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The other day on the radio I heard a talk show host describing a product that provided retirees all of the upside potential of the stock market with NO downside risk. 

And, if you acted now, there would be a “bonus” interest rate added to your account for the first year. 

In addition, you could begin a monthly income that would grow with the market, but could never go down.  And all of this “GUARANTEED”!!!!  A simple, single product solution that addressed every retiree’s concern. 

Throughout the program there was much discussion about other investments and the world economy. 

When I researched the host of this show, I discovered that he was not registered with a broker dealer, did not have a securities license nor any license that would allow him to advise on investments.  In other words, he was not regulated by the investment industry. 

Then, not long after this astounding presentation, I read a commentary stating that a properly designed retirement income portfolio must consider the pricing of puts and calls, risk premiums, forward pricing, lognormal assumptions and standard deviation. These discussions were led by Ph.D.s, MBAs and economists.

All I could think to myself was, “Thank God I’m not the average retiree trying to decide who or what to believe regarding what to do with my retirement savings.”

Simply stated, a retirement income solution should not be a single product, nor should it be based on some mathematical analysis that requires an advanced degree in quantum physics. 

In my opinion there are three steps to an overall retirement income strategy:

1. Define and create an adequate “floor” of income that you cannot outlive.
2. Segment your retirement into no longer than five-year increments.
3. Create the proper mix of fixed and market opportunity asset classes.

Let’s begin with the floor. I define the floor as the source of payment for all those expenses that you can’t avoid (basic survival needs).  Typically, these expenses fall into the food, clothing and shelter categories.  Your sources of income to meet these expenses could include pensions, Social Security, life annuities, and deferred annuities with guaranteed income riders.

Now, on to segmentation.  Most of the additional expenses above your “floor” are important, but are not necessarily critical and don’t repeat themselves every year.  (Certainly they are desirable for a comfortable and worthwhile retirement.)  These would include travel, new cars, gifts, dining out, entertaining, etc.  For most retirees these expenses comprise 25%-50% of their total income need.

Dividing your retirement years into five-year segments allows you to adjust your income periodically in case these expenses change or go away.  Segmentation also allows for adjustments to events that are unplanned or out of your control, such as helping children or grandchildren, coping with changes in health, keeping up inflation or taking advantage of opportunities.

Finally, proper mix.  Having a proper mix of fixed and growth asset classes in your overall portfolio is important to ensure an inflation-proof income. The exact mix is a function of an easy acronym: TNT (Time, Need and Tolerance).  What is your retirement TIME horizon, how much income do you NEED and how high is your TOLERANCE for risk. 

This mix will obviously be different for everyone, but a good rule of thumb is to put at least 25% of your portfolio in equity (growth) asset classes.  The first ten years of your retirement income should be taken from fixed accounts, while the remaining growth-oriented portfolios can be re-invested and ride the market’s turbulence.

There are a variety of products that are consistent with this 1, 2, 3 approach. Thoughtful consideration and research should be applied before you choose them. As you proceed, keep in mind:

1. Don’t put all your retirement savings in one product.
2. Guarantees come with a “cost.”
3. Ideally, the advisor who specializes in retirement income planning should have multiple licenses, and have expertise in insurance as well as investment products.  

Philip G. Lubinski is president and CEO, Strategic Distribution Institute, LLC, Denver, CO.

© 2010 RIJ Publishing. All rights reserved.

Some managers like to tackle big, hairy problems by giving people colored pushpins, felt-tip markers, and big sheets of newsprint and then telling them to pin the paper to the walls and start scribbling their ideas.

The Departments of Labor and Treasury seem to have had a similar goal in mind this spring when they issued their Request for Information (RFI) about adding lifetime income options to 401(k) plans.

But instead of having people post their ideas on newsprint pinned to the wall, the DoL solicited the ideas via the Internet and posted all of them—unless obscenity-laced—on the website of the Employee Benefits Security Administration (EBSA).

