Annuities get a bad rap, but some are the right solution for retirement savings dilemmas.
from TheStreet, Jan. 8, 2019
by Robert Powell
We know what you’re thinking. Annuities! Run away!
But that would be a mistake. Annuities are just an investment product — like many others, and much like Social Security and defined benefit pension plans.
Annuities get a bad rap because people tend to lump all annuities — single premium income annuities (SPIA), variable annuities, fixed index annuities, deferred income annuities, and qualified longevity annuity contract (QLAC) — together, but they shouldn’t.
Annuities also get a bad rap because some advisers recommend these products (and earn in some cases hefty commissions) for all people and all fact patterns. After all, it’s tempting to treat everything like nail if the only tool you have is a hammer.
But annuities are appropriate for some people in some situations, and not for others. When are such products appropriate? Consider the case where you are trying to use guaranteed sources of lifetime income (Social Security and a defined-benefit pension) to pay for essential expenses (housing and healthcare, for example) in retirement. And let’s say there’s a gap between your sources of lifetime income and your essential expenses.
How might you plug the gap? Well, you could simply withdraw money from your accounts earmarked for retirement. But if you did that, you would be using risky assets — assets that could decline in value – to pay for a certain lifestyle, a standard of living to which you aspire.
Another option would be to purchase, for instance, a single premium income annuity, or SPIA, with some of the assets (not all) in you accounts earmarked for retirement that would be plug the gap.
Doing this, would manage one of the major risks you and your household face in retirement: longevity. And that, at least from my perspective and that of many other academics, is an appropriate use of an annuity.
Unfortunately, the world has a bias against annuities, which, truth be told, are more often sold than bought.
So, enter the Alliance for Lifetime Income. In June, 24 services asset management and insurance companies, including AIG, Jackson, Lincoln Financial, Prudential and TIAA, came together to form the Alliance for Lifetime Income, an organization that aims to educate consumers and refocus the national retirement discussion on lifetime income planning versus accumulation.
In a recent interview, Colin Devine, the spokesman for the Alliance, discussed the organization’s mission, its research (the Protected Household Index), and its tool (the Retirement Income Security Evaluation) that helps financial advisers and their clients better quantify and understand their protected retirement income needs.
“Its primary mission is education,” said Devine. “Its mission is not advocacy. There are other organizations that do this. What the alliance is committed to doing is making people aware you don’t just need to save for retirement, but you really need to plan your retirement income and that is a complex task and to make advisers… consumers and individuals aware of the need to do that and to do it early.”
Devine also spoke about the Alliance’s research, the Protected Lifetime Income Index. That research revealed that most people haven’t saved enough for retirement. “They don’t have sufficient financial resources,” he said.
What’s more, he said, most people don’t understand whether their nest eggs will provide them with the amount of retirement income they were anticipating, and most people don’t understand what an important role products like annuities, among others, can play in helping to secure that income.
Of note, Fidelity Investments says those retiring at age 67 should have at least 10 times their final salary saved to fund their desired standard of living in retirement. Read more here about how much you need to save for retirement.
For his part, Devine there are at least two important factors to consider when planning your retirement income. “It’s not just how long you’re going to live, but it’s also how healthy you’re going to be,” he said. “And so, your retirement income plan really needs to address those two very, I couldn’t stress it enough, significant risks.”
To put it in perspective, Devine said a 65-year-old man, today, on average is going to live about another 20 years. For a woman, it’s about 23. And, if you take a traditional couple, male/female, and combine that, you would see — at about the 50th percentile — one of them survive until about their 92nd or 93rd birthday.
“Now, first, who doesn’t think they can beat the average?” he asked. “So, that’s everybody, and second, who wants to take a 50% chance of running out of money?”
In addition, he noted that there’s probably, for that couple, about a 10% chance one of them will survive until age 100. “Clearly, if retirement is 65, making your money last 35 years from your last paycheck is a pretty daunting task,” Devine said.
Living longer is, however, only one factor to consider as one contemplates planning for retirement income. “You’ve also got to factor in how healthy you’re going to be,” he said.
Other risks, including inflation, must also be addressed within the context of a retirement income plan. “Let’s pick a probably fairly modest inflation rate, perhaps long term, of 3%,” he said. “That means you need to double your purchasing power every 23 years, but let’s step back and go, but hold on, we’re planning for retirement that may be 35 years or more if we’re thinking at age 100. Inflation absolutely does matter.”
Devine also said there’s no single product or investment that can be used to manage all the risks one might face in retirement. “There is not one single product,” he said. ‘Wouldn’t that be easy? Wouldn’t that be nice? And it’s just not the case.”
Instead, a retirement income plan might include Social Security, a life annuity or deferred income annuity, as well as dividend income funds, and fixed income investments. “There’s no cookie cutter, easy, back-of-the-envelope solution,” he said. “I think for every single person it’s different.”
Of course, the elephant in the room is always the fees and commissions associated with annuities. “Absolutely, there is certainly a perception that some products have very high fees, variable annuities would come to mind,” he said.
But Devine noted that he owns eight annuities. “After 20 years on Wall Street, they were the single best investments I’ve ever made,” he said. “When I looked at the protected lifetime income that my wife and I will enjoy after days like maybe yesterday in the markets, I was able to sleep last night.”
Devine’s advice for those looking at purchasing an annuity. Make sure you understand what you are buying and why. Of course, annuities are complicated. In fact, Devine had to call a wholesaler to help explain them to him “because I couldn’t make sense from the literature.”
And one thing to know about annuities is that “securing protected retirement income is not cheap,” he said. “There is no way I can make it cheap and it’s gotten a lot more expensive because interest rates have come down,” he said. And that means buying retirement income has become a lot more expensive.
Helping people understand their retirement risks, how annuities work, and where they might fit is part of the mission of the Alliance for Lifetime Income. It’s a tall order. “We made these products as an industry too complicated, too confusing, and shame on us, we want to get that fixed,” he said.
Consumers and financial advisers can find educational content and other resources about the lifetime income at RetireYourRisk.org.