Today's Retirees Face Two Risks Their Forebears Did Not

Investment risk can take many forms. One form is sequential risk. Here, the overall return on investment is the same as expected but the sequence of performance is not and, as a result, the assets don't last as long as anticipated. Of course, this is a risk that the retiree of 10 years ago did not have to worry about because the employer assumed it in the defined benefit plan. Today's retiree, however, assumes this risk because the defined contribution plan has replaced the defined benefit plan.

The second critical factor for figuring out how to support a desired lifestyle in retirement is longevity risk. This is the risk that the individual will live longer than the retirement plan contemplates and, by consequence, run out of assets. This is another example of a risk that the defined benefit plans of old assumed.

An annuity is the one financial product that can provide protection from both risks, because the insurance company can guarantee lifetime payouts.

The traditional way to use an annuity for this purpose is to purchase an immediate annuity, which starts lifetime payments immediately. But there is a downside to this approach. The individual pays a premium to the insurance company in exchange for the promise to make payments for life, but the premium is no longer a personal asset and can't be passed on to heirs. In other words, the policy owner gives up control of this retirement asset.

The new generation of annuities, though, has guaranteed lifetime benefits that enable purchasers to retain some form of control over the annuity asset. So an individual can pay a premium, knowing that a certain withdrawal amount can be made from the annuity for life.

With guaranteed lifetime benefits added, even if an annuity's investment performance is poor and the annuity runs out of money, the insurance company will stand behind the contract and continue the lifetime payouts. If the investment performs well, the individual is able to capture the upswings in market value. And should the individual die prematurely, the remaining value in the annuity passes on to the policy beneficiaries.

Regardless of the form of annuity payout chosen, it's imperative–now more than ever–that today's retiree understand investment and longevity risks and make sure that the right amount of retirement savings are positioned to manage these risks.