Since that started, some interesting discussions have begun. Several of them unfolded last Thursday at the Lifetime Income Summit in Washington, D.C. Organized by AARP, ASPPA and WISER (Women’s Institute for a Secure Retirement), the event was deemed a great success by the 250 or so people who attended—many of whose companies and organizations had submitted opinions to the RFI.

It’s not that anything dramatic happened. The one-day conference ended without producing any major decisions or conclusions, and none are expected soon. “[Labor Secretary] Phyllis Borzi believes in very deliberative decisions,” said Michael Davis, Deputy Assistant Secretary of Labor at EBSA.

But the meeting was attended by many of the most active players and thinkers in the institutional retirement space, and before the day was over, most of the major issues—like whether people are most likely to think about income before or after they leave their plans—had been aired.

Just to drop a few names at random: Bob Reynolds of Putnam Investments, Rep. Earl Pomeroy (D-ND) (pictured above), Mark Iwry of the Treasury Dept., Steve Utkus of the Vanguard Group, Sandy Mackenzie of AARP, Kelli Hueler of The Hueler Companies, Jody Strakosch of MetLife, Christine Marcks of Prudential, Dallas Salisbury of the Employee Benefit Research Institute and Francois Gadenne of the Retirement Income Industry Association.

There were a couple of clear “takeaways.” First, there’s no governmental plot to force participants to buy annuities, according to Jason Furman of the Treasury Department. But that doesn’t preclude a partial “default” into an annuity for people leaving 401(k) plans. Bureaucrats and Congressional staffers also emphasized that the Obama administration has no plans to dictate the course of retirement income industry. They made it equally clear that the industry shouldn’t expect any new tax breaks.

Fiduciary liability was the top issue for 401(k) plan providers. Their primary customers, the plan sponsors, fear participant lawsuits if they recommend an annuity and the issuer subsequently goes out of business. Before they will offer in-plan annuities, plan sponsors the government to identify a safe harbor solution that they can offer and not get sued.

“You can’t overestimate the potential for litigation,” said Lynn Dudley, senior vice president, policy, of the American Benefits Council, a plan sponsor group.

There are other obstacles that need to be cleared away before annuities can be offered in 401(k) plans. One is the absence of a mechanism that allows participants of employer-sponsored plans generally to annuitize a portion of their savings or benefit and take the rest as a lump sum.

It wasn’t clear why this is so, especially when, as Dallas Salisbury, president and CEO of EBRI, noted, “It only takes annuitization of 10 to 15 percent of assets to ensure that people won’t run out of money.”

Another problem involves the lack of resolution over joint and survivor annuities. Most retirees, including couples, opt for single life annuities when they can. But some policy makers don’t want to see surviving spouses on welfare, so a joint-and-survivor contract is likely to be their choice for a default annuity.

The meeting was not a pure lovefest. There were hints of a deep disagreement within the retirement industry over whether rollover IRAs or 401(k) plans will be the arena where most Boomers will decide whether to buy an annuity or a payout mutual fund or not.

Steve Utkus of Vanguard’s Center for Retirement Research and William Gale of the Brookings Institution both tossed polite grenades into the punchbowl by suggesting that the workplace either will not (Utkus) or should not (Gale) be the locus of individual decision-making about retirement income.

“There nothing that has to be done at the employer level,” Gale said. “Years from now we’ll look back and wonder why we even considered this. There’s no reason why distribution from defined contribution plans should be firm-specific. It would be better if employers let it go. Employers pay salaries but don’t worry about how employees spend them. They give people health benefits but don’t tell them which doctors to go to. Firms can care about their employees’ retirement security and not try to control how they spend their savings.”

Of course, the retirement income opportunity is big enough to accommodate both scenarios. It may come to pass that millions of rank-and-file participants are auto-enrolled, auto-invested in target date funds, make auto-escalated contributions and are defaulted into some kind of joint-and-survivor annuity-all without leaving the plan. That will enable current plan providers to continue to manage the money.

But, even if that happens, it won’t prevent millions of mass-affluent or high net worth participants from consolidating tax-deferred savings accounts from half a dozen jobs into one rollover IRA and collaborating with an advisor on a bespoke retirement income strategy. That will provide plenty of opportunity for financial advisors.

