Brandon Buckingham, J.D., LL.M.
Whether or not there is a retirement “crisis” in America today is up for debate. What’s not debatable is this: Most Americans in their 20s, 30s and 40s are much less likely than their parents or grandparents to enjoy a ﬁnancially secure retirement.
The good news? As the retirement challenges of younger individuals become more widely recognized, some parents who have already locked in a ﬁnancially secure retirement will look for ways to help their children. And they will ﬁnd a number of valuable tools that can help them succeed.
Current Retirees: Doing Well, On Average
Alicia Munnell, director of the Center for Retirement Research at Boston College, and a leading authority on retirement security, notes that those who retired in the 1980s and 1990s enjoyed a “golden age” of retirement income.1 A recent report by two economists at the U.S. Census Bureau supports her claim. Looking at data from 2012, it shows median household income for all retirees totaling $44,400. For households with married retirees, the ﬁgure jumps to $65,200.2
Much of that money is being generated by traditional deﬁned beneﬁt pension plans, an income source for 65 percent of all retirees.3 In addition to pension income, most retirees today also receive Social Security payments. Taken together, these two beneﬁts produce a reliable stream of income for many older Americans.
Other factors also have played a role in the ﬁnancial security so many current retirees enjoy. Perhaps most importantly, wages, real estate values and stock prices were generally on the rise, for the most part, during their working lives, creating a positive environment for building personal savings and other forms of wealth. In addition, many current retirees continue to receive health care beneﬁts from their former employers, mitigating what they have had to spend out-of-pocket on medical bills. All this helps to explain why, from 1989 through 2013, the median wealth of American families headed by someone 62 or older increased by an inﬂation-adjusted 40 percent.3
Future Generation X and Millennial Retirees: A Very Different Story
While current retirees tend to be in good ﬁnancial shape, the outlook is quite diﬀerent for the members of Generation X who will be following them into retirement, and for millennials born after Gen Xers. The reasons are many. Wage growth has been in a downtrend for nearly three decades now,4 and real estate values across much of the country remain skewed by losses sustained during the 2008 ﬁnancial crisis. Meanwhile, most workers today pay more for their health insurance plans than current retirees did when they were employed, and face larger out-of-pocket medical costs due to higher deductibles and co-insurance limits. Add it all up, and the wealth of households headed by someone under the age of 40 fell by an average 28 percent from 1989 through 2013.5
Compared to their parents, Gen Xers and millennials will need to pay more for their healthcare and save more for retirement...
Other trends are similarly discouraging for today’s workers. Because employer-provided health insurance is becoming an increasingly rare retiree beneﬁt, people in their 20s, 30s and 40s will need to save more for future medical expenses. In the private sector, deﬁned beneﬁt pension plans for active employees also have become quite rare, putting the onus on younger workers to save for retirement on their own, largely through employer-sponsored 401(k) plans. Those plans can be valuable investment vehicles if workers save appropriately, but many people ﬁnd it challenging to salt away as much as they should, with big-ticket expenses like housing and education taking precedence. In 2016, for example, 72 percent of college graduates left school with student loan debt, up from 45 percent in 1993. During that stretch, the average amount borrowed for college increased to $37,172 from $9,320.6
Meanwhile, Social Security, though it will remain a source of retirement income for younger workers, won’t be as helpful as it was for older generations. Americans born in 1937 or earlier were able to begin collecting 100 percent of their Social Security beneﬁt beginning at the “full retirement age” of 65. But the Social Security Administration has been raising the full retirement age for years to account for increased life expectancies. Now, for those born in 1960 and later, full retirement age is 67 rather than 65. Even that could be pushed back if Congress deems it necessary to further delay beneﬁt payments to protect the integrity of the Social Security Trust Fund. Barring systematic changes, the fund will be depleted by 2034, at which time new money ﬂowing into it will be suﬃcient to pay only about 77 percent of scheduled beneﬁts.7 Growing life expectancies present other challenges for Gen Xers and millennials, too, in that their savings will have to fund their retirements for longer periods of time.
Compared to their parents, Gen Xers and millennials will need to pay more for their healthcare and save more for retirement, will reap relatively less in Social Security beneﬁts, will carry higher student loan debt, and will have to ﬁgure out how to stretch their savings even longer than previous generations.
Retirement “crisis” or not, this is cause for concern. The question is, what can be done about it?
Can Inheritances Help?
As we’ve noted, some current retirees who have achieved ﬁnancial security will likely want to help fund their children’s retirement by leaving them a legacy. This assumes, of course, that current retirees don’t outlive their assets. It also assumes the legacy they leave will be used as they intend.
