Pooled Income: The secret to getting more out of your retirement savings

One of the hardest things for people to do in retirement is translate nest-egg savings into reliable income that lasts. A way to do so – and generally get back more income per dollar compared to other alternatives – is through “pooled income.”

Though entities as commonplace Social Security and defined-benefit pension plans utilize pooled income approaches, few are aware of how such arrangements actually function.

Baby Boomers – especially those with 401(k)s and no traditional pension to fall back on – can benefit tremendously from a better understanding of the benefits of pooled income.

Below, from the writings of economist Moshe Milevsky, PhD., is one of the best – and most entertaining – descriptions I have ever read on how pooled income works.

The 95 Year Old Bridge Club

“My 95-year old grandmother loves playing bridge with her four best friends on Sunday every few months. Coincidentally, the five of them are exactly 95-years old, are quite healthy and have actually been retired – and playing bridge – for 30 years. Recently this game has gotten somewhat tiresome and my grandmother has decided to juice-up their activities. Last time they met, she proposed that they each take $100 out of their purse wallets and place the money on the kitchen table. “Whoever survives to the end of the year, gets to split the $500…” she said. “And, if you don’t make it, you forfeit the money…Oh yeah, don’t tell the kids.”

Yes, this is an odd gamble, but you will see my point in a moment. In fact, they all thought it was an interesting idea and agreed, but felt it was risky to keep $500 on the kitchen table for a whole year. So, the five of them decided to put the money in a local bank’s one-year certificate of deposit paying 5% interest for the year.

So what will happen next year? According to statistics compiled by actuaries at the U.S. Social Security administration, there is a 20% chance that any given member of my grandmother’s bridge club will pass-on to the next world during the next year. This, in turn, implies an 80% chance of survival. And, while virtually anything can happen during the next 12 months of waiting – actually, there are 120 combinations, believe it or not — the odds imply that an average four 96-year olds will survive to split the $525 pot at year-end. (I sure hope
grandma is one of them.)

Note that each survivor will get $131.25 as their total return on the original investment of $100. The 31.25% investment return contains 5% of the bank’s money and a healthy 26.25% of “mortality credits”. These credits represent the capital and interest “lost” by the deceased and “gained” by the survivors.

The catch, of course, is that the average non-survivor forfeited their claim to the funds. And, while the beneficiary’s of the non-survivor might be frustrated with the outcome, the survivors get a superior investment return. More importantly, they ALL get to manage their lifetime income risk in advance, without having to worry about what the future will bring.”

Click to view the original paper, “Grandma’s Longevity Insurance,” from Moshe Milevsky, PhD.

Important notes on the story:

In a real pooled income arrangement, the people don’t get to keep the money at the end. Instead, funds are allocated to assure that income for the remaining participants persists.

Those who live the longest do reap the greatest rewards. But, that’s really the point. People have the choice to cling to the funds they have and risk running out of money at later ages, or, let go, “jump in the pool,” and rest assured they will always have a guaranteed income no matter how long they end up living.

Few argue that individuals should put all of their funds into pooled income products. The key is to cover basic living expenses – food, shelter, utilities, everyday expenditures. Therein lies security. Once basic expenses are covered, more traditional investment alternatives would be preferred due to their liquidity, growth potential, and suitability for inheritance planning.

Relative to the issue of inheritance, it is useful to recall the warning flight attendants give to airline travelers, “Put the oxygen mask on yourself, before putting it on your child.” Similar logic applies to retirement funding, “Make sure to cover your basic income security, before worrying about leaving money to your kids.” (One idea is to leave kids your “stuff” instead – house, physical assets, etc.)

Mentioned in the story above is the concept of “mortality credits.” Mortality credits are what create the magic and give pooled income arrangements – including Social Security, pension plans, and individual annuities – the ability promise more long-term income to participants than other comparable mechanisms.

Assuming proper funding, mortality credits allow for the assets of pooled funds to be invested in highly safe instruments, such as intermediate and long-term bonds, and still deliver superior results.

Arguably, mortality credits may afford pooled funds the ability to take on a bit more risk to achieve their objectives. In grandma’s story above, if the group had put the $500 into a hot growth stock and lost 20%, the survivors would have still each gotten their money back.

Finally, securing basic living expenses with pooled income can give individuals more freedom to pursue higher investment returns with their remaining funds. This happens because a person’s “base” income is safely separated from his or her overall investment risk.

In summary, here are several major benefits provided by pooled income mechanisms,

  • They serve as a form of insurance to cover basic expenses in retirement.
  • They generally provide more retirement income per dollar allocated.
  • They protect against the risk of living too long and outliving retirement funds.
  • They insulate retirees from the ups and downs in the market.
  • They allow greater freedom to pursue higher returns with remaining retirement funds.
  • They provide a simplified means of translating retirement savings into steady, reliable income.

