Remember the Seinfeld episode “The Opposite,” where George Costanza tries doing the opposite of his natural inclinations, and suddenly everything starts going right for him? Through this exercise, he discovered that many of his instincts were often wrong.
Much like George Costanza, many of our natural inclinations are wrong when it comes to retirement planning. It was mostly our own preferences – a desire for control and portability and an appetite for chasing investment returns – that fueled the move from traditional pensions to 401(k)s over the last few decades. But, as shown in a TIME magazine article titled “Why It’s Time to Retire the 401(k),” it turns out that our preferences hurt us.
The article asserts that the defined contribution 401(k) plan left most workers with a much less prosperous and secure retirement than if they had participated in a traditional defined benefit pension plan.
So, let’s examine our preferences. When we save for retirement, what natural preferences do we have?
- Safety. It’s hard to save money for retirement, and it’s particularly disheartening to see a large, or even small, portion of your retirement savings evaporate because of investment risk. As Will Rogers once said, people are generally more concerned about the return of their money than the return on their money.
- High earnings potential. However, if taking certain risks generates high earnings, we want to participate in those earnings. As a result, we sometimes convince ourselves that a risk is safe, even if it is not.
- Control. We prefer to have the option of moving our money at any time if a “better” opportunity comes up. We dislike long-term commitments to any one financial product.
- Taxes. We usually respond when Congress creates a tax incentive, but we prefer immediate tax savings over long-term tax savings, as evidenced by the fact that 95 percent of IRA money is in traditional rather than Roth IRAs.
- Death. We’re ambiguous about death. On the one hand, many people are skeptical of immediate annuities, which can guarantee an income for life, because they are concerned they will die early and won’t receive sufficient value. On the other hand, they often won’t purchase an adequate amount of life insurance, either.
Could it be that our preferences are actually self destructive, as the TIME magazine article implies?
Social Security: Running counter to our preference
Social Security, the largest retirement plan of all, provides a great lesson here. This plan is extremely popular – so popular that despite its somewhat shaky financial footing, politicians are afraid to tweak it. It has also essentially eliminated poverty among the elderly. Yet Social Security runs counter to all our preferences.
- Safety. You pay into it, yet there’s no guarantee you’ll ever get anything out of it. If you die before you start taking payments, and if you leave no spouse or young children, it’s a total loss.
- High earnings potential. Your payments are determined by a formula that has nothing to do with equity returns or anything else that could create a high return.
- Control. Other than one vote in elections where millions of votes are cast, you cannot control the program.
- Taxes. The program costs you taxes your entire working career.
- Death. When you die, payments on your behalf stop; if you have a spouse or young children, however, payments do continue for them, providing significant financial protection for your family.
When people think of funding their retirement through means that are fueled by their preferences, they think of 401(k) plans, IRAs, and mutual funds. These options fit our preferences very well – but remember that our preferences are somewhat self-destructive. As the TIME magazine article illustrates, our preferred mix of products isn’t working for us.
Insurance in retirement planning
Now, let’s look at the products the insurance industry recommends. Take immediate annuities. They remain a niche financial product because many consumers find their loss of control after purchase unacceptable, and they are also often concerned about the potential loss of value at death. Yet immediate annuities are the closest privately owned financial product to replicating the Social Security program.
As another example, take cash value life insurance. Better than any other product, it provides for your family if you die prematurely, and its long-term tax advantages are compelling. It is one of the few products that can provide a tax-free cash flow in retirement.
For many clients, the long-term nature of annuities and life insurance products is their biggest concern. They run counter to our preferences for control and immediate tax benefits. But retirement funding is a long-term issue, so long-term products can play a key role. Here is a compelling analogy to the Social Security program – you fund it over a very long period of time, you receive benefits over a very long period of time, there is significant pooling of risk, and you can never access a cash balance.
So, while most people don’t think of life and annuity products first when it comes to planning for retirement, perhaps they should. It’s time to change our impulses.
Chris Conklin is a licensed agent and Principal and actuary of Insurance Insight Group and MyAnnuityTraining.com. He can be reached at 801-290-3320 or [email protected]