In other words, it’s not necessarily a zero sum game. But the competition for assets is nonetheless serious. At the end of last year, a tipping point was reach. The amount of money in IRAs exceeded the amount of money in 401(k) plans for the first time, by $4.2 trillion to $4.1 trillion. (See cover story “Who’s Winning the Rollover War?” for more on that.)

Coincidentally or not, large plan sponsors recently reversed course and said they now prefer that former employees keep their assets in their plans. It could be a sign that the fight for Boomer assets is intensifying. As DoL and Treasury officials pore over the RFI submissions and try to develop helpful public policy in this area, they should take care not to get caught in the crossfire.

© 2010 RIJ Publishing. All rights reserved.

According to the Department of Treasury’s auction staff, the U.S. auctioned $8.8 trillion in bills, notes and bonds in fiscal year 2009. That number is greater than the entire publicly traded debt, which is currently $8.4 trillion.

The reason for the enormous amount of debt issuance is due to our surging annual deficits and rollovers that must occur more frequently because of the government’s decision to issue debt on the short end of the yield curve.

The astronomical size of debt the Treasury must auction each year raises a question; who will buy it? The U.S. saved $464.9 billion last year and is currently saving at a $304 billion annual rate in March. China liquidated $34 billion in Treasuries in December of 2009, while Japan and Europe are struggling to meet their own government obligations.

Since we do not have the domestic savings to fund our own debt and foreigners may not have the will or means to continue to funnel their savings to the U.S., the result is we must depend on current holders to rollover their debt on a continual basis.

However, if interest rates begin to rise to their historical levels (the average yield on the 10-year note is 7.3%) investors may balk at rolling over their debt, which would increase our interest rate expenses and could bankrupt the country.

Of course, that leaves our central bank as the buyer of last resort and is the primary reason why gold is rising in all currencies and recently reached an all-time nominal high in U.S. dollars.

The U.S. is now more addicted to artificially-produced low interest rates than at any other time in her history. But that’s not just my opinion.

Listen to what Ben Bernanke said before the House Financial Services Committee regarding whether the U.S. faces a debt crisis similar to Greece; “It’s not something that is 10 years away. It affects the markets currently…It is possible that the bond market will become worried about the sustainability [of deficits over $1 trillion] and we may find ourselves facing higher interest rates even today.”

Separately, Bloomberg reports that the “Maestro” himself, Alan Greenspan, is so concerned about a sudden sharp increase in interest rates that every day he checks the rate of the 10-year note and 30-year bond, calling them “the critical Achilles heel of the economy.”

And what does China think of the fiscal state of the country and the precarious state of our bond market? Deputy Governor of the People’s Bank of China Zhu Min said in December that “the world does not have so much money to buy more U.S. Treasuries.”

The United States is the largest debtor nation in history. Our continued solvency depends upon low interest rates. But low rates are engendered either naturally from increased savings or artificially from money printing.

Without having the adequate savings to bring down rates, the Fed has supplanted savings with monetization of debt. However, money printing eventually leads to intractable inflation and will send bond yields much higher, especially on the long end of the curve.

To make matters worse, we currently see the difference between revenue and spending headed further in the wrong direction.  The budget deficit for the month of April was reported to be $82.7 billion. That figure was nearly 4 times last year’s reported deficit in April, which was $20.9 billion. The April shortfall was the second for that month since 1983. The deficit for fiscal 2010 to date, which ends in October, is $799.7 billion.

Revenue fell 7.9% YOY while spending increased 14.2%. According to the CBO, the nation’s publicly traded debt will reach 90% of GDP in 2020 and, most importantly, interest payments are projected to quadruple to more than $900 billion annually by that year. Of course, as daunting as that trillion-dollar annual interest rate expense will become, it could be much greater if rates do in fact rise.

Indeed, if rates rise significantly the country will face a liquidity and solvency crisis the likes of which the planet has never before witnessed. There is a significant amount of pent-up selling pressure in our bond market. Nearly fifty percent of our publicly-traded debt is held by foreigners and 63% of foreign central bank reserves are held in dollars.

