MONEY Pensions

Here’s a New Reason to Think Twice About Trading In Your Pension

More workers are being offered lump-sum pension buyouts. But the information packets they receive leave out crucial details, a GAO study finds.

If you are due a pension from a former employer, there is a good chance you were or soon will be offered a lump-sum payment in exchange for giving up that guaranteed monthly check for life.

Should you take it? Probably not, but making a smart decision depends on a complex set of assumptions about future interest rates, possible rates of market returns and your longevity. It is a tough analysis unless you have an actuarial background.

Unfortunately, employers are not providing enough information.

That is the conclusion of a recent review by the U.S. Government Accountability Office of 11 lump-sum-offer information packets provided to beneficiaries by pension plan sponsors.

The key failings included unclear comparisons of the lump sum’s value compared with the value of lifetime pension payouts. Also lacking were many of the explanations of mortality factors and interest rates used to calculate the lump sums.

Even more worrisome was missing information about the insurance guarantees that probably would be available to participants from the Pension Benefit Guarantee Corp in the event of a sponsor default.

That is a major problem because fear of pension failure is one of the biggest factors driving participants to accept lump-sum offers. Having PBGC insurance is like having your bank deposits guaranteed by the Federal Deposit Insurance Corp; if a plan fails, most workers receive 100% of the benefits they have earned up to that point.

The GAO did find that the packets were in compliance with the Internal Revenue Service rules on disclosures to employees. However, it urged the U.S. Department of Labor to tighten reporting requirements on lump-sum offers and to work with other federal agencies to clarify the guidance sponsors should be providing.

Better information certainly would be helpful to beneficiaries as the lump-sum trend continues to grow.

Private sector pension plans are trying to lower their risk that recipients will live longer and therefore collect more than the actuaries originally planned.

Twenty-two percent of sponsors say they are “very likely” to make lump-sum offers to former, vested workers this year, up from 14% in 2014, according to a study by Aon Hewitt, the employee benefit consulting firm.

But better information alone is not likely to lead to better decisions,” says Norman Stein, a law professor at Drexel University and an expert on pension law.

Beneficiaries often make up their minds based on emotional factors like fear of a pension plan default or the appeal of getting a large pile of cash up front, says Steve Vernon, an actuary and consulting research scholar at the Stanford Center on Longevity.

In most cases, beneficiaries will come out ahead by sticking with a monthly check from a pension, but you should evaluate the lump-sum offer against such factors as your likely life expectancy and other sources of guaranteed income (Social Security or a spouse’s pension).

Some beneficiaries accept lump sums expecting to get better returns by investing the proceeds. But an apples-to-apples comparison requires measuring the rate of return used to calculate your lump sum against risk-free investments like certificates of deposit or Treasuries. After all, most private-sector pensions are a guaranteed income source backed by the U.S. government.

You could also take the lump sum and buy an annuity, but these commercial products typically will generate 10% to 30% less income than your pension, Vernon says.

“A good measure of the lump sum offer is to calculate how much it would cost you to buy that annuity from an insurance company,” he says.

You can get an estimate of a lump-sum conversion at ImmediateAnnuities.com. Vanguard offers an annuity marketplace for its customers.

But Vernon has a more basic way to think about a lump-sum decision.

“Just the fact that employers call this ‘pension risk transfer’ should give you pause,” he says. “These big corporations want to transfer mortality and interest risk to you because they don’t want it.

“Ask yourself: ‘Why should I take something my employer doesn’t want?'”

Read next: Here’s How to Tell If You’re Saving Enough for Retirement

MONEY retirement planning

Why Your Empty Nest May Be Hazardous to Your Retirement

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Alamy—© Mode Images / Alamy

You may want to live a little when your kids leave home. But what you do with that money can make or break your retirement, a new study finds.

How well prepared you are for retirement may come down to one simple question: what do you do with money that once would have been spent on your kids?

In recent years, two common models of retirement preparedness in America have begun to draw vastly different pictures. The optimal savings model, which looks at accumulated savings, concludes that only 8% of pre-retirees have insufficient resources to retire comfortably. The income replacement model, which looks at the level of income that savings will generate, concludes half the working age population is in deep trouble.

