Who Is Your Money For?

Most people I talk to have two primary goals for their retirement savings. First and most obviously, they want their savings to last them the rest of their lives. Second, they hope to leave behind something for their kids/grand kids/other loved ones.

At first glance, these goals seem almost indistinguishable: If you don’t run out of money during your life, there will be something left for your heirs. And efforts that serve one goal tend to simultaneously serve the other goal. For example, if you cut your annual spending, you reduce the chance that you’ll run out of money, and you increase the amount of money your heirs are likely to receive.

Competing Retirement Goals

What many investors don’t intuitively grasp, however, is that in some cases, these two goals are in direct competition with each other.

For example, if you allocate a significant portion of your portfolio to an inflation-adjusted lifetime annuity, you create a source of income that will last the rest of your life (insurance company default notwithstanding). Such products can be a great way to reduce the chance that you’ll outlive your money.

At the same time though, they eliminate the chance that the annuitized money will outlive you. When you die, the money that you put into the annuity is gone — your heirs don’t get any. (Possible exception: You can pay for a rider that allows your heirs to continue receiving payments for a certain length of time. The drawback, of course, is that such riders reduce the payout on the annuity.)

Waiting until age 70 to claim Social Security works the same way: By increasing your monthly benefit — a source of income that will last the rest of your life — you reduce the chance of running out of money. But when you die, your children don’t continue receiving benefits (unless they’re under 18, under 20 and in high school, or disabled).

Selecting an asset allocation for your portfolio involves a similar trade-off. By using a conservative asset allocation in which TIPS are the largest component, you reduce the chance of unexpectedly-poor returns forcing you to deplete your portfolio prematurely. In exchange, you give up the possibility of unexpectedly-good returns creating a large inheritance for your loved ones.

In short, by making decisions that increase the risk and expected return of your savings, you tend to increase the amount that your heirs would be expected to receive. At the same time though, you’re increasing the chance of depleting your portfolio while you’re still alive.

Balancing these two goals is naturally a personal choice — nobody but you can decide the relative importance of each goal. But it’s important to be aware that the two goals do often compete with each other, and just because a particular course of action serves one goal doesn’t necessarily mean it serves the other.