The Fed must quickly move away from its zero percent interest rate policy, otherwise inflation will ravage the country just as it has done every other time the Fed has taken rates below inflation and left them there for a protracted period. If they delay too long, they will be forced to bring the yield curve much higher to fight that insidious inflation.

It seems to me the sooner they move the less they will have to raise rates. Therefore, it’s imperative for the Fed to act now before they are forced to aggressively raise rates to fight inflation or the market forces interest rates higher on its own; which, given our extreme level of debt, will render the U.S. insolvent.

 Michael Pento is chief economist of Delta Global Advisors and is a senior contributor to GreenFaucet.com. This essay first appeared on PrudentBear.com.

Not everyone was swept away by the paranoia about confiscation. On February 24, the following e-mail posts appeared on Morningstar’s Boglehead Forum, where fans of Vanguard founder Jack Bogle’s low-cost investing philosophy gather to chat and deconstruct the economic news:

Paula H.: I keep hearing on the radio that the Government is considering a mandatory conversion of 401K funds to Government annuities for the protection of retirees. Searching, I have not been able to confirm that this is being discussed by government policymakers. Do any of you know about this and its likelihood? Thanks!  

Bobcat2: I believe what’s being discussed at least among academics is that most DC plans include an option at retirement for the employee to annuitize some portion of the DC portfolio. Currently most DC plans don’t have such an option. (Small firms might be exempted from offering this option.) I believe what’s also being discussed is that such an option could be made reversible, say after a period two years, with only a small penalty for dropping the annuity.

In the last few days of the 90-day window for public comments on 39 questions about annuity options for defined contribution plans, the DoL was deluged with lengthy papers from dozens of companies, groups and individuals. Almost every player in the retirement income industry, representing millions of people and trillions of dollars in savings and investments, filed pdfs ranging in length from three to 90 pages.

They included financial services companies (insurers, plan providers, banks and fund companies) like TIAA-CREF, Prudential Financial, Allianz Life, MetLife, Lincoln Financial, Putnam Investments, American Equity Life, Great-West Retirement Services, AEGON USA, ING, Alliance-Bernstein, Genworth Financial, Vanguard, Fidelity, T. Rowe Price, John Hancock, Wells Fargo, J.P. Morgan Asset Management, New York Life, BlackRock, Nationwide, The Hartford, Raymond James, Charles Schwab and Mutual of Omaha. 

Also submitting comments were trade groups like the Insured Retirement Institute, the Profit Sharing Council of America, the Retirement Income Industry Association, the American Council of Life Insurers, the American Society of Pension Professionals and Actuaries, the Investment Company Institute, the Women’s Institute for a Secure Retirement, the SPARK Institute, LIMRA, the AFL-CIO, SIFMA, the Pension Rights Center, the Defined Contribution Institutional Investors Association, the National Association of Fixed Annuities and many others.

Then there were consulting firms and academic groups like Financial Engines, Morningstar Inc., the Pension Research Council at the Wharton School, Milliman, Hewitt Associates, the law firm of Morgan Lewis, Pension Consultants Inc., Dietrich & Associates, the Individual Finance and Insurance Decisions Centre at the Fields Institute in Toronto, and many others.

At press time, there were submissions too many to read, let alone analyze or assess. 

Regarding the provocative Question 13, most seemed to agree that annuities should not be a mandatory offering in 401(k) plans.    

The suggestions were nothing if not diverse, however. Some advocated stand-alone living benefits. Others promoted institutionally priced income annuities. Others advocated longevity insurance. In one submission, Scott Stolz, president of the Raymond James Insurance Group, suggested three ways to make “a simple lifetime income option work within existing defined contribution plans”:

1. Provide a projected income quote on retirement plan statements, based on current annuity rates, along with the account balance.
2. Allow retirement plan participants to purchase future income with existing assets, in chunks, systematically and irrevocably.
3. Only the biggest and strongest insurance companies should be allowed to offer income plans, and the federal government must guarantee the income payments.