These two models incorporate many different assumptions, which is why they can reach contradictory conclusions. For one thing, the optimal savings model assumes savings are held in something like a 401(k) plan and drawn down over time. The income replacement model assumes savings are converted to lifetime income through an annuity at retirement.

Accounting for these and many other differences, researchers at the Center for Retirement Research at Boston College have concluded that the key variable in retirement readiness is empty nest spending patterns. “If households consume less once their kids leave home, they have a more modest target to replace and they save more between the emptying of the nest and retirement,” the authors write. This creates a financial comfort level that those who spend the same amount—most likely on themselves—have greater difficulty achieving.

When the more conservative empty nest spending assumptions of the optimal savings model are applied to the income replacement model, the level of retirement preparedness is similarly optimistic. What the paper cannot answer, however, is which model accurately reflects the way empty nesters behave.

“Do parents cut back on consumption when kids leave, or do they spend the slack in their budgets?” the authors write. “No one really knows the answers.” How households react when kids leave the fold is not well understood, they say.

Yet that’s a problem for academics. You can control the way you act. The upshot is that if you resist the temptation to spend instead of save the money your kids were costing you, retirement readiness may be at your fingertips.

Read next: 5 Ways to Know If You’re on Track to Retire Early

MONEY Social Security

Why Social Security Benefit Rules Are Making Inequality Worse

Laurence Kotlikoff, an economics professor at Boston University.
Jodi Hilton—The New York Times/Redux Laurence Kotlikoff, an economics professor at Boston University

Benefit rules are so complex that a new book on claiming strategies has become a best-seller. Here’s how to get it right.

If you find Social Security rules bewildering, don’t feel too bad; so do Social Security experts. As Boston University economics professor Larry Kotlikoff points out, the 2,728 Social Security rules, if you print them out, are longer than the federal tax code. Little wonder his new book explaining to how to max out Social Security benefits—Get What’s Yours, co-authored with MONEY contributor Philip Moeller and PBS journalist Paul Solman—landed on the New York Times and Amazon best-seller lists. Kotlikoff recently spoke to MONEY about the program’s shortcomings and the best way to claim benefits.

Q: Why are Social Security rules so maddeningly complicated?

A: The system was designed decades ago by older white males who may have had their own interests somewhat at heart. In any case, it awards benefits unfairly. Single people are at a disadvantage to married couples, who have more types of benefits available to them. Married couples with two earners are at a disadvantage to those with one earner. The disabled are also treated unfairly.

Worse, whether you get all the benefits you are entitled to is a random process. It all depends on whether you understand the complex system, and you get the right information from customer representatives, who aren’t well trained. Americans are leaving billions on the table as a result. But higher-income people are better able to take advantage of Social Security’s claiming options. This worsens economic inequality.

Q: You’re an advocate for entitlement reform, yet you’re also encouraging Americans to max out their benefits. Isn’t that contradictory?

A: I want to expose inequities wherever they are. I’ve written about the nation’s generational inequities [“The Coming Generational Storm“], and the expropriation of money that should go to our kids because of the ballooning costs of these programs. But Social Security rules are a disgrace and unfair to people of all ages. No one should get more benefits just because they know the rules.

Q: Given the program’s funding problems, should younger Americans count on Social Security?

A: The system is 33% unfunded, according to the last trustees’ report. So somebody has to pay to fix it. My co-authors and I don’t agree on how to fix things—there’s a debate about solutions in the book. I explain my preferred solution at the Purple Social Security Plan.

Still, I think people 55 and older will get their full benefits. It’s too difficult politically to change their treatment. Younger people will likely receive something, but they’ll probably pay for it with higher taxes.

Q: What is the biggest mistake people make when they claim?

A: For many households, the problem is claiming benefits too early. If you wait to claim till age 70, you can increase your benefits by 76%, compared with starting at age 62, the earliest age you can claim. By delaying, you have an opportunity to tap a source of guaranteed inflation-proof income at an incredibly low price. That said, many people can’t afford to wait, since they have no other means of support.

Q: Many financial planners recommend claiming based on your “break-even” age—how long it will take for higher benefits claimed at a later age to exceed what you’d get by claiming early at 62.

