New Programs Guarantee Retirement Income

Highly paid executives have a new way to guarantee lifetime monthly income from their company's 401(k) plans. It's a nifty new array of products; but they do have drawbacks.

Retirement plans have started including "income replacement funds" for employees. These are annuities that enable workers to buy a specific amount of lifetime guaranteed future income during the accumulation phase of retirement savings. These types of products are often called participating annuities.

There are several types of income replacement funds already offered by retirement plan sponsors.

For example, with "ClearCourse," offered by Genworth Financial in Richmond, Va., every 401(k) or 403(b) plan contribution purchases a specific amount of lifetime retirement income. Contributions go into a balanced mutual fund, which invests about equally in stocks and bonds, according to Genworth. So employees may even get income payments greater than the guaranteed amount.

"Personal Pension Builder," issued by MetLife in New York, is a tax-deferred fixed annuity. Each of an employee's regular investments locks in a specific interest rate and a specific sum of money is paid out during retirement. This annuity changes into an immediate fixed annuity when a worker retires, providing periodic income for life, according to MetLife.

For example, a 40-year-old employee contributing $200 monthly for 25 years would buy $11,262 in annual income for life, based on current rates, according to MetLife.

MetLife's program solves the problem of lower annuity payments, often triggered by rolling 401(k) money into an immediate annuity during a low-rate period. "Personal Pension Builder" lets employees dollar cost average into the annuity to create a future income stream. As a result, when inflation and interest rates are high, employees can buy more future income.

With the "Hartford Lifetime Income Builder," provided by The Hartford Financial Services Group in Simsbury, Conn., an employee purchases shares. Each share provides a guaranteed $10 per month for life starting at age 65. The cost per share will change based on current interest rates and the employee's age. So the guaranteed monthly income payment beginning at age 65 is determined by multiplying the total number of accumulated shares by $10. If an employee accumulates 50 shares of lifetime income, for example, he will get $500 of monthly income for life, starting at age 65, according to Hartford.

With this set-up, people know how much income they will get when they retire. Employees with 401(k)s can target their investments accordingly to provide a maximum amount of income and growth. For example, an employee can invest part of the 401(k) in mutual funds for growth and the rest in the "Hartford Lifetime Income Builder." So the annuity will provide a guaranteed source of income to cover basic expenses, such as food, clothing, housing and medical expenses.

Prudential Financial's "Prudential IncomeFlex" guarantees a lifetime minimum withdrawal benefit based on an employee's investment in a 401(k). An employee over the age of 50 can select from five mutual fund portfolios -- ranging from conservative to more aggressive, according to Prudential Retirement Insurance and Annuity Company in Hartford, Conn. Starting at age 65, employees can obtain a guaranteed yearly payment equal to a minimum of 5 percent of their "income base." The income base is the amount invested in Prudential's portfolios. Defined contribution plan assets, as well as future contributions, can be transferred into the plan sponsor's funds to take advantage of the minimum 5 percent guarantee. Withdrawals in excess of the guaranteed amount can proportionately reduce future withdrawals.

In all of these plans, if the employee dies during the accumulation phase, the annuity's assets along with the other 410(k) investments go to the designated beneficiaries. During the payout phase, the guaranteed lifetime income can be set up as a joint and survivor or period-certain payout option.

Meanwhile, each fund has a market value that fluctuates with performance. So it's possible to earn more than the minimum guarantee.

John Diehl, a Wayne, Pa.-based financial planner, says that income replacement funds let executives who don't have pensions better target their investments. The guaranteed lifetime income from the 401(k) annuities may cover basic expenses such as food, clothing, housing and medical expenses.

Other investments in taxable accounts and individual retirement account rollovers can provide a source of income for lifestyle expenses, such as travel, entertainment and maintaining a comfortable lifestyle.

There is no free lunch with these programs. Expect to pay about 70 to 100 basis points of the full, annual account balance in annual charges, plus any mutual fund management fees.

Lance Wallach, a Plainview, N.Y.-based financial planner, is concerned that executives may get locked into these annuity-type 401(k) investments. In addition, if the executive leaves the company, the annuity isn't portable. The executive would have to keep the annuity in the existing 401(k) plan in order to get lifetime income. However, the employee typically can cash out the annuity, pay a penalty and transfer the cash to another 401(k) or put it in an IRA rollover.

"There is the potential to put too much into the annuity and not have enough liquid assets during retirement," he warns.

Jeffrey Dellinger, actuary and publisher of Retirement Income Solutions in Fort Wayne, Ind., cites pros and cons to these annuity-type products.

The benefit: It lets executives purchase future amounts of guaranteed income during the accumulation phase, while permitting investments in mutual funds for potentially greater gains; they strike a balance between a 100 percent fixed payout annuity and a 100 percent variable immediate annuity, he says.

The big drawback: The employee needs to be sure to purchase enough guaranteed future income to cover his or her retirement years. In addition, products that let employees accumulate money in a fixed annuity may not protect employees adequately from inflation risk.

"While the guaranteed income guards against longevity risk, if the benefit remains level, it fails to allow a retiree to maintain his or her standard of living," he says.

Alan Lavine is co-author with his wife, Gail Liberman, of Quick Steps to Financial Stability (Que/Penquin Group, 2006).

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