And some said that, except for promoting financial education, government should leave the defined contribution plan alone. Here’s a submission in that vein from Ryan Boutwell, a retirement plan advisor in suburban Minneapolis:

“I would like to offer my opinion regarding the discussion of Lifetime Annuities being offered within company qualified plans. I am a consultant in the qualified plan industry and have worked with hundreds of business retirement plans over the last 10 years. I do not believe requiring plans to have an annuity feature is a good idea.

“The retirement plan industry is already grappling with the fee disclosure issue and I tend to find small plans are already burdened with onerous compliance rules. Adding a requirement of an annuity feature is going to add more cost inside these plans that are already expensive to administer and invest in.

“It might benefit some of the insurance/annuity providers of retirement plans, but it will definitely be a burden to the pure mutual fund/open architecture recordkeeping programs. These programs are often the most cost competitive for small business plans.

“In an industry that is already under a lot of fee scrutiny adding in another possibly expensive layer of requirements to have a mandatory annuity feature is not a constructive move in my opinion. Especially considering that annuity products are already available to former plan participants on the open market away from their employer.

“If you ask me, the retirement plan industry does not need more requirements to meet, it needs less and from a participant standpoint, participants need more education. I have met with thousands of business retirement plan participants over the last 10 years, most of them are looking for simplification and good solid financial advice. An annuity can be an appropriate investment vehicle for some employees, but it is not a one-size-fits-all solution and at the end of the day it comes back to education to the participant.

“A better-educated participant will make better choices and this will benefit everyone from the Small Business that offers a plan to the participant, to the Vendors that work in this industry. If you are looking to make changes to retirement plans don’t do it by mandating new features that may be right for some, but not others, do it by promoting education within the workforce.”

Now the Department of Labor will try to sift through hundreds of thousands of words to see what patterns or conflicts or insights emerge.  The executive branch is also getting into the act. On June 16, the Senate Special Committee on Aging, chaired by Sen. Herb Kohl (D-WI), will hold hearings on the matter. Presumably the committee will want to hear all sides of the story. ;RIJ will attend and report on the proceedings.

© 2010 RIJ Publishing. All rights reserved.

How did the conspiracy theory about confiscating 401(k) assets get started? Some say that the chronological ground zero was economist Teresa Ghilarducci’s October 2008 testimony before Congress, when she suggested replacing the flawed 401(k) system with mandatory contributions to private retirement accounts. For that comment, Rush Limbaugh labeled her the “most dangerous woman in America.”

A year later, in early November 2009, shortly after BusinessWeek reported that the government was interested in exploring the idea of income options in DC plans, Limbaugh said on his ubiquitous radio show (Thanks to David Shankbone for archiving a much longer excerpt):

“Do you know what’s going to happen to you? We don’t know what’s going to happen, but do you know what the Democrat plan for your 401(k) is?”

“Then we’re going to take it. We’re going to take your 401(k), and we will put it in your Social Security account that the government is monitoring for you, and we will invest every year in 3% government bonds.”

“The bottom line is, they’ll take your 401(k) and put it in Social Security.”

Last February 2, the Departments of Labor and Treasury published their RFI in the Federal Register. It consisted of 39 open questions to the public. The 13^th question—the numbering may have been unwise—read as follows:

13. Should some form of lifetime income distribution option be required for defined contribution plans (in addition to money purchase pension plans)? If so, should that option be the default distribution option, and should it apply to the entire account balance? To what extent would such a requirement encourage or discourage plan sponsorship?

On February 17, two weeks after the DoL’s RFI was published, Newt Gingrich and Peter Ferrara published an opinion piece in Investor’s Business Daily that seemed to seize on this question. It said in part:

“In plain English, the idea is for the government to take your retirement savings in return for a promise to pay you some monthly benefit in your retirement years.

“They will tell you that you are ‘investing’ your money in U.S. Treasury bonds. But they will use your money immediately to pay for their unprecedented trillion-dollar budget deficits, leaving nothing to back up their political promises, just as they have raided the Social Security trust funds.”