A: This is a fundamental misunderstanding. People mistakenly look at Social Security as an investment, and they try to figure out the break-even point, when they’ll make their money back. They don’t understand the economics of working longer, or how to value the extra income you get by waiting.

Social Security is insurance—an inexpensive, safe payout—not an investment. You don’t look at your homeowners’ insurance on a break-even basis. You look at the worst-case scenario, which is your house burned down, you have no place to live, and the insurance is there when you need it. The worst-case scenario here is living to 100 and running out of money well before then.

Q: Have you figured out your own Social Security claiming strategy?

In my case, it’s relatively straightforward—I can just look at my own book, and I don’t need to use my claiming software (MaximizeMySocialSecurity). I’m 64, and I’m older than my ex-wife and my fiancée. They’ll both be able to claim spousal benefits on my earnings record. I’m going to wait till age 70, and then collect my benefit.

Read next: The 3 Secrets to Maxing Out Social Security Spousal Benefits

MONEY Ask the Expert

The 3 Secrets to Maxing out Social Security Spousal Benefits

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: My wife was born in 1950 and will be 65 this year; I was born in 1953 and will be 62. As I have earned more in my lifetime, my Social Security benefit is estimated to be larger than hers at full retirement age. But her spousal benefit would be less than half of her individual retirement benefit. When the younger spouse has a higher estimated benefit, what are some strategies to explore? —Jack

A: If there’s one set of rules worth understanding, it’s spousal benefits. Every year, couples leave literally billions of dollars on the table because they make the wrong claiming choices. Here are three secrets to getting this claim right, and how they apply to your situation:

1. To get spousal benefits, the primary earner must file for retirement benefits first. Spousal benefits can equal as much as half of the amount the person would receive in individual Social Security benefits at full retirement age (FRA). For anyone born in 1943 through 1954, FRA is 66; it will gradually rise to 67 for people born in 1960 or later.

2. If you file for a spousal benefit before your FRA, you will end up with a smaller amount. You can file as early as age 62 but if you do, you will be hit with benefit reductions. Retirement benefits will rise each month they are deferred between FRA and age 70. Spousal benefits peak at FRA, so there is no reason to defer claiming them past that point.

An early filing will also trigger a Social Security provision called deeming—this means the agency considers you to be filing both for your individual retirement benefit and you spousal benefit. You will be paid an amount roughly equal to the greater of the two benefits. But you lose the opportunity to get increases for delayed claiming on your individual benefits. This is a bad deal.

3. Use a file-and-suspend strategy. If both spouses defer claiming until FRA, the higher-earning spouse can file and suspend benefits then. This way, the lower-earning spouse can file for spousal benefits, allowing his or her individual retirement benefit to grow due to delayed retirement credits. Then you can each file for maximum retirement benefits at age 70.

So what’s the right approach for you? If you both defer filing, you can file and suspend your benefit at age 66. This will enable your spouse, who will have turned 69, to file for her maximum spousal benefit. Meanwhile, she can continue to allow her individual benefit to grow due to delayed credits up to age 70

Alternatively, your wife can file and suspend at 69, allowing you to file for your maximum spousal benefit at 66 and collect it for four years, while deferring your own retirement benefit until 70. Even though you are the higher earner. this strategy seems likely to maximize your family’s total benefits.

There’s another advantage to waiting until 70: if you die before your wife, she will receive a widow’s benefit that will equal your maximum retirement benefit. (She can only collect the greater of her retirement or widow’s benefit.)

Of course, choosing the best spousal claiming strategy for a couple depends on many factors, including relative ages, finances and health. This is something married partners need to talk about.

Best of luck!

Philip Moeller is an expert on retirement, aging, and health. He is the co-author of “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and a research fellow at the Center for Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: New Rules for Making Your Money Last in Retirement

MONEY Savings

5 Signs You Will Become a Millionaire

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Martin Barraud—Getty Images

A million isn't what it used to be. But it's not bad, and here's how you get there.

A million bucks isn’t what it used to be. When your father, or maybe you, set that savings goal in 1980 it was like shooting for $3 million today. Still, millionaire status is nothing to sniff at—and new research suggests that a broad swath of millennials and Gen-Xers are on the right track.

