No Pension? No Worries, Part II

{3:06 minutes to read}A recent survey found that many middle age and older people fear that they will run out of money in retirement. While there are many reasons for this concern, 2 major factors are the decline of the traditional pension and the increase in our life span.

A traditional pension is a defined benefit plan that pays an employee a lifetime benefit based on their final average salary and years of service. A 401(k) or IRA is a defined contribution plan that contains a fixed amount of money contributed by you and/or your employer.

With the decline of the traditional pension, more and more people are relying on their 401(k) or IRA to fund their retirement. 

The Problem

The problem, of course, is that you may outlive the funds in your account.  This becomes even more critical when you are in the midst of a divorce since you may be dividing these funds with your spouse.

For example, I was recently working with a couple who had a $200,000 IRA owned by the husband and a pension owned by the wife that would pay $1,000 per month for life starting when she turned 65.

The husband believed that he would need about $1,000 per month in addition to his social security to meet his needs once he retired, and he would receive about $500 from his interest in the wife’s pension. If he transferred half of his IRA to his wife he would be left with about $100,000 and if he started withdrawing funds from this IRA when he was 65, he would run out of money when he was about 85, depending on how well his investments did.

On the other hand, the wife felt she could live on her social security if she were able to keep her entire pension but if she gave any of it to the husband and used her interest in his IRA she would also run out when she was 85.

The concern of course is what would happen if they each lived past age 85?

The Solution

To address this concern, the husband met with a financial planner who showed him how he could create a lifetime income stream of $1,000 per month, adjusted for inflation, by purchasing a longevity annuity which delayed income payments until he turned 85.

What he had to do was use $100,000 of his IRA to purchase this annuity, which left him with $100,000 to use for his expenses until he turned 85. Since the annuity would provide him with a lifetime income stream no matter how long he lived, he was now able to use the $100,000 left in his IRA to meet his needs until he turned 85. And he was now able to waive the claim he had to the wife’s pension, allowing her to keep the “lifetime income stream ” that she desired.

By working together in mediation, this couple was able to reach a settlement that was better than they would likely have received if they went to court.