Tuesday, July 29, 2014

Nest Egg Choices

Until recently, retirees with defined contribution plans (401ks for those here in the States) had to buy an annuity, which provided a guaranteed stream of payments for life, when entering retirement.   Given the low interest rates over the last few years, it doesn't surprise FLG that this has come into question.   If you happen to retire when rates are low, then you are pretty much screwed with low payments for life. 

Buttonwood mentions that independent advisers are now going to be helping retirees.  He's skeptical of all the conflicts of interest, but this really struck a cord with FLG:
When the government abolished the need to annuitise, it was hailed as a great populist move. I worried at the time that this was a mistake; annuity rates are low because bond yields are low and people live longer. If people think that they can beat what is, in essence, the risk-free rate, they will have to take risk. And who will they blame when the risk goes wrong and they run out of money in their late 70s, as will inevitably be the case for some people? Not the independent advice centre, one suspects
Assuming a retiree does some comparison, then the annuity rate should be the risk free rate.   Therefore, anything above that is by definition risky.

FLG's Personal Wealth Management professor suggested pouring enough money into TIPS so as to guarantee bare minimum nest egg at retirement and subsequent lifetime stream of payments.  Anything above that, which necessarily entails risk, would be gravy.   When you run the numbers in a extremely low interest rate environment like today with the a multi-decade retirement, the prospect of saving even a subsistence level nest egg is downright daunting.  But that doesn't change that doing anything else pretty much necessitates taking on risk.  And with risk, somebody is going to lose out.

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