Professor Lawrence Frolik, of the University of Pittsburgh School of Law, presents “The Perils of Post-Retirement Rollover IRAs.”
On March 31, 2010, Lawrence Frolik, a professor at the University of Pittsburgh School of Law, spoke on “The Perils of Post-Retirement Rollover IRAs,” as part of the Center for Tax Law and Employee Benefits’ Distinguished Lecture Series. He discussed the growing need for a fresh look at lifetime income options.
The modern retirement system began during the early 1900s. Under pressure from labor unions, companies developed a paternalistic obligation to provide income for former employees through a pension benefit. The pension benefit provided retired employees a guaranteed payment for life. Over time, employers moved from a predominantly pension-based system to a predominantly retirement- benefit-based system. Under a retirement-benefit-based system, the employee is responsible for funding his retirement, and benefits are paid in the form of a lump sum.
Frolik explained that current retirees face a new set of problems related to longer life spans and fewer plan options. In fact, most retirees are expected to live 20 years past the normal retirement age of 65. Of those retirees, 10 percent are expected to live past the age of 90. At the same time, employers are switching to defined contribution plans, shifting the risk to fund and manage benefits from companies to retirees. Under these plans, retirees become responsible for investing their growing benefits, and managing their funds during retirement. Currently, 80 percent of employers have defined contribution plans.
Unfortunately, most retirees lack investment and money- management experience. Once receiving their benefits, some retires underestimate their life expectancy, splurge on expensive items, and run out of retirement funds. Others live drastically below their means to avoid running out of money. Those that reinvest funds typically make an initial selection from which they never deviate, risking their savings to the whims of the market. The unfortunate result is the mismanagement of retirement savings.
According to Frolik, retirees are left with three options. The first option is to elect a spouse or child to act as the retiree’s guardian and manage the funds. Aging spouses and elderly children may have good intentions, but lack the economic savvy to properly manage the funds. In addition, there is little legal oversight to ensure funds are managed for the benefit of the retiree. The second option is to give a person power of attorney over the retiree. A power of attorney authorizes a designated person to act on behalf of the retiree. The designated person could be a family member or private guardian with specialized investment knowledge; however, the same issues of legal oversight would arise.
By Cam Moultrie, Esq. LLM in Employee Benefits candidate
The third option is to purchase an annuity whereby the retiree receives a monthly payment for life. By purchasing an annuity, the retiree relieves himself of the obligation to manage funds, which may become increasingly difficult if the retiree’s mental capacity diminishes. The retiree also shifts the risks associated with maintaining adequate resources throughout an unpredictable life expectancy. But there are disadvantages with the third option, as well. First, retirees generally lose the ability to pass on the remainder of their retirement fund through inheritance. The annuity only guarantees payments during the life of the retiree. Second, once the money is annuitized it cannot be used for hardships or medical expenses. Third, annuity payments may not be adjusted for inflation.
While annuity products are not perfect, they are a useful product for long-term retirement planning. Frolik opined that diversifying assets between annuity products and other investments will safeguard retiree income while providing the flexibility to address unforeseen events.