How to generate retirement income the TIAA-CREF way

June 3, 2011

How to generate reliable income in retirement? It’s becoming the new holy grail for the financial services industry in the wake of the 2008 crash.

But if your workplace retirement plan is handled through a mutual fund, brokerage firm or bank, the retirement income solutions offered most often are simply strategies for decumulation of your savings. They’re not designed to provide lifetime income, which is the only way to protect yourself from longevity risk – the risk of outliving your money.

In order to get lifetime income, you need the benefits of annuitization, which can be found only via a defined benefit pension or insurance product – both of which pool mortality risk. Many of the big retirement platform companies are starting to partner with insurance companies to sell income annuities to workers upon retirement, and industry initiatives have proposed ways to make defined contribution plans more like pensions. But the role model for success actually has been around since 1918.

That would be the TIAA Traditional Annuity, which is offered by TIAA-CREF, the nonprofit retirement solutions provider that serves academic, medical, cultural and research institutions. TIAA is the insurance side of the company; Traditional is a guaranteed fixed annuity product offered through workplace plans and or a retail IRA.

TIAA Traditional is structured to provide a guaranteed rate of return during workers’ accumulation phase, and for optional conversion of all or part of the account to a lifetime income annuity upon retirement. Traditional’s principal is guaranteed, and so is a minimum interest rate during accumulation – generally 3 percent. But additional returns have been awarded every year since 1948, averaging 7.51 percent. In 2010, it returned 4 percent.

Just as significant, Traditional guarantees a minimum interest during the payout phase to participants who annuitize, with the potential for additional amounts depending on the fund’s portfolio performance.

“It’s not a mutual fund,” says Brett Hammond, managing director and senior economist at TIAA-CREF. “In effect, you’re buying the ability of TIAA to make promises and deliver returns that meet those promises. That determines how we invest, which for Traditional is more conservative than if it were a stock fund.”

Traditional is funded via a $198.6 billion portfolio heavily weighted toward corporate and government bonds (around 46 percent). But it also includes structured finance products such as mortgage securities, equities and commercial mortgages.

“It’s oriented toward fixed-income and real assets, and we have reserves set aside to meet those promises in case of a rainy day,” Hammond says. “That enables an individual to get a guaranteed floor below which they can’t go. It’s a bit like Social Security or a defined benefit pension plan. It has extraordinarily low volatility plus a little upside.”

Why isn’t this type of plan available in more workplace plans? In part, because most defined contribution plans are focused on the 401(k) investing model. “It’s about getting good returns, picking the right funds, building the nest egg,” says Hammond.

And by law, lifetime income options must be offered by regulated insurance companies. More insurance companies are striking up alliances with mutual fund and brokerage companies to offer single premium income annuities (SPIA) at retirement.

New York Life Insurance Co., for example, reports that SPIA sales jumped 45 percent during the first quarter this year, mainly on the strength of third-party distribution. And Fidelity Investments, which offers income annuities from New York Life and four other insurance companies, had its best first quarter ever for SPIAs, up 25 percent from the fourth quarter last year.

A Towers Watson study last year found that 22 percent of employers that sponsor defined contributions plans already are offering an annuity as a distribution option – and that another 10 percent are considering adding it. At the same time, financial services companies have been rolling out new annuity offerings tailored for workplace retirement programs.

TIAA Traditional also bears some resemblance to a the concept of the Guaranteed Retirement Account (GRA) – a plan developed by progressive-leaning policy and research analysts. The GRA would be a government-sponsored plan that would serve as an add-on to Social Security, 401(k)s and IRAs. All workers would be mandated to contribute five percent of earnings to a GRA, a 401(k) or an IRA.

The GRA’s architect is Teresa Ghilarducci, director of the Schwartz Center for Economic Policy Analysis at The New School for Social Research and author of When I’m Sixty-Four: The Plot Against Pensions and the Plan to Save Them (Princeton University Press).

Ghilarducci calls for scaling back the current tax breaks on 401(k)s, especially for high earners; in its place, the government would set up a system of universal retirement accounts.

It’s an interesting idea, although some critics think it makes more sense to simply expand Social Security benefits. Of course, in the current Washington climate, neither idea seems likely to gain much traction.


Disclaimer: The author participates (indirectly) in TIAA Traditional via his spouse, a university professor who contributes to it via her workplace plan.

Comments

I will be 77 in a few weeks. I worked my whole life in academe and had a TIAA-CREF retirement plan. While the CREF part (stocks) has had its ups and downs, TIAA traditional annuity has been a great retirement investment. I am at present able to live on what I receive each month from TIAA and Social Security. The only problem in my financial planning is caused by the US government which after the age of 701/2 begins a program of ever increasing tax deductions which at some point will reduce the TIAA income to next to nothing. So as the population of the country continues to live longer, the government policy would create a whole cast of older seniors who are quite poor, even if they all had TIAA or some similar plan. This is a governmental policy that is self-defeating and should be revamped. But definitely TIAA traditional is excellent and a fine model for other retirement plans.

