A Comparison of Low-Risk Income Producing Retirement Strategies

By Klimek, Janice L.; Koehn, Jo Lynne | Academy of Accounting and Financial Studies Journal, January 2008 | Go to article overview

A Comparison of Low-Risk Income Producing Retirement Strategies


Klimek, Janice L., Koehn, Jo Lynne, Academy of Accounting and Financial Studies Journal


ABSTRACT

Historically, sources of retirement income have typically included private pensions, Social Security and personal savings. Unfortunately, recent developments are impacting all three sources, making a retirement free of financial worries less probable. Securing retirement savings has challenges for fixed income savers and equity investors. Low interest rates have reduced income levels for fixed income investors. Equity investors are being advised to lower expectations. Retiring employees are discovering that pension benefits may not be distributed as promised.

Recent research suggests that investing in government bonds is a viable strategy for accumulating retirement savings due to low risk and ease of investing. However, the previous focus has been on accumulation of retirement savings rather than on distribution management, which takes place after retirement. This article evaluates two important income withdrawal strategies available to households looking for low-risk retirement income: the purchase of fixed annuities and planned withdrawals of savings bond investments.

INTRODUCTION

For most wage earners, the main reason that saving for retirement is important is to replace earnings lost upon retiring from the workforce. Sources of retirement income have typically included private pensions, Social Security and personal savings. However, in the last 25 years, challenges have arisen for each of these potential sources of retirement income.

Only about 50 percent of the workforce participates in employer-sponsored retirement plans. As late as 1980, a majority of those workers participated in defined benefit (DB) plans where the employer contributes and all covered employees automatically earn benefits, usually based on years of service. Today, however, the most prevalent plan has changed to a defined contribution (DC) plan. In 2006, only 20 percent of the workforce participated in DB, while 43 percent participated in DC plans. Approximately 12 percent of workers participated in both types of plans. (Purcell and Whitman, 2007)

The result of such a shift in type of employer-sponsored plan is that employees approaching retirement are now discovering that pension benefits they were counting on for retirement income may not be secure, or may not be fully distributed as promised. Reports now show that there is a significant under-funding of many corporate pensions. The Pension Benefit Guaranty Corporation (PBGC), which helps pay benefits when corporations are unable to fulfill their defined benefit pension obligations, is showing signs of stress due to this under-funding. Congressional research staffers have recently estimated that the PBGC faces a shortfall of more than $120 billion dollars over the next decade due to the rising number of corporate bankruptcies. (Borrus, 2005)

Additionally, large companies such as International Business Machines Corp. and Verizon Communications Inc. have recently announced the freezing of their defined benefit pension plans. (Schultz, 2006) A study conducted on such activities found that almost one in ten companies offering defined benefit pension plans have frozen their plans. (Schroeder, 2005) When pension plans are frozen, those vested in the plans will receive reduced monthly benefits relative to the benefits previously estimated.

For those workers who are not part of a DB plan, the responsibility for securing an adequate retirement income lies solely with the individual. In 2006, 20 percent of workers with DC plans available through their employers chose not to participate. (Purcell and Whitman, 2007) Those who do participate risk funding at less than adequate levels, and also risk making bad investment decisions. For both groups, there exists a substantial threat that retirement income from employer-sponsored plans will fall short of retirement needs.

A second source of retirement income, Social Security, does not appear to be the answer to the retiree's financial concerns. …

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