Four days after Gingrich’s IBD article appeared, the syndicated radio host Bob Brinker was asked about the issue by a caller. Brinker, whose show runs on dozens of U.S. stations, mused on the issue, and then added his own opinion:

“This basically started with hearings that were held by committees involving the politicians you mentioned… And what they did, they had a witness come into the hearing from the New School in Manhattan, and her name was Teresa Ghilarducci.

“Teresa’s idea is to develop a program that would allow 401(k) members… to convert those accounts to government retirement programs. Now what that would involve, if you elected to convert your account, you would give all the money in your 401K to the United States government… and in return for that, you would receive a guaranteed retirement payout for the rest of your life once you became eligible…

[The caller pointed out that even though they are saying it’s not going to be mandatory, if it doesn’t get much participation, they will turn around and make it mandatory.]

“I think that if it’s not voluntary that you are absolutely right… Not only would I oppose it vehemently, but I would expect that large numbers of 401K holders people across America would rise up in protest of a mandatory confiscation-that’s what it would be…

“If they made it mandatory that would mean that the United States Government… would confiscate all assets in 401K and replace those assets with a guaranteed retirement payout. Now I think if they proposed that to be mandatory that would be a dramatic step toward basically a Socialist system in Washington.”

[Ken said that would be just like they did in Argentina.]

“I don’t know where Ms. Ghilarducci got her idea, but I noticed that her testimony occurred not that far away from El Presidente Christina in Argentina announcing that the government of Argentina—and this just happened within the last several weeks—has announced that they are confiscating all pension fund assets in the country of Argentina. It is a government confiscation of funds.”

By early March, the conversation had moved down the media food chain to the blogging community.  A blogger named Sylvia Bokor, who describes herself as an artist and author, began riffing on the RFI:

“From the perspective of the employee, the EBSA Proposal is equally unjust, violating their rights as well. It wants to force Defined Contribution employees to use “a lifetime stream of income-i.e., government issued annuities—thereby forbidding lump sum payouts. In other words, the employee’s money will no longer be his to use as and when he wants it. Government officials will decide when employees can have the money they’ve earned and how they can receive it.

“When government takes over retirement accounts, the money will not be invested in reputable securities earning a return and watched over by expert investment analysts. The money will be siphoned off for other schemes, as is the money one pays into Social Security and Medicare. Employees’ savings will be wiped out. The Proposal is undisguised looting of employer and employee alike.”

On April 3, on a blog called “Krazy Economy,” the blogger “C.W.” elaborated on the government’s supposed scheme, stating as a fact that Uncle Sam planned a massive sell-off of confiscated 401(k) assets. He wrote: 

“The following is clear. At some point the government will begin seizing accounts. It may seize only the accounts of retirees and those it deems close to retirement. It is unknown if they’ll seize more. But it will at least seize those and issue annuities for at least those who are retired. This may not be for just the newly retired, but anyone who is retired and has an account large enough to be attractive to seize.

Since the reason for seizing retirement accounts is to use the money for government purposes, it will convert the assets to cash to buy government bonds, probably a newly created special class. The government will sell the securities in the seized retirement accounts.

“This point is absolutely necessary to understand: The government will be selling the seized securities.”

Three days later, the media megaphone was back in Newt Gingrich’s hands, but this time on television. On the April 6 edition of Fox News’ Fox & Friends, this exchange was recorded between Gingrich and co-host Steve Doocy:

Doocy:  “There was a BusinessWeek report that said the Treasury and Labor department are asking for public comment on a scheme, it sounds like, to convert 401(k)s and IRAs, into some sort of retirement thing where you give the money to the government, all the money you’ve saved your whole life, and then they will dole it out over a period of time. What’s up with that?”

Gingrich: “I think it’s a very dangerous idea. This is really a secular socialist machine that wants to take over your life. They want to take it over in terms of a proposal that they would, in effect, over time, abolish 401(k)s, migrate Americans to a government-run program so that the politicians would then have your money.”

[An on-screen graphic during the segment stated: “Protecting your savings: Your 401K and IRA confiscated for govt. debt?”]

© 2010 RIJ Publishing. All rights reserved.