One noted study found that only half of inherited money is saved, while the rest is spent, donated, or lost investing.8
Perhaps not surprisingly, another study found that only four out of ten parents are very conﬁdent that their children will use any money they receive responsibly.9 Where retirement security for the next generation is the goal, these ﬁndings argue against simply leaving assets to children in a lump sum.
For parents who wish to help their children achieve ﬁnancial security in retirement, then, the challenge is two-fold. The ﬁrst is protecting the parents’ assets throughout the course of their own retirement, ideally while allowing them to be invested for growth. (Some parents also will want to preserve access to their assets in the event of an emergency.) The second is getting their children to use their inheritance to bolster their retirement savings rather than spend the money elsewhere. Putting assets in a trust, with a directive to dole the funds out over time, would help with the second objective, but not with the ﬁrst. Fortunately, there are other tools and strategies current retirees can use, regardless of the size of their estate, to help their children achieve a more ﬁnancially secure retirement of their own.
A New Idea: Structuring Annuity Payouts to Enable Retirement Savings for the Next Generation
In one highly ﬂexible, two-step approach, parents and children will rely on two common but powerful ﬁnancial tools: a 401(k) plan, and a variable annuity coupled with a death beneﬁt rider. The annuity and death beneﬁt rider are used by the parents to protect their legacy. The parents then direct the proceeds of the annuity to be paid to their children in installments after the parents’ death. The children, in turn, use those annuity payouts to reimburse themselves for making contributions to a 401(k) plan out of their own paychecks, lessening the ﬁnancial strain those contributions might otherwise impose.
The 401(k) plan underpins this strategy because it remains, for the majority of individuals, the most eﬀective way to save for retirement. Plan participants beneﬁt not only from preferential tax treatment of their contributions and earnings, but also from any matching contributions their employers provide and from the institutional pricing typically associated with 401(k) investment options. Because contributions to 401(k) plans are automated, via payroll deduction, 401(k) plans also help participants overcome behavioral obstacles that might otherwise prevent them from saving in the ﬁrst place. Under current tax law, participants can contribute up to $18,500 per year to a plan, or, if they are 50 or older, as much as $24,500. These amounts are for 2018 and are indexed for inﬂation.
One noted study found that only half of inherited money is saved, while the rest is spent, donated, or lost investing.
The variable annuity with death beneﬁt rider is also critical to making this strategy work, because it solves for so many of the parents’ concerns. Here’s an example of how this strategy might work, using products from Prudential. To put it into motion, the parents ﬁrst invest the assets they wish to pass on as an inheritance into any of Prudential’s Premier Retirement variable annuities, while simultaneously electing an optional death beneﬁt rider to protect those assets. The rider provides a guaranteed annual growth rate for the death beneﬁt protecting the assets against market downturns. The guaranteed growth rate, also known as a roll-up rate, continues to increase the death beneﬁt until it reaches the roll-up cap or until the annuity owner reaches age 80, whichever comes earlier. In addition, the cash value of the annuity contract remains available for withdrawals should the annuity owner need to access the assets while they are still living.
In summary, the death beneﬁt rider gives the annuity contract holder – the parents – access to the upside potential of the markets, conﬁdence to stay invested during volatile times, and protection against loss for their heirs. Throughout, the contract holder is able to maintain a customized and well-diversiﬁed investment portfolio with access to a full range of investment strategies. The annuity itself, meanwhile, can grow tax-deferred, possibly over multiple generations. This provides parents and their beneﬁciaries with control over the timing of taxes. Meanwhile, annuities also pass outside probate, allowing all parties involved to avoid the expenses and delays associated with that process.
Importantly, Prudential Premier Retirement annuities offer several ﬂexible wealth transfer options that allow the contract holder to retain some measure of control over their legacy even after their passing. In short, these options let the contract holder place restrictions on how and when beneﬁciaries will receive their inheritance. This can be appealing to those who fear their beneﬁciaries will mismanage, lose, or otherwise squander their inheritance. It also can help reinforce the beneﬁciary’s commitment to funding their 401(k) account, knowing they can use their annual inheritance income to oﬀset their contributions.
A Planning Opportunity
Financial security in retirement is a critical goal for families, but the rules of the game have changed. On average, today’s retirees are much more ﬁnancially secure than their children will be once they reach retirement age. With proper planning, however, retirees can leverage any savings they won’t need into a powerful legacy that can improve the retirement security of their children.
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About the Author
Brandon Buckingham, J.D.*, LL.M. is Vice President and National Director for the Advanced Planning Group for Prudential Annuities.
About the Author
James (Jim) Mahaney is a Vice President with the Strategic Initiatives unit of Prudential.