The “emerging affluent” class, as defined in the latest Fidelity Millionaire Outlook study, has many of the same habits and traits as today’s millionaires and multimillionaires. You are in this class if you are 21 to 49 years of age with at least $100,000 of annual household income and $50,000 to $250,000 in investable assets. Fidelity found this group has five key points in common with today’s millionaires:

  • Lucrative career: The emerging affluent are largely pursuing careers in information technology, finance and accounting—much like many of today’s millionaires did years ago. They may be at a low level now, but they have time to climb the corporate ladder.
  • High income: The median household income of this emerging class is $125,000, more than double the median U.S. household income. That suggests they have more room to save now and are on track to earn and save even more.
  • Self-starters: Eight in 10 among the emerging affluent have built assets on their own, or added to those they inherited, which is also true of millionaires and multimillionaires.
  • Long-term focus: Three in four among the emerging affluent have a long-term approach to investments. Like the more established wealthy, this group stays with its investment regimen through all markets rather than try to time the market for short-term gains.
  • Appropriate aggressiveness: Similar to multimillionaires, the emerging affluent display a willingness to invest in riskier, high-growth assets for superior long-term returns.

Becoming a millionaire shouldn’t be difficult for millennials. All it takes is discipline and an early start. If you begin with $10,000 at age 25 and save $5,500 a year in an IRA that grows 6% a year, you will have $1 million at age 65. If you save in a 401(k) plan that matches half your contributions, you’ll amass nearly $1.5 million. That’s with no inheritance or other savings. Such sums may sound big to a young adult making little money. But if they save just $3,000 a year for seven years and then boost it to $7,500 a year, they will reach $1 million by age 65.

An emerging affluent who already has up to $250,000 and a big income can do this without breaking a sweat. They should be shooting far higher—to at least $3 million by 2050, just to keep pace with what $1 million buys today (assuming 3% annual inflation). But they will need $6 million in 2050 to have the purchasing power of $1 million back in 1980, when your father could rightly claim that a million dollars would make him rich.

Read next: What’s Your Best Path to $1 Million?

MONEY Longevity

The New Rules for Making Your Money Last in Retirement

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Murat Giray/Getty Images

In today's longevity economy, retirement as we know it is disappearing. Here's what to do now.

Are you ready to live to age 95—or beyond?

It’s a real possibility. For an upper-middle-class couple age 65 today, there’s a 43% chance that one or both will reach at least age 95, according to the latest data from the Society of Actuaries.

Living longer is a good thing, of course. But there’s a downside—increasing longevity may mean the end of retirement as we know it.

Problem is, a long lifetime in retirement is a huge financial challenge. As Laura Carstensen, head of Stanford Center on Longevity, said in a recent presentation, “Most people can’t save enough in 40 years of working to support themselves for 30 or more years of not working. Nor can society provide enough in terms of pensions to support nonworking people that long.” Instead, Carstensen argues, we need to move toward a longer, more flexible working life.

Carstensen is hardly alone here. Alicia Munnell, head of the Center for Retirement Research at Boston College and a co-author of “Falling Short: The Coming Retirement Crisis and What to Do About It”, has long warned about the nation’s lack of retirement preparedness. Following the Great Recession, Munnell has pounded away at the reality that continuing to work is the only feasible strategy for many people if they wish to have any hope of affording even modestly comfortable retirements.

For many retiring Baby Boomers, the notion of working longer has appeal—not only for the additional income but as a way of staying involved and giving back. That’s what spurred Marc Freedman, founder of Encore.org, to encourage older workers to use their skills for social purpose. Chris Farrell, a Money contributor, captures this movement in his recent book, “Unretirement: How Baby Boomers are Changing the Way We Think About Work, Community, and the Good Life.”

