In the financial world, it’s a common occurrence for the press to report that investing in securities that are long-term, as well as taking up more risk, is one surefire way to get income.
Of course, for individual retirees who are always on the lookout for new ways to potentially earn more income for their future, especially in a low-income environment such as this, this is more than good news. But why even worry about this in the first place?
The current retirement landscape
Retirement systems in developed countries have changed so much during the last couple of decades that it may be hard for someone newly retired to keep up. Back then, employers were able to save and invest on behalf of their employees through defined benefit pensions, shouldering all the risks involved. Nowadays though, employees themselves have to bear all the risks on their own while managing their own investments in defined contribution plans.
This change in the landscape first came about during the early 1970s, right after the legislation that made it a requisite for employers to fund pensions was passed. It then proved that passing this risk to employees was a good solution.
Of course, that’s not to say this changed system is automatically bad, just vastly different. It may work for others, and for some it may not. And while the sound of idealizing the past system seems highly tempting, there’s no perfect system, and the old one was just another example of it. In fact, between 1970 up to 1997, benefit plans that are defined only covered around 45 percent of the entirety of private-sector workers in the U.S.
And while it’s good that defined benefit plans take into account the risk of longevity, the bulk of other risks still fall onto the employee. For example, switching to a different job renders your previous pension worthless, while going into bankruptcy means that an employee’s pension will be handed over to regulators, where it’s more likely to be cut off.
Where does this leave us then?
Balancing your risks with one steady cash flow
Of course, as you near retirement, common sense dictates that riskier assets in your portfolio should be reduced and replaced with safer bonds. However, these safer bonds usually generate lower returns, and since a longer life expectancy imbues more money, is this really a risk worth considering?
In a Forbes release, Certified Financial Planner and Blankenship Financial Planning agent Jim Blankenship said, “Living far beyond your 80s is becoming relatively common, and the expectations are that this longevity trend will continue. You’ll need to stretch those income streams out further than you expected.”
Given this statement, where should one invest then?
Well, for starters, it’s important to understand that looking for ways to generate more income always comes with risks.
As a matter of fact, according to Kiplinger, there are usually four risks involved when trying to get income. These risks are duration risk, where you increase your income by investing in later-maturing bonds; market risk, where your securities may fall due to its issuer; reinvestment risk, where you have to reinvest when a security starts to mature; and timing risk, which is buying high but selling low.
But what if there’s a way to eliminate all these possible risks by focusing on a new one?
Enter income annuity, which, according to Investopedia, lets you turn a part of your retirement funds into a stream of lifetime payments that guarantee consistent income by means of a single sum of money called a “premium.”
Freeing yourself up to exploring more risks
How does this work then? And what is the risk that comes with it?
Income annuities come with what is called a survival risk, which ironically, is what generates the income.
And in an unsteady market that poses all sorts of high-risk scenarios, earning a steady cash flow gives you the benefit of taking more risks with your portfolio.
In truth, no one really has a concrete idea of where this will all end, but using income annuities to balance all those risks is one way of securing your financial success once you finally start on your retirement.
(Featured image by DepositPhotos)
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