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Do you have a personal pension plan?

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As widely reported in recent years, the number of U.S. workers covered by pensions continues to decline. 

But it’s likely that some of your clients who don’t have pensions and must rely solely on defined contribution plans, such as 401(k) accounts, would still benefit from a guaranteed lifetime income. In those cases, one approach is to create a personal pension, which is the subject of the book, “Pensionize Your Nest Egg: How to Use Product Allocation to Create Guaranteed Income for Life” (Wiley, 2015) by Dr. Moshe A. Milevsky and Alexandra C. Macqueen, CFP.

Many people undervalue a pension’s benefits, Macqueen notes, because they misjudge the key financial risks retirees encounter. “What’s the real risk of longevity?” she asks. “What’s the real risk of inflation? What’s the real risk that you have a poor market experience early in retirement and it permanently reduces how much you can take out of the portfolio?”

Ways to grow with clients: A Silo Approach

A central theme in the book is the authors’ use of what they describe as “silos” to shift the focus from the usual asset-based, retirement-portfolio allocation discussion toward a product allocation. It’s an interesting approach and the silos consist of immediate income annuities, traditional investment portfolios and variable annuities with guaranteed living income benefits.

Readers can think about the silos as combining two extreme positions with a middle position, Macqueen explains. The traditional stock and bond portfolio offers growth potential but doesn’t hedge against the longevity risk.

Life income annuities are at the other end of the spectrum. These products avoid market swings and protect against the longevity risk. “You might choose one or the other based on how much you fear living a long life and how much you fear inflation and how much market risk you’re willing to accept,” she says.

Variable annuities with a guaranteed living income benefit or guaranteed minimum withdrawal benefit occupy the middle slot in the allocation. “It operates a little bit like a stock and bond portfolio because you retain the value of the portfolio,” she explains. “You don’t have to give it all up so you retain some liquidity and it can provide inflation protection in the form of step-ups if the portfolio does well and it provides that guaranteed income. But, it all comes at a cost.”

By shifting the allocation among the silos, advisors can show clients each product’s impact on the sustainability of their retirement income. “If a client puts 10 percent of their wealth into a pension annuity, here’s what the implication is for the sustainability of their income,” she says. “If I have some clients worried about running out of money, OK, let’s add 10 percent into a pension, what does that do? OK, now, let’s try 20 percent and so on.”