Still, to afford a longer life, Americans will have to rethink their savings and withdrawal methods too. Right now, most retirement calculators default to no more than a 30-year time horizon. What if you want to keep your retirement income going past age 95? Fidelity’s planners suggest three alternatives that can help:

*Stay on the job longer. Say you are a 65-year old woman who earned $100,000 a year, and you have a $1 million portfolio. You’ll also receive a $30,000 Social Security benefit ($2,500 a month) and you plan to withdraw an initial $50,000 a year from your portfolio. All told, you’ll have $80,000, or 80% of your pre-retirement income. If inflation averages 2%, and the portfolio grows by 4%, your savings will likely last for 25 years, or until age 90. After that, odds are the money will run out.

But if you instead work four more years, until age 69, and keep saving 15% of your income, your portfolio will grow to $1,240,000. That would be enough to provide income for eight more years—until age 98.

*Postpone Social Security. Another move is to work two more years and defer claiming Social Security till age 67, which means your monthly benefit will rise from $2,500 to $2,850. That would replace 35% of her income, instead of 30%, and her portfolio would need replace just 45% of your pre-retirement earnings vs 50%. By age 67, your portfolio will total $1,110,000, which will deliver retirement income till age 98.

*Consider an annuity. You could purchase an immediate annuity, which would give you a lifetime stream of income. The trade-off, of course, is that your money is locked up and payments will cease when you die (unless you add a joint-and-survivor option, which would reduce your payout). Many advisers suggest using only a portion of your portfolio to buy an annuity—you might aim to cover your essential expenses with a guaranteed income stream, which would include Social Security.

A 65-year-old woman who invested $200,000 in an immediate annuity with a 2% annual inflation adjustment would receive guaranteed monthly payments of about $870 a month, or $10,440 a year, according to Income Solutions. Added to Social Security, this income would replace roughly 40% of a $100,000 salary, which will allow the rest of the portfolio to keep growing longer.

But make no mistake. This is a big decision, and many investment experts oppose locking up money in an annuity, given today’s low interest rates. But longevity investing raises the appeal of guaranteed streams of income, and annuity payouts will become more attractive if and when interest rates slowly rise toward historical norms.

Philip Moeller is an expert on retirement, aging, and health. He is the co-author of “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and a research fellow at the Center for Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: The Suddenly Hot Job Market for Workers Over 50

MONEY retirement planning

How to Balance Spending and Safety in Retirement

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Roberto A. Sanchez—Getty Images

Every retirement withdrawal method has its pros and cons. Understanding the differences will help you tap your assets in the way that's best for you.

You’ve saved for years. You’ve built a sizable nest egg. And, finally, you’ve retired. Now, how do you withdraw from your savings so your money lasts as long as you do? Is there a technique, a procedure, a product that will keep you safe?

Unfortunately, there is no perfect answer to this question. Every available solution has its strengths and its weaknesses. Only by understanding the possible approaches, then mixing them together into a personal solution, will you be able to move forward with an enjoyable retirement that balances both spending and safety.

Let’s start with one of the simplest and most popular withdrawal approaches: spending a fixed amount from your portfolio annually. Typically this is adjusted for inflation, so the nominal amount grows over time but sustains the same lifestyle from year to year. If the amount you start with, in year one of your retirement, is 4% of your portfolio, then this is the classic 4% rule.

The advantages of this withdrawal method are that it is relatively simple to implement, and it has been researched extensively. Statistics for the survival probabilities of your portfolio, given a certain time span and asset allocation, are readily available. This strategy seems reliable—you know exactly how much you can spend each year. Until your money runs out. Studies based on historical data show your savings might last for 30 years. But history may not repeat. And fixed withdrawals are inflexible; what if your spending needs change from year to year?

Instead, you could withdraw a fixed percentage of your portfolio annually, say 5%. This is often called an “endowment” approach. The advantage of this is that it automatically builds some flexibility into your withdrawals based on market performance. If the market goes up, your fixed percentage will be a larger sum. If the market goes down, it will be smaller. Even better, you will never run out of money! Because you are withdrawing only a percent of your portfolio, it can never be wiped out. But it could get very small! And your available income will fluctuate, perhaps dramatically, from year to year.

Another approach to variable withdrawals is to base the amount on your life expectancy. (One source for this data is the IRS RMD tables.) Each year you could withdraw the inverse of your life expectancy in years. So if your life expectancy is 30 years, you’d withdraw 1/30, or about 3.3%, in the current year. You will never run out of money, but, again, there is no guarantee exactly how much money you’ll have in your final years. It’s possible you’ll wind up with smaller withdrawals in early retirement and larger withdrawals later, when you aren’t as able to enjoy them.

