How fix a critical flaw in 401(k) plans

"Longevity risk, the possibility that retirees will outlive their savings, is one of the most significant threats to retirement security. Yet, many defined contribution (DC) retirement plans do not include any guaranteed lifetime-income features or other functions to help manage the challenges of the financial drawdown phase of retirement."

That's how a recent comprehensive report from the Bipartisan Policy Center (BPC) summarizes one of six serious challenges to Americans' retirement security.

Simply put, most 401(k) and other DC retirement plans focus on accumulating savings for retirement, but they provide little guidance or support for retirees who want to use their savings to generate retirement income. Indeed, most retirees are left on their own to manage their savings for the rest of their potentially long lives.

Plenty of evidence shows that retirees are struggling with the reality of managing their savings, and they tend to fall into two camps regarding this issue.

The first camp "wings it" and withdraws amounts needed to meet their current spending needs, without much planning to ensure their savings last for a lifetime. Many such retirees plan to withdraw their savings at a fairly high rate, with the unfortunate result that most will experience "money death" before physical death -- they'll outlive their savings.

The second camp takes an opposite strategy, withdrawing as little as possible, hoping to preserve this money for a rainy day. Popular retirement blogger Michael Kitces neatly tackles the issues with this strategy in a recent post, "Why Most Retirees Will Never Draw Down Their Retirement Portfolio." And many retirees are using this strategy, according to a recent study from the Society of Actuaries that reported on the results of interviewing focus groups of people who've been retired for 15 years or more.

Retirees who have the ability to stick with such a strategy stand a pretty good chance of making their money last for their entire life, but there's also a good chance they'll die with a substantial amount of money left unspent. While some retirees may welcome this outcome so they can leave money to their heirs, others might want to spend more while they're alive so they can better enjoy their retirement.

Fortunately, there's a middle ground: You can develop a thoughtful strategy for making your retirement income last for life and preserve some funds for that rainy day. Such a strategy might involve deploying retirement savings to four potential uses:

  • Use savings to optimize Social Security benefits, often by postponing these benefits for the primary wage earner for as long as possible (but no later than age 70).
  • Invest a portion of savings for growth potential and withdraw it at a prudent rate (called systematic withdrawals).
  • Deploy a portion of savings to purchase an annuity from an insurance company that will guarantee a lifetime income and protect against stock market volatility.
  • Set aside a reasonable amount of savings that you can use to pay for unexpected expenses.

The BPC report contains nine policy recommendations that would encourage employers to offer easy-to-use retirement income generators in their DC retirement plans and help guide older workers to make informed choices to generate lifetime retirement income. If adopted, these recommendations would certainly help older workers and retirees follow strategies to generate reliable retirement income and boost that income in the process.

However, employers will need motivation to spend the time and money to make the necessary enhancements. The BPC report notes that to date, when employers offer retirement-income options in their plans, uptake is fairly modest. Employers will be more motivated when many older workers request help with managing their savings in retirement.

On the flip side, older workers need to learn about the various methods to generate retirement income from their savings, and they should ask their employers for help with this critical planning task. If you're approaching retirement, you can politely ask your employer to consider the enhancements outlined in the BPC report. If enough colleagues make the same request, enlightened employers might respond.

Meanwhile, if you're retiring in the next year or two, you'll likely be on your own to generate retirement income from your savings, or you'll need to shop for a qualified, unbiased adviser who can help you. In any case, investigating your options and creating a workable plan is highly recommended.

You'll thank yourself when you reach your 80s or 90s and still have enough income to cover your expenses, no matter how long you and your spouse or partner live.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.