Retirement: Goal-Based Investing Gains Traction

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Despite their hefty fees, annuities are recommended by Soto at the Urban Institute as a way to lock in lifetime income. Annuities tend to be overpriced because they attract people more likely to live very long lives, while there's a shortage of enrollment among people of average life expectancy who would subsidize the later payouts of those living longer. "So, if you're the average household, you're not going to get a good deal," says Soto.

The Fidelity Freedom Lifetime Income Annuity guarantees a certain minimum income stream, but its payments vary with the performance of the underlying mutual funds that an investor chooses. As with all variable annuity products, although the fluctuating payment can protect against inflation, your payments can decrease if your annuity funds don't perform well.

"My sense is today those products are too early and might be too expensive," says Soto. "They're offering flexibility, so they have to be expensive."

annuity options

Don Ezra, Bob Collie, and Matthew X. Smith, in their new book The Retirement Plan Solution, suggest delaying buying an annuity as long as you can. How long you can delay depends on your tolerance for risk. The authors suggest thinking about what your total wealth enables you to do and defining four wealth zones according to your ability to cover essential expenses: a desired lifestyle, bequests to others, and for the super-wealthy who can live on investment returns alone, endowments.

If you're concerned only with your longevity, you might buy a conventional lifetime annuity to cover essentials and invest the remainder in traditionally risky assets or a variable lifetime annuity, with the hope that the assets perform well enough to fully fund your desired lifestyle. Those who think they may be able to afford a bequest should stay away from variable lifetime annuities, "because no matter how well the risky asset does, there is nothing that outlives you," the authors write.

In response to one of the biggest retirement risks—longevity—insurance firms such as MetLife (MET) and Hartford Financial Services Group (HIG) have begun to offer Advanced Life Deferred Annuities (ALDAs) that are purchased at retirement but don't start to pay until the owner turns 80 or 85.

Policymakers now recognize the need to provide incentives so people can plan for predictable streams of retirement income. In June, Representative Earl Pomeroy (D-N.D.) proposed the Retirement Security Needs Lifetime Pay Act (H.R. 2748) to encourage workers to annuitize some of their retirement savings by providing a 50% percent tax break for up to $10,000 of lifetime annuity payments each year. The bill would also exempt from taxes 25% of lifetime income payments from Individual Retirement Accounts (IRAs), qualified plans, and similar employer-sponsored retirement plans other than defined benefit plans.

Many advisers still have to be convinced about the value of goal-based investment plans because there are incentives built into the way they're used to managing clients' assets. "They are acting as fiduciaries and trying to serve clients to the best of their ability, but this is still a new area for a lot of advisers to think about," says Setzfand at AARP.

Still, as the company pension goes the way of the dodo, financial pros will be paying attention as they try to help their clients make the smartest choices for financing their retirement.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

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