What if you want more certainty? Annuities appear to solve most of the problems with fixed or variable withdrawals. With an annuity, you give an insurance company some or all of your assets, and, in exchange, they pay you a monthly amount for life. Assuming the company stays solvent, this eliminates the possibility of outliving your assets.

Annuities are good for consistent income. But that’s also their chief drawback: they’re inflexible. If you die early, you will leave a lot of money on the table. If you have an emergency and need a lump sum, you probably can’t get it. Finally, many annuities are not adjusted for inflation. Those that are tend to be very expensive. And inflation can be a large variable over long time spans.

What about income for early retirement? It’s unwise to draw down your assets in the beginning years, when there are decades of uncertainty looming ahead. The goal should be to preserve net worth until you are farther down the road. If your assets are large enough, or the markets are strong enough, you can live off the annual interest, dividends, and growth. If not, you may need to work part-time, supplementing your investment income.

Every retirement withdrawal technique has drawbacks. Some require active management. Some can run out of money. Some don’t maintain your lifestyle. Some can’t handle emergency expenses or preserve principal for heirs. Some may be eroded by inflation.

That’s why I believe most of us are going to construct a flexible, “hybrid” system for living off our assets in retirement. We’ll pick and choose from the available options, combining the benefits, while trying to minimize the liabilities and preserve our flexibility.

Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com.

For more help calculating your needs in retirement:
The One Retirement Question You Must Get Right
How to Figure Out Your Real Cost of Living in Retirement
4 Secrets of Financial Freedom

MONEY Social Security

Why We Make Irrational Decisions About Social Security Benefits

piggy bank and hourglass
iStock

Everyone tends to over-weigh a sure gain compared with a slightly riskier gain, even if the expected value of the certain gain is lower.

Financial professionals often recommend that you wait until full retirement or even later before applying for social security benefits. An individual who’d receive $1,000 per month at full retirement age would get a mere $750 by claiming early at age 62. And that same person could get as much as $1,320 per month by waiting until age 70. For many Americans, it appears to make a lot of sense to wait.

As a general rule of thumb, if you expect to live beyond your late 70s, waiting until at least full retirement might be the smart choice. According to the Social Security Administration, a man reaching 65 today can expect to live until 84.3. And a woman turning 65 can expect to live until age 86.6. Given that one out of every four 65-year olds today lives past age 90, you’d assume that most folks would hang on until full retirement before applying for benefits.

That assumption would be wrong, however. In practice, many Americans seem to be ignoring the data. According to The New York Times, 41% of men and 46% of women choose to take their benefits at 62 — the earliest age possible. Why aren’t they listening to the experts?

Your Social Security and your brain

Obviously, there are some very rational reasons for claiming your benefits at 62. For example, you might have some serious health concerns. Or you may just really need the money. Sometimes real life is more complicated than insurance data and actuarial tables.

There might be another powerful reason that people aren’t even aware of, however. According to psychological research, we are all hardwired to lock in certain gains, even if such a decision has a lower expected value. In other words, our psychology could be leading us to make suboptimal financial choices when it comes to social security.

The price of certainty

The underlying principle involved here, which was highlighted in the work of Daniel Kahneman and Amos Tversky, is called the “certainty effect.” This idea is actually quite easy to understand. Essentially, everyone tends to over-weigh a sure gain compared with a slightly riskier gain, even if the expected value of the certain gain is lower.

Here’s an illustration of how it works. Suppose there are two options. Option 1 gives you a chance to win $9,500 with 100% certainty. Option 2, on the other hand, provides you with the opportunity to win $10,000 with 97% certainty, though there’s a 3% chance you will win nothing.

Even though the expected value of Option 2 is higher ($9,700 compared to $9,500), the “certainty effect” would predict that more individuals would choose Option 1 than Option 2. According to Kahneman:

People are averse to risk when they consider prospects with a substantial chance to achieve a large gain. They are willing to accept less than the expected value of a gamble to lock in a sure gain.

