This is an odd topic for a family law blog until I started to think about. Today’s on line Marketwatch website featured an article by Chris Farrell about whether retirees should consider rolling assets from defined contribution products into annuities. The law allows you to do so without the transaction being a taxable event at the federal level.
The appeal of Farrell’s argument comes from the fact that your $100,000 IRA in an S&P500 index fund may have been $100,000 on December 31. But today it’s looking more like $82,000. If you are drawing on that fund because you are retired, things get kind of scary. Now bear in mind had you put your money into an annuity two years ago, you would have missed out on all that handsome gain in securities since mid 2020. Sorry to say, you can’t have both.
My prejudices run against annuities. Someone else has your money and doles it out to you based upon a schedule to be agreed. You die early and there may be a windfall to the fund you gave the money to. But conversely, if you plan to give Methuselah a run for his money, annuities are the road to follow.
As I read Farrell’s useful article about making annuities a part of retirement planning, my divorce experience reminded me that there are some other sound reasons to at least consider annuities aside from eluding dips in the market like the one we have today.
It comes as no surprise that people getting divorced often have different attitudes and anxieties about money. Today, family lawyers don’t see many defined benefit (annuity) plans unless the family has someone working in government. So, typically, we sit down with a case where there is $500,000 to $2,000,000 in retirement. If we use $1,000,000 in 401K retirement as a model, each spouse is going to end up with a low of $400,000 or a high of $600,000 in retirement once the accounts are divided in divorce. It is not uncommon for a client to turn to me and ask: “What can I do to make certain my ex doesn’t blow that money? He/she has never really managed a chunk of money that big.” The first answer is that is the former spouse’s concern and not the client’s. Alas, their uniform replay is: “You don’t understand. If my spouse runs out of money, our kids are going to be on my butt to fix the problem even though I had nothing to do with it..”
Hmmmmmm. No good rejoinder for that one. And there’s a second problem emerging in our cases. That is the divorced spouse who thinks he or she must rescue an adult child from the grasp of drug addiction or their own divorce or a business failure. I have worked with clients who took 30% of their retirement as a distribution (and paid the income taxes) to help their son buy a bar that was failing. Their aspiration was admirable but they ignored a harsh reality. While, yes, in theory, we can work until the day we die and replenish retirement lost to poor investment, the human body and the fortunes of life do not always cooperate in those goals.
Had the client converted his 401K/IRA into an annuity, the option of buying a bar or paying for rehab for a child would not have been an option. One could say that’s a disadvantage. But perhaps it is not. The Bank of Mom & Dad was chartered to take care of their needs at a time when they could not return to the workforce. Today, many people are working into their 70s and 80s. That’s nice, but fate does not tell us when it will make tomorrow our last day of employment.
The sensible financial choice may be to balance defined benefit plans with the 401K/IRA constellation and take a measure of each. Recall, that for most of us, social security will fund some regular monthly income. To this writer’s thinking, people should ask themselves how much is needed beyond social security to fund the “bare minimum” of expenses. If social security is $1,000 a month and the “bare minimum” is $2,500 to survive, perhaps converting some 401K/IRA into an annuity to assure the needed $1,500 is a good idea. If there are other retirement funds, ordinary investments and home equity to supplement, that’s fine. Let those funds do their work in regular bond and equity markets or in the now crazed real estate market.
Farrell’s article cites an economist who sagely noted that 401Ks and IRAs were designed to help people save for retirement. They provide no guidance for how to spend retirement. Yes, there is the 4% rule (take 4% of your retirement balance each year as your income) but there are many, many temptations. If you checked your bitcoin IRA you are down 38% year to date.
In a divorce setting, where one spouse “worries” that the other will spend his/her pot o’ gold on fast women or the grandchild’s private kindergarten, it may make sense for the parties to do an analysis similar to that above (assessing “bare minimums”) and agreeing to fund parts of retirement through annuities.