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Can An Annuity Create Your Personal Pension?

Personal Pension

A legitimate question that I frequently get is “How does a pension work?” In an almost pension-less world, it is understandable why people need more clarity on this subject. The short answer is a pension is a lifetime income stream. If you work for a government entity or union, you probably already have a pension. Lucky you! Social Security payments also function as a pension because you can never outlive the payments.

Most Americans have no pension type income guarantees in place other than their Social Security. Because of that, they are having to create their own personal or private pensions to fill in that needed income floor of payments that pay for life. After retiring from work, having enough income to live comfortably is a primary goal.

As much as it pains some financial pundits and (stock market only focused) advisors, annuities are the only solution to create your own personal pension. I know it’s trendy to “hate all annuities,” but it’s the only financial product that guarantees an income stream regardless of how long you live. It’s a monopoly that only annuities can offer.

So, let’s take a look at how annuities can help you create that additional pension income stream, and how you can create your own personal pension fund.

Demographic Tidal Wave

Due to 10,000 baby boomers reaching retirement age every single day, there is a demographic tidal wave of Americans searching for more guaranteed income. In my opinion, every retirement plan should have guaranteed income strategies that work in conjunction with Social Security payments.

Because traditional pension plans are scarce in the private sector, your investment decisions as you get older should be transitioning to lifetime income. There are many types of retirement plans available, but the majority do not have transfer of risk income choices.

Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), Qualified Longevity Annuity Contracts (QLACs), and Income Riders attached to some deferred annuities all offer lifetime income guarantees. Each can serve as a personal pension plan, and all should be shopped for the highest contractual payout for your specific situation and goals.

Growth To Income

I get questions like “Is a pension plan the same as a 401k?” or “Is a 401k or a pension plan better?” The answer…apples and oranges. They are not the same...and one isn’t better than the other. Most 401k plans are in place to grow your money, with employees’ contributions combining with employers' contributions for tax-advantaged (i.e. tax-deferred) growth. Your employer matches a percentage of the worker’s contribution to the plan, and the rest is up to the employee for turning that lump sum into income when they retire. In most cases, that means shopping all annuity carriers for the highest payout available.

A defined contribution plan (aka 401k) is what most employers offer as a retirement plan choice. Now a “pension plan vs 401k” can be easily broken down. One is for lifetime income and one is growth. As you move toward retirement, most people transition from focusing on growing their money to focusing on converting some or all to income.

No More Gold Watch

In the past, you went to work for a company for life. You retired, got a gold watch, and hopefully a pension payment that you could live comfortably on. That Norman Rockwell painting no longer exists.

Only a small percentage of companies currently offer pension plans (aka defined benefit plan) to their employees, so it’s up to the worker to figure out how to create their own pension plan.

Most Americans have no pension type income guarantees in place other than their Social Security. Because of that, they are having to create their own personal or private pensions

Most current pension plan participants are government or union workers (i.e. public sector) because defined benefit pension plans and cash balance plans are few and far between in the private sector.

This is when annuities have to come into play for lifetime income needs. Single Premium Immediate Annuities (SPIAs) are the most efficient, pro-customer choice for income needs that need to start as soon as 30 days up to one year. SPIAs have no annual fees, no moving parts, and the payments are primarily based on your life expectancy at the time you start the payments. SPIAs are the best choice for most circumstances when it comes to creating your personal pension.

DC Helping DC’s

With the Secure Act being signed into law in December of 2019, our friends in DC are now encouraging 401k plans to offer annuity income strategies as part of the plan investment choices. This is a good thing and a welcomed addition to retirement plan strategies.

In 2014, the Department of Labor and the IRS introduced Qualified Longevity Annuity Contracts (QLACs) for use in qualified accounts. This helps the people plan for future income since most Americans do not have pension benefits through their employer. QLACs are growing in popularity every year as people learn more about simple future pension products.

Washington, DC has made some positive moves in the past. They’ve established the Pension Benefit Guaranty Corporation (PBGC) to ensure plans, as well as the Employee Retirement Income Security Act (aka ERISA) to establish minimum standards for private pension plans. These are both good foundational entities, and the addition of the Secure Act is a definite step in the right direction. People need to start planning for future income needs and not just rely on Social Security as their only lifetime payment source.

Life Expectancy Matters

Because most of the employers during your career probably never offered a pension, you have to take the steps to create your own personal pension.

So, what is a pension plan and how does it work? In essence, it’s a transfer of risk lifetime income stream using an annuity. It’s important to point out that the income stream will be taxed at ordinary income levels.

For your own pension plan, you need to decide on a few key points:

  1. If you want the lifetime income stream to cover your life or joint-life with a spouse/partner.
  2. Whether you want to invest a lump sum or reverse engineer a quote to solve for a specific monthly dollar amount
  3. How soon you want the lifetime income stream to start, or the number of years you want to defer until the scheduled payments begin
  4. Find an annuity calculator or personal pension plan calculator that objectively shops all carriers for the highest contractual guarantee for your specific situation.

Understand that annuity quotes are like a gallon of milk, and expire every 7 to 10 days unless you lock those numbers in during the application process. Also, remember that annuities are transfer of risk contracts. There’s “No ROI till you die.” ROI stands for return on investment.

Creating your own personal pension has become part of the retirement process. Enjoy the journey and the lifetime income.