Posted by adulto101 | Report as abusive
 

I think this is a great way to build a retirement. 401K plans and their mutual funds are most often funds within a fund or in index funds that can wipe out years of savings in just one downturn of the market. Often unsophisticated savings buy when the market is high and sell when it is low. Take this, the fees and the taxation upon withdrawal, you do not have a viable plan for retirement.

Posted by bmerk | Report as abusive
 

Sadly for many they have no longer have a pension fund victims of globalization and Wall Streets cries for ever increasing profits. My paltry 410k tanked with the Wall Street meltdown and now Republicans want to eliminate Medicare and privatize Social Security. This is just a Republican economic version of death panels. Want to invest in a growth company, try one that makes economical cat food.

Posted by seattlesh | Report as abusive
 

This is a great article, but until we are able to get healthcare costs under control, you’ll end up poor regardless of your retirement plan.

Posted by Adam_S | Report as abusive
 

The Financial Services Industry.

That phrase always reminds me of Steinbeck’s novel The Grapes of Wrath where one of the characters notes that what businessmen mean by “service” has a great deal in common with what he did when he took his cow to be “serviced” by the bull in a nearby farm.

Whenever I hear the word “service” in a military or business context, I always know someone is getting ****ed.

Posted by jrpardinas | Report as abusive
 

This article is written by someone whose research stopped after reading the TIAA-CREF prospectus. The reality is that once your money is in TIAA Traditional it cannot be moved…anywhere. I worked for TIAA-CREF for awhile as an advisor and the number one complaint I received from clients was the inability of my clients to get their money out of Traditional. It grows at a guaranteed rate, about 2-3% when I worked there, but it cannot be cashed out, rolled over, or moved into any of TIAA-CREF’s equities. TIAA-CREF takes the money invested in Traditional and invests it among their own investments and they make a lot more than 2-3% return off that money. TIAA Traditional is another tool for investment firms to rob people of their money under the premise of promising investment growth. The reality is that TIAA-CREF makes four to five times that off the money invested in Traditional while clients get pennies on the dollar in comparison.

Posted by lshughart | Report as abusive
 

There should be a quasi-Government non-profit corporation, like FANNIE MAE, that offers plans rolled up in a number of standard sizes, much like Medigap plans. There could be tight regulation on fees and profits for private sector competitors, and foreign institutions from such places as the UK, Canada, France, and Germany should be eligible to compete.

And there should be a guarantee of financial destruction on those who defraud such plans.

Posted by txgadfly | Report as abusive
 

As far as medical care for the elderly goes, students who benefit from and participate in Government funded institutions should have compulsory service of a minimum of 5 years and a maximum of 15. Any institution that gets Federal research or grant money would be considered “public” for this purpose. Sorry Harvard!

If Americans balk at this, I am sure we can find plenty of very able foreigners who want to come join up.

Posted by txgadfly | Report as abusive
 

TIAA or not, anyone can take a lump sum from a defined contribution plan (most likely a 401k) and buy a life annuity. Best of all, they can shop from among hundreds of insurance companies. You can find the best rates at http://www.comparativeannuityreports.com which appears to be an unbiased ranking of rates for life annuities among insurance companies. For those who desire additional education, there appears to be an unbiased educational resource at http://www.annuity-fixed-variable.com/an nuities with a number of posts on life annuities.

Posted by bobrichards | Report as abusive
 

You didn’t mention the expenses associated with TIAA Traditional. For what I’ve researched, most annunities carry expenses so high that they can materially affect not only the monthly payout you can receive, but can also reduce the amount of time your money will last by several years or possibly a decade. Also, for me, if you can’t get out once you’re in, that makes it a no-go from the start.

Posted by bbains | Report as abusive
 

A few observations about TIAA Traditional. Yes the Traditional is “guaranteed” but that means the same thing as for any corporation, i.e., the assets of the organization are pledged. Secondly, the minimum interest rate depends on when your contract was issued, as pointed out by others the additional amount changes yearly and could be zero. Third, TIAA uses “vintages” which depend on when the monies were contributed to the account, in turn these determine the actual rate of interest you will receive. Although if pressed they will tell you how much you have in each vintage at any given time, they don’t regularly report this to participants and the amounts you have in each vintage will change even if you are no longer contributing. Finally it is possible to withdraw funds from the Traditional if you are 70 or over by using Required Minimum Distribution. If you are retired and not yet 70 you can use the Interest Only Option. After you retire most likely you can “rollover” your retirement investments to an IRA BUT you can’t rollover the TIAA Traditional except over the ten years using a Transfer Payout Annuity. Moreover if you use this route, you will earn less interest once it is in an IRA. You do have to pay attention to the details in the contract between your employer and TIAA-CREF, some contracts have more benefits for participants than others, some are more restrictive than others, there isn’t just one uniform contract. Just this summer the Arizona Board of Regents severely limited the investment choices excluding TIAA Real Estate, Social Choice, Global Equities, Growth & Income, Equities Index, almost all of the TIAA-CREF mutual funds and almost all of the “outside” mutual funds putting much of the emphasis on LifeStyle funds

Posted by EarlM | Report as abusive
 

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