A team of academics recently tested this theory, and reported their findings in a paper titled “Risk preferences and aging: The ‘Certainty Effect’ in older adults’ decision making“. They discovered that “older adults were more likely than younger adults to select the sure-thing option when it was available — even if it had a lower expect value.” In other words, they not only found evidence supporting the “certainty effect,” they found that older adults were moresusceptible to it than younger ones. The overall conclusion of the study is very instructive:

… [W]hen it comes to the important decision whether to claim social security benefits at the earliest retirement age (i.e., 62 years old) and receive a sure but lower-dollar payout (i.e., up to 20% less) versus a higher-dollar payout a few years later at full (between 65–67 years old) or after full retirement age (at 70 years age at the latest, with a benefit increase between 4% and 8% for each year after full retirement age until age 70) at the risk of not being alive, older adults might sub-optimally go for the sure payout at the earliest possible age rather than delaying their retirement benefits; thus, permanently reducing their benefits.

Clearly, our instincts can inadvertently lead us astray on financial matters. As Jason Zweig notes in his classic book Your Money and Your Brain, “[I]nvestors habitually are their own worst enemies, even when they know better.” When deciding when to apply for social security benefits, it might be wise to remember how our brains are wired. Otherwise, you could be leaving a lot of money on the table.

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MONEY retirement income

Forget About Retirement Planning for Millennials

piggy bank with locks for earrings
YAY Media AS—Alamy

The goal of achieving financial independence is more appealing than the idea of saving for a retirement that's decades away.

When it comes to millennials and money, many financial planners are focusing on the wrong issue.

The retirement advice most financial professionals provide was designed for Baby Boomers. Gen Y’s situation, however, looks nothing like this 30-year-old norm.

Few members of Gen Y get excited about the idea of working for the next 40 to 50 years, doing all the heavy lifting when it comes to ensuring they’ll have enough savings for the future, and then retiring to a life of no work and no purpose shortly before expiring.

Yet traditional retirement planning asks people to do just that. This doesn’t make sense for millennials — but that doesn’t mean they should throw their financial security to the wind and have no plan at all, either.

Instead, we planners should shift the focus from the nebulous concept of “retirement” to something concrete and accessible. It should be something that millennials can take real action to achieve in the short-term, not something that won’t matter for 40 years.

We should focus on preparing Gen Y for financial independence.

What Is Financial Independence?

Financial independence refers to a situation where an individual can generate enough income to pay all expenses for the rest of his or her life. Typically, that refers to passive income that comes from savings and investments, but it might also come from a side business, real estate assets, or royalties from past work.

Financial independence frees individuals from the obligation to work a particular job in order to secure a specific paycheck. It’s possible when you’re in your 20s to start building the income streams that will meet your needs for life and help you reach independence. Creating a side job that earns $500 a month today could build to provide $1,000 a month in a few years and $2,000 a month in five or 10 years.

Don’t believe it? You must not get around the blogosphere much.

Financial bloggers — not advisers or planners — have been championing this concept for years. The idea of financial independence is gaining traction thanks to bloggers popularizing it — and succeeding at it themselves.

One example: Mr. Money Mustache, a financial blog run by a man who reached financial independence in his 30s. By investing 50% to 75% of his income during his working career in his 20s and early 30s, he reached financial independence before 40.

Other bloggers have reached financial independence by building and selling a business or investing in multiple real estate properties that generate monthly income.

But the most popular way is probably the most accessible: save huge percentages of income. Bloggers, even the ones not as Internet-famous as Mr. Money Mustache, frequently report saving anywhere between 30% and 70% or more of their income. The majority of this group then invests that money in inexpensive, passively-managed index funds.

They don’t need $1 million to $3 million in the bank when they’re 63 years old. Instead, they may need to reach an investment goal of $250,000 or $500,000 in assets before they can start withdrawing 3-4%, because along with other income streams this is enough to cover their expenses each year for life.

Why Financial Independence Is the Financial Planning Answer for Gen Y

Financial independence makes sense for Gen Y because it’s more realistic, and it’s something that people don’t have to wait until they’re 60 or 70 years old to achieve.

