BERKELEY HEIGHTS, N.J. (TheStreet) -- Fewer and fewer retirees will begin their retirement years with a defined benefit pension plan or, as it is more commonly known, a traditional pension plan. The U.S. Department of Labor's Bureau of Labor Statistics National Compensation Survey showed as of March 2009 that just 20% of private-sector workers were covered by one -- only one in five.
The same survey indicated 43% of private-sector workers participated in a defined contribution plan. The defined contribution plan most people are familiar with is the 401(k).
What's the difference? With a defined benefit plan, a monthly pension payment is paid to the participant as long as they live. It is essentially a lifetime annuity with the added benefit that the recipient is not subject to investment market risk. With a defined contribution plan, the participant accumulates a sum of money open to investment market risk during the accumulation and distribution phases.
Also, once an person retires with a defined contribution plan, it is their decision how much money to take out each year, with a minimum withdrawal amount mandated by the IRS once they hit 70.5 years old. The traditional pension plan provides some longevity insurance, since the participant can't outlive the payment stream; with a defined contribution plan a person can exhaust the money before they die and they are subject to market swings.
Unhelpfully, the shift from defined benefit pensions to 401(k)s has occurred during a time longevity has been increasing due to medical advances. At a time when more people need a traditional pension plan, very few have them.
So what can a new retiree do to create their own pension income stream?
One option for retirees without a traditional pension plan is to buy an immediate fixed annuity -- handing over the investment market risk and longevity risk to an insurance company. With an immediate fixed annuity, a lump sum is paid to the insurance company in return for a stream of monthly payments. The payments can be received over one's lifetime or various other options. For a nonqualified immediate annuity, only a portion of the monthly payment is taxable income, as a portion of the payment is considered return of principal. The website immediateannuties.com can provide an estimate of how much a lump sum would be worth if an immediate fixed annuity were bought. The amount of income a lump sum can buy will be dependent upon the interest rate environment in effect at the time of purchase. For that reason it might make sense to buy them over time, particularly when interest rates are low. (Also, review the financial stability of the insurance company; you will be subject to their credit risk.)
An immediate fixed annuity can provide a stable lifetime source of income for a retiree lacking a traditional pension plan. Combined with social security, it can create the foundation of a retiree's income stream.
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