people who live beyond average life expectancy.) That’s what a well-designed pension is all about. But that sharing of longevity risk is sorely missing from the 401(k)-type investment vehicles now underpinning most people’s savings. As a result, most people have no intuitive sense of how much lifetime income they can truly expect to reap from their retirement portfolios.

Fortunately, trends are afoot to address this situation. For example, government policy shows signs of changing. One key provision in the proposed Lifetime Income Disclosure bill (S. 267) requires employers to disclose to workers annually, in a standardized format, how their retirement balances would translate into monthly lifetime income. (This data might surprise those investors who have been feeling rich because “I have a lot more investments than either Dad or Grandpa ever had.” But those generations had defined-benefit pension plans, the present values of which were a lot more than the typical current 401(k) account.)

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