Building income streams allows individuals to achieve financial independence within years, if those income streams are sound and stable. Even working toward financial independence via saving and investing can be accomplished in a fraction of the time it normally takes people to achieve retirement goals. Invest 50% of your income, for example, and you’ll reach financial independence in 17 years; save 75% and you’ll be there in 7 years.

And financial independence allows you to experience the kind of freedom that “retirement” does not. Free from the obligation of working a job because it’s necessary to pay bills allows financially independent people to explore new work, projects, businesses, and opportunities. It enables individuals to try new hobbies or go new places that old age and ill health may eliminate in traditional retirement after a decades-long working career.

We shouldn’t focus on traditional retirement planning for millennials. Instead, let’s give them the tools and knowledge they need to reach financial independence.

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Alan Moore, CFP, is the co-founder of the XY Planning Network, where he helps advisers create fee-only financial planning firms that specialize in working with Generation X & Generation Y clients.

MONEY retirement income

Simple Steps to Avoid Outliving Your Money in Retirement

Nearly all workers say guaranteed lifetime income is important in retirement. Yet few are doing anything about it.

The slow switch from defined-benefit to defined-contribution retirement plans has been under way for three decades. But only now are workers starting to fully appreciate the impact.

The vast majority of Americans say that having a guaranteed monthly check for the rest of their lives is important, according to a TIAA-CREF lifetime income survey. Nearly half say securing enough guaranteed income to cover monthly expenses should be the top goal of their retirement plan.

Just a year ago, only one third believed guaranteed income should be their top priority. Meanwhile, more Americans now say they would accept bigger risks and smaller returns in exchange for guaranteed income, the survey found.

Few saw this coming in the 1980s, when companies began to abandon their traditional pensions in favor of 401(k) savings plans. The thought was that the 401(k) would complement the guaranteed income from a traditional pension—not supplant it. Today the only guaranteed income most Americans will enjoy in retirement comes from Social Security. Meanwhile, the majority of workers keep the bulk of their liquid savings in a 401(k) plan. And they must manage those distributions throughout retirement, while trying not to run out of money before they pass away.

This new reality is just now hitting a generation that figured their 401(k) plan would grow so big that making the money last in retirement would be fairly simple. But for most it didn’t work out that way—and now they are searching for answers. Guaranteed lifetime income, once a staple of old age for many Americans, has become an elusive grail.

One big problem is that workers typically do not understand how to convert savings into a lifetime stream of income, and they generally do not trust the annuity products available to them. While 84% say lifetime income is important only 14% have bought an annuity, TIAA-CREF found. Fixed annuities through a high-quality insurance company are among the simplest ways to purchase guaranteed lifetime income.

With this gap in mind, policymakers and employers have been taking steps to make it easier and more palatable for 401(k) plan participants to convert some or all of their plan assets to an income stream. Yet 44% of Americans have no idea if their plan offers a lifetime income option. Some 62% have never tried to calculate lifetime income from their current level of savings.

Fortunately, it’s getting easier to figure out the amount of income your 401(k) is likely to provide. For starters, check with your benefits department and ask if your employer has, or is considering, an option that will convert savings into a lifetime annuity. If so, and you’re close to retirement, you can get an estimate of the amount of income it may provide.

There are also online tools for do-it-yourself annuity shoppers.You can get quotes for immediate and deferred annuities at immediateannuites.com. And for pre-retirees, you can get an idea of how far your savings will go by plugging in your age and savings on BlackRock’s CoRi calculator. Currently, BlackRock estimates that a 58-year-old with $1 million in savings and who retires at 65 will be able to purchase $51,600 of annual guaranteed lifetime income.

Annuities come in many varieties—and some have a checkered past, while others may be linked to high fees and hard sales pitches. But immediate and deferred fixed annuities are fairly straightforward and offer the most direct way to secure lifetime income. Typically advisers recommend that you put only a portion of your income into one. (For more on annuities, click here.)

If an annuity sounds right for you, consider moving slowly. If interest rates move up the second half of the year, as many expect, you’ll get more income for your dollars by waiting.

Read next: The Right Way to Tap Income in Retirement

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