If you would like to learn more about the suitability of pooled income products for your situation, you are welcome to contact me by email or through my Cincinnati, OH based insurance agency, McCarthy Stevenot Agency, Inc.

Bonus content: Use this simple method to calculate how much basic income you may need in retirement.

Amazon links to other works by Moshe Milevsky, PhD. (Purchasing books through these “sponsored” links help defray the cost of this website. Thank you!)

The secret to saving the Baby Boomers

By 2030, the last of the Baby Boomers will reach retirement age. At that time, nearly one in five Americans will be over the age of 65.

Many experts predict a retirement crisis will be arriving shortly thereafter.

The issue here is money…

  • Will Baby Boomers have saved enough?
  • Will the money they have saved last?
  • What will be the status of social safety nets like Social Security and Medicare?
  • Will the “do-it-yourself” 401(k) retirement model succeed in generating reliable income for such a sizeable retired population?
  • Will the possibility of market crashes, bubbles, and corrections complicate matters even more?

The solution for saving the Boomers

The solution for saving and assuring the future security of Boomers is income.

Especially guaranteed income that is immune to market turbulence, adjusts for inflation, and lasts for a lifetime no matter how long a person lives.

I’m not talking here about income to send people on exotic vacations or take trips around the world.

I’m talking about basic income that affords a person the ability to live with dignity.

  • This means income to buy food when you are hungry, to keep you warm when it’s cold, to help pay for medicine, everyday necessities, and keep a roof over your head.
  • This means income that will be there regardless of the future – no matter how long you live and no matter what your physical condition.
  • This means income to provide a backstop, a safety net, and insurance.
  • This means income powerful enough to say to a spouse with certainty, “I love you and even though one day I may be gone, this money will be here for you no matter what the future may bring.”

If a person lacks such basic income, it really can be a crisis.

Heartbreak. Destitution. Poverty. Hunger.

So, how does a person obtain the necessary income to cover his or her basic needs?

There are generally two sources for generating income in retirement, pooled income and investment income.

Pooled Income versus Investment Income

Pooled income should be used as insurance to protect and guarantee income needed for basic living expenses. After that, investment income should take the lead covering additional expenses and legacy planning.

Differences between pooled income and investment income.

Pooled Income

  • Pooled income – while still expensive – is the cheapest way to create lasting income and it provides the greatest guarantees for future security.
  • Money is placed in a shared “pool” and funds are withdrawn to provide income for participants.
  • Pools are typically administered by large insurance companies, pension plans, or government entities.
  • Income is usually guaranteed for life.
  • Depending on the source, cost of living adjustments may or may not be provided.
  • Except for survivor benefits, pooled income provides no inheritance for heirs.
  • Funds are illiquid – except for the checks a person receives every month.
  • For those living the longest, pooled income generates an enhanced yield that is virtually impossible to beat using conventionally traded instruments.
  • Examples of pooled income include Social Security (were it funded properly), traditional “defined benefit” pension plans, and annuities.

Investment Income

  • Investment income is generated by investment funds.
  • Investment funds tend to be more liquid and provide a greater appearance of control.
  • Generally, investment income requires a larger starting balance (when compared with pooled income) to generate the same sustainable targeted income amount.
  • May fluctuate based on the ups and downs of the markets.
  • Generally provides no guarantees.
  • Principle can suffer from market turbulence and funds can be depleted.
  • Is compatible with leaving inheritances, assuming funds last.
  • Allows for greater liquidity to make larger, immediate expenditures.
  • Funds may be invested in a wide array of investment alternatives.
  • Examples of investment income sources include IRAs, personal investment accounts and 401(k) type savings plans.

My intent is not to argue that either type of income is necessarily better than the other.

Both income types serve a valuable purpose depending on the need.

I am generally as opposed to relying on investment income to cover basic expenses as I am for using pooled income to finance luxuries.

The goal is to align the income types so as to provide the highest possibility for future success.

Covering the basics

We can help save the Baby Boomers by encouraging them where possible to seek guaranteed pooled income to cover their basic income needs in retirement.

The more basic income Boomers obtain from such sources, the safer they will be from running out of income and facing serious financial hardship in their senior years.

Have you ever wondered how much money you will need to cover basic living expenses in retirement? Click here for an easy way to calculate the income amount you may need.

So what do you think?

  • How well do you believe the stock market will serve to support the income needs of Boomers during their retirement years?
  • If you knew you had enough guaranteed income to support your income needs in retirement, would it give you peace of mind?
  • What do you think of the idea of forgoing inheritance for kids if it means gaining income security for your retirement?
  • What steps could you take to make your